U.S. Markets closed

Edited Transcript of PGTI earnings conference call or presentation 7-Nov-19 3:30pm GMT

Q3 2019 PGT Innovations Inc Earnings Call

NORTH VENICE Nov 17, 2019 (Thomson StreetEvents) -- Edited Transcript of PGT Innovations Inc earnings conference call or presentation Thursday, November 7, 2019 at 3:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Jeffrey T. Jackson

PGT Innovations, Inc. - President, CEO & Director

* Sherri Baker

PGT Innovations, Inc. - Senior VP & CFO

================================================================================

Conference Call Participants

================================================================================

* Alvaro Lacayo

Morgan Group Holding Co. - Research Analyst

* Keith Brian Hughes

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Kenneth Robinson Zener

KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst

* Margaret Jane Wellborn

JP Morgan Chase & Co, Research Division - Analyst

* Philip H. Ng

Jefferies LLC, Research Division - Senior Research Analyst

* Truman Andrew Patterson

Wells Fargo Securities, LLC, Research Division - Associate Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good day and welcome to the PGT Innovations Inc Third Quarter 2019 Earnings Call. Today's conference is being recorded. (Operator Instructions)

I would now like to turn the conference over to Sherri Baker. Please go ahead.

--------------------------------------------------------------------------------

Sherri Baker, PGT Innovations, Inc. - Senior VP & CFO [2]

--------------------------------------------------------------------------------

Thank you. Good morning everyone and thank you for joining us on the call today. On the Investors section of the company's website, you will find the earnings press release with our third quarter 2019 results, as well as the slide presentation we have posted to accompany today's discussion. This webcast is being recorded and will be available for replay on the company's website.

Before we begin our prepared remarks, please direct your attention to the disclosure statement on Slide 2 of the presentation, as well as the disclaimers included in the press release related to forward-looking statements.

Today's remarks contain forward-looking statements, including statements about our updated 2019 guidance that may involve risks, uncertainties and other factors that could cause actual results to differ materially. This disclaimer is a brief summary of the company's statutory forward-looking statements disclaimer, which is included in the company's filings with the SEC.

Additionally, on Slide 3, you should also note that we report results using non-GAAP measures, which we believe provide additional information for investors to help facilitate comparison of prior and present performance. A reconciliation to the most directly comparable GAAP measures is included in the tables attached to the earnings release and in the appendix of the slide presentation.

I am joined today by PGT Innovations CEO and President, Jeff Jackson and Brad West, Senior Vice President of Corporate Development and Treasurer. After our prepared remarks, we will be available to take your questions. I will now hand the call over to Jeff for opening remarks.

--------------------------------------------------------------------------------

Jeffrey T. Jackson, PGT Innovations, Inc. - President, CEO & Director [3]

--------------------------------------------------------------------------------

Thank you, Sherri, and good morning everyone. Before going into our third quarter results, each quarter I'll provide an overview of our strategic plan for those of you who are new to the PGT Innovation story.

Slide 4 provides a summary of our 4 strategic pillars that we execute against to create long-term value for our shareholders, as well as our customers. Our first pillar is to place our customers at the center of our business by delivering exceptional products and exceptional service before, during and after the sale. We believe customer loyalty across our portfolio of brands, which in turn drives the sales growth.

Our second pillar addresses our belief that succeeding in a competitive market requires that we have the best talent. Our success is ultimately accomplished by having a highly capable and dedicated team of employees, which is why we continually strive to retain the best people and make our company an incredible place to build in a career. A third pillar and investing in our business operations to meet expected increases in demand, while continuingly to build the very best products that our customers demand. We recently held a grand opening of our iLab Innovation facility based in Venice, Florida, and we've seen solid initial customer order and quoting patterns for our newly launched, highly engineered products, such as our bi-fold, pivot and lift-and-slide doors.

And finally, our fourth pillar is to allocate capital that is generated from our strong free cash flow to support continued growth. This could potentially include further expanding our national footprint with acquisitions of niche building products strong brands, our new channels that are positioned to generate attractive margins and cash flow. We also continually assess our capital allocation options, including reduction of debt and reinvestment in the business, all with the goal of driving shareholder return.

In addition, we believe when it is appropriate to do so, given our share price and other factors, we repurchase shares of our common stock. In the third quarter, we purchased 5.5 million shares of our stock at an average price of $14.07.

Now, turning to our results for the quarter on Slide 5. Our legacy business faced a very tough comp, as we lap the third quarter of 2018, in which we posted record sales growth, driven by heightened awareness from hurricanes, driven meaningful uptick in our repair and remodeling activity following Hurricane Irma and Michael.

As a reminder, we acquired Western Window Systems in the middle of the third quarter of 2018 and the current year quarter benefited from a full quarter of Western sales.

Additionally, in the current quarter, we experienced lost revenue of approximately $5 million related to the impact of the disruptions to operations caused by hurricane Dorian. The net result of these factors was a 1% decrease in net sales for the quarter versus prior year, which came in at $198 million.

The decline in our legacy business offset the growth in net sales at Western Windows systems, which we were able to achieve, despite a continued California housing headwind.

Our gross margins were down versus prior-year quarter. We've continued accretion from Western Window Systems being offset by an expected, unfavorable shift in mix away from repair and remodeling product in our legacy business and 2 key investments made during the third quarter.

The first investment was increasing our promotional efforts in the southeastern region on the heels of hurricane Dorian. While this spin unfavorable impacted margins in the short-term, we view this as an investment that should ultimately result in future increased sales.

The second investment impacting gross margin relates to a continued increase in product mix in our Western region towards custom products, rather than our volume product lines.

Our custom products continued to produce accretive margins in comparison to our legacy margins. However, we invested in both direct labor and fixed cost in the near-term to ramp up productions of the more labor-intensive custom products, in order to provide better lead times for our customers.

Across our legacy product lines, we continue to control cost by focusing on operational efficiencies and for the quarter, we achieved an adjusted EBITDA of $35 million or approximately 18% of sales.

In our Western business unit, we grew sales of 11% on a pro forma basis in the third quarter, despite a housing headwind in our core markets, where single-family permits were actually down 6% year-over-year in the second quarter.

We are achieving this growth through 3 primary areas. First, as I mentioned earlier, we are seeing strong growth in our custom products. Second, we continue to expand our footprint in emerging markets, which grew 18% versus prior year. The Western 3700 series performance vinyl line launched in early 2019 is seeing strong customer adoption in emerging markets in the Pacific Northwest and Midwest states. Third, our commercial channel post significant growth in the quarter, up 58% versus prior year. While these product lines and channels offer attractive accretive margin profiles, the price point is typically lower than the legacy product price point and more importantly, more complex to produce then western volume product line.

Next, I'll give an update on the macroeconomic factors in key markets and the assumptions behind our guidance revision. As evident on Slide 6, we are lapping a quarter of exceptional growth. In our legacy repairing remodeling business, sales declined 13% which was in line with our expectation of 10% to 15% decline versus the prior year quarter. We expect continued trends in the fourth quarter of 2019 overlapping the fourth quarter of 2017 and '18, which had 30% and 18% growth rates, respectively.

In Southeastern states outside of our core Florida market, we experienced 23% growth in our window and doors business, as a result of our strategic focus to sell impact product outside of Florida in regions that have not previously been affected by storms. We believe increased activity in main storms in recent years has increased consumer interest in the benefits of impact-resistant products along the East Coast and Gulf Coast, in addition to our core traditional Florida market.

We are continuing our efforts to increase awareness of the benefits of our products. In the Florida Panhandle and other markets that have not traditionally been perceived as core markets for us. We are looking at different options and attacking those markets where penetration has lagged. In our legacy new construction business, new construction sales were down 5% versus prior year, primarily due to Florida single-family permits in the second quarter declining 9% year-over-year.

Regarding large projects, we are experiencing reduced volumes in the back half of 2019, from what we experienced in the back half of 2018. We are optimistic that we will see an uptick in large project volumes in the first half of 2020, based upon the pipeline of large projects in the marketplace.

Overall, we expect the legacy repair and remodeling and new construction trends we've experienced in the third quarter to continue into the fourth quarter, as we compete against very tough comps from 2018, a year in which we experienced 27% organic growth in net sales.

Looking into 2020, we have not forecasted data from John Burns Real Estate Consulting to our internal data to determine relevant correlations that we believe we can reasonably rely upon to forecast future growth rates. These factors include single-family permits, households, population, home values and medium household income. Our initial forecasting suggests flat volume demand in the legacy repair and remodeling for 2020, as compared to 2019. We expect new construction in the primary markets for our legacy in Western Window products to be slightly up in the low single-digits in 2020. Regardless of the macroeconomic outcome, we are focused on continuing to deliver above market construction performance, from various initiatives that we believe will deliver increased sales. These initiatives include meaningful dealer expansion, third-party financing and specific marketing initiatives to accelerate adoption of Impact Products in the production builder market, following 3 consecutive years of significant hurricane activity.

We expect to implement these initiatives, which we believe will deliver our sales growth above these market estimates. Now I'll return the call back over to Sherri to discuss the financial results in more detail. Sherri?

--------------------------------------------------------------------------------

Sherri Baker, PGT Innovations, Inc. - Senior VP & CFO [4]

--------------------------------------------------------------------------------

Thank you, Jeff. Now turning to Slide 7 to give more detail on our results. For the third quarter net sales were $198 million, which included $162 million of legacy sales reflecting a 10% decline in our legacy business versus the prior year quarter, driven by the decline and the repair and remodel channel. As Jeff already discussed, the decline primarily reflected the test comparison with the prior-year quarter. Our sales in the third quarter included the contribution of $36 million from Western Windows Systems, reflecting 11% pro forma growth in sales for Western versus the prior year quarter. We achieved this growth against the headwind of the softening California housing market, which further underscores our optimism in longer-term consumer demand for the Western business unit products that unify indoor and outdoor living spaces.

Gross profit for the third quarter was $70 million, a decrease of $3 million versus the prior year quarter and gross margin decreased to 35.4% of sales, a 130 basis point decrease from the prior year quarter. This decline was driven primarily by the continued unfavorable mix away from repair and remodel products in our legacy business, which typically have higher margins and the expense of promotional efforts in our legacy markets on the heels of hurricane Dorian. These items were offset by the continued accretion from Western Window system, which was acquired in the middle of the quarter. Adjusted selling, general and administrative expenses increased $4 million versus the prior year quarter to $45 million, inclusive of our increased marketing spend associated with hurricane Dorian, an impartial quarter impact of incremental SG&A from Western Window System. We expect the marketing investments made in the third quarter to contribute to top line growth in future quarters. Adjusted EBITDA for the third quarter of 2019 was $35 million, or a margin of nearly 18% of sales versus adjusted EBITDA for the third quarter of 2018 of $40 million or 20% of sales.

This marks a 2% decline in adjusted EBITDA as a percent of sales, driven by unfavorable shift in mix from our model products and our legacy business and the promotional efforts previously discussed.

Our effective tax rate for the quarter came in at 20.4%, below our guidance estimate of 26% and was driven by excess tax benefits of approximately $700,000. Our tax rate guidance for the full year is 25% excluding discrete items. We reported GAAP net income for the quarter of just over $15 million or $0.26 per diluted share versus $13.6 million or $0.26 per diluted share of the third quarter of 2018.

Adjusted earnings per share for the third quarter of 2019 was $0.26 versus $0.38 in the same quarter last year. The current quarter includes 6 million additional shares as a result of our September 2018 equity issuance, partially offset by shares repurchased in the current quarter.

Turning to Slide 8, let's review our balance sheet highlights. We ended the quarter with net debt of $298 million, up slightly from $295 million in the second quarter of this year, driven by timing of semi-annual bond interest payments. On an all-cash net basis, we maintain a net debt to trailing 12 month adjusted EBITDA ratio of approximately 2.2 times, pro forma for the Western Windows Systems acquisition.

As you can see, we have a proven track record of successfully reducing leverage after completion of an acquisition.

Next, turning to our capital allocation priorities on Slide 9. Our first priority for capital allocation remains internal investment in projects that we believe will drive our growth and generate future shareholder value. As we demonstrated in the third quarter, we support our product portfolio by making investments in advertising and marketing programs that have proven successful towards that goal.

Our second priority is for capital strategic acquisitions that would give us a platform for expanding into new geographies or markets or other building products and channels that would expand our footprint and thus generate strong margins. Our third priority is our commitment to debt reduction and maintaining a strong balance sheet. We finished the quarter with the cash position of $82 million and net debt of approximately 2.2 times.

We expect to maintain a conservative leverage profile with a range of 2 to 4 times net debt to EBITDA and the absence of any additional large acquisitions. Our fourth capital allocation priority is the opportunistic repurchase of shares, when we believe the stock price and other market factors make this an attractive use of capital. Since the end of the third quarter, we have repurchased approximately 394,000 shares at an average price of $14.7 for a total price of $5.5 million. We currently have an authorization in place for the repurchase of up to $24.5 million of our shares.

For the full year 2019, we are updating our financial guidance as shown on Slide 10. The top line reduction in guidance is largely a result of business interruption from Hurricane Dorian, where labor constraints in the marketplace hinder our ability to recapture the sales in the fourth quarter and reduce the large project demand in our legacy markets versus our prior expectation. The reduction in adjusted EBITDA is driven by the topline volume reduction, along with the 2 investments discussed earlier, promotional efforts in our legacy business, following Hurricane Dorian, which we expect to positively impact future sales. And labor investments in our Western business unit, which we believe will better serve our heightened custom product mix.

We continue to show strong focus on controlling costs in our legacy business, as evidenced by actions recently taken in our legacy markets. In October of 2019, we reduced our annual legacy cost structure by an expected $4 million, through salary personnel reductions and by leveraging our operational efficiencies in our Venice, Florida, glass operations, to vertically integrate much of our glass needs at our higher Hialeah plan.

For the full year 2019, PGT now expects to finish in the following ranges. Net sales of $730 million to $740 million, adjusted EBITDA of $126 million to $130 million and adjusted net income per diluted share of $0.79 to $0.84. Our assumptions for depreciation and amortization, interest expense, tax rate, and stock compensation remain unchanged.

And now, I would like to turn the call back over to Jeff for some closing comments.

--------------------------------------------------------------------------------

Jeffrey T. Jackson, PGT Innovations, Inc. - President, CEO & Director [5]

--------------------------------------------------------------------------------

Thanks, Sherri. Before moving to Q&A, I would like to conclude with PGT Innovations investment thesis on Slide 11. First, we are a national leader and have leading brands and growing categories in which we compete. Second, we are product innovators, we intend to maintain our advantages leaders in our industry by investing in R&D to support product development, as well as higher and retain the best talent. Third, we plan to continue our focus on improving operational efficiencies through driving additional margin expansion over the long term. Fourth, we are excited and executing on our strategy and we believe it will create long-term value for our customers and shareholders. And finally, we believe our product portfolio across the markets we serve will position us to capture profitable growth in both new construction and repair and remodel.

All of us at PGT Innovations remain excited as ever about the possibilities for future growth in our family of brands.

With that, I'd like to turn the call over to the operator to begin our Q&A. Operator.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) We'll go first to Keith Hughes at SunTrust.

--------------------------------------------------------------------------------

Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [2]

--------------------------------------------------------------------------------

The question is on the fourth quarter, the implied guidance here with revenues be down about 30%. A couple of questions on that. Number one, what would Western look like versus the historic PGTI business in this estimate?

--------------------------------------------------------------------------------

Sherri Baker, PGT Innovations, Inc. - Senior VP & CFO [3]

--------------------------------------------------------------------------------

We will see Western in the range of flat to up probably low to mid-single digits, and what you will also see is a continued mix that is heavier on the custom business than what we have historically been seeing in prior quarters, although very similar to I think what we saw in Q3. So, we're seeing a higher mix of custom products versus what were previously considered our volume product lines and we're also seeing some nice growth in our commercial business, as well. But those different lines of businesses have different margin profile, so you will see that impacting partially on the sales line, but also on the margin lines as well.

--------------------------------------------------------------------------------

Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [4]

--------------------------------------------------------------------------------

So, take the other side of that, that would mean Florida historically did our business were down mid-teens. As you look within that, I know you have difficult comparison still, but the third quarter was the most difficult comparison you're going to face. That seems like a deceleration into the four. Is there something else going on? Is there a competitive situation or is the tail from the hurricane being longer, just any sort of insight you would have on the fourth would be great in Florida?

--------------------------------------------------------------------------------

Sherri Baker, PGT Innovations, Inc. - Senior VP & CFO [5]

--------------------------------------------------------------------------------

Yes, great question. And I think the other piece that you need to factor in, is also the backlog that we had in Q4 of last year. So, recall just with the significant growth that we had, we were eating through some of that pipeline in Q3. That Q3 pipeline last year was over $100 million and we still had a backlog in Q4 of last year over $64 million. So, that is the other factor that you will also need to take into account, we think the macro pieces from the R&R and new construction will be, for the most part, predominantly similar. But that's the incremental piece that you have to factor it as you're analyzing Q4.

--------------------------------------------------------------------------------

Jeffrey T. Jackson, PGT Innovations, Inc. - President, CEO & Director [6]

--------------------------------------------------------------------------------

Keith, if you recall, R&R is typically a tough quarter for us, it's Thanksgiving, it's Christmas. So historically, the fourth quarter has been our toughest quarter. Last year, Sherri hit it spot on, we had accumulated a backlog, given the significant growth we've had over a couple of years and it took us well from a technology capacity standpoint to catch up to that. But quite frankly, we have, PGT from an operational perspective, we're best we've ever been. We made more units this year with about 200 less people than we have in the past. So operationally, we are executing phenomenally well and we were able to eat in and catch up to that backlog, and we're not carrying that into the fourth quarter of this year.

--------------------------------------------------------------------------------

Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [7]

--------------------------------------------------------------------------------

Do you have a sense that the hurricane demand has, from a couple of years ago, has all been satisfied and now it's back to just traditional renovation? Or is there still some lagging renovation that was storm-driven in Florida?

--------------------------------------------------------------------------------

Unidentified Company Representative, [8]

--------------------------------------------------------------------------------

Yes, I think the significant surge we saw in both '17 and '18 has been, I would say satisfied, but what we've benefited from is the awareness that's still there. So, when people are moving to Florida unlike 5 years ago, when I was doing these calls, from people moving to Florida they end in a hurricane, so the awareness wasn't there. Now, when folks are moving into Florida in 2020 and beyond, there is a significant awareness of hurricane and our quoting activity is actually reflected that and still been up and the demand in the corporate builder program that we're pushing to be more impact in terms of mix. All of that's still there, and we still benefiting from the hurricane. A significant spike, yes, I think what we've done is we've worked through that and, from a capacity operational standpoint, we're ready for whatever comes out next.

--------------------------------------------------------------------------------

Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [9]

--------------------------------------------------------------------------------

Just final question on the Dorian, $5 million from Dorian, and just need to understand, did that hurt you in the third quarter? And you don't expect to get that back until next year, is that your view?

--------------------------------------------------------------------------------

Unidentified Company Representative, [10]

--------------------------------------------------------------------------------

Yes, in terms of the marketing efforts we put in place, yes. We made some investments in promotional and marketing activities. We think we will definitely get that back in the first quarter of next year, into the first half, so to speak. Again, that's to more consumer awareness but fourth quarter, we don't see necessarily getting that $5 million back at this point.

--------------------------------------------------------------------------------

Operator [11]

--------------------------------------------------------------------------------

We'll go next to Michael Rehaut at JPMorgan.

--------------------------------------------------------------------------------

Margaret Jane Wellborn, JP Morgan Chase & Co, Research Division - Analyst [12]

--------------------------------------------------------------------------------

This is Maggie on for Mike. First, I wanted to ask a question on Western Window, so following the announcement last week that (inaudible) is stepping down, I was wondering if you could talk about your plans for leadership within that segment going forward?

--------------------------------------------------------------------------------

Unidentified Company Representative, [13]

--------------------------------------------------------------------------------

Yes, Scott and I have talked, he is going to help me extended transition, 90-day transition, obviously Scott stepping down to pursue a personal dream and a goal he has, that has to be admired. Over the next several weeks, we are putting together a structure that we think will support both the continued growth in the platform to currently are operating in and into the future.

I have viewed and been consistent with the message that Western and the platform out here will be our out-of-state hub, if you will, in our growth vehicle. So, the leadership here is strong. The teams that have been built all the way from operation, especially in the sales arena and marketing side, are incredibly strong. So, Scott will be missed in terms of a leader. But I think, like any good leader, you put in place people around you that can deliver.

And I think, that's what's happened here. And we will work together for a smooth transition and determine what that looks like into the future. It's too early to give details on that at this point.

--------------------------------------------------------------------------------

Margaret Jane Wellborn, JP Morgan Chase & Co, Research Division - Analyst [14]

--------------------------------------------------------------------------------

Okay, thank you and good luck to Scott. And a second question, I was wondering if you could talk about a little bit more on those promotional efforts in the Southeast in your legacy business. You mentioned that some of the benefits you're expected to come in 1Q of next year or in the first half of next year. So, can you maybe quantify the expected benefits? And then, also remind us how much of the legacy sales are outside of Florida right now and where do you see that number going through the end of next year maybe?

--------------------------------------------------------------------------------

Sherri Baker, PGT Innovations, Inc. - Senior VP & CFO [15]

--------------------------------------------------------------------------------

From a promotional perspective, we ran a couple of different promotions and one that was earlier in the third quarter, we ran a consumer rebate. And then second, we ran a promotion where we were offering a free upgrade on some of our products. So, you will see that really comes more in the form of net sales. So, that is where that will be showing up, you will see partially, I'd say two-thirds of the investment, of that shows up in Q3. And then you'll see another third of that investment come into Q4 and that has all been factored into the guidance ranges that we've just said.

So, it's a little difficult to say what we expect that full sales led to be. But note that we are continuing to analyze other promotions that we believe will drive sales because it's important to us, not just to raise awareness on the heels of Hurricanes. But it's important for us to also raise awareness of our products, maybe in other areas where we're not quite stronger or competing. So, I think it's important for us to look at that and analyze what those paybacks are. That is one.

And then the second piece is that, as you all know, Florida is still the majority of our legacy business, call it about 90% of our business. But for the 10% that is outside, we have seen strong double-digit growth as of late. And we're very encouraged by that and we will clearly continue to drive sales initiatives to further expand that as we go into 2020.

--------------------------------------------------------------------------------

Unidentified Company Representative, [16]

--------------------------------------------------------------------------------

Yes, I would just a little bit further add on that the 23% growth we have seen outside the state. It's really driven up the East Coast and the Carolinas. And then again, like I had mentioned to you earlier, we've been trying to get more penetration into what had traditionally been our core markets in that Panhandle along through Mobile and all the way to Texas. So, we've gotten initiatives in place to drive more volume there. What we have experienced that we did mention is the international piece, which is really flat to down year-over-year.

And we attribute that mainly just storm activity in the past, as well. As you guys know the Bahamas was devastated by the storm recently and we do expect an increase once that country gets back in line, it's going to be a good market for us as well.

--------------------------------------------------------------------------------

Operator [17]

--------------------------------------------------------------------------------

Our next question comes from to Ken Zener at Citibank.

--------------------------------------------------------------------------------

Kenneth Robinson Zener, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [18]

--------------------------------------------------------------------------------

I have several questions here. I appreciate your patience. Let me start with how you balance growth with profitability, which is I think the issue investors are struggling with, especially as it relates to FY 20 and beyond. So my first question. Cut growth comps I think explained the sales remission at $18 million this year. So, can you break down the $13 million EBITDA revision, in terms of how much is related to the Southeast investment? Because I assume could be transitory in FY20, the $5 million drag from Dorian. I don't know if that just flows through. Let's say 30% and then, how much relates to WW? I'm trying to understand at sales versus EBIT cost component.

--------------------------------------------------------------------------------

Sherri Baker, PGT Innovations, Inc. - Senior VP & CFO [19]

--------------------------------------------------------------------------------

Yes. I'll break it down. I won't discreetly call out the exact numbers in all of them, but I'll put them maybe in order of importance. So, I think the first piece, at least for Q3 and to some extent Q4, would be the promotions and the marketing efforts that we've put into the legacy business, so that would be one. The second piece would be the product mix and that's product mix both in the legacy business and at Western. So you have to put the 2 of those together and then the third is just candidly volume. So, there is a point that comes in for just the lower volume. And that's the last piece of the EBITDA. So, I probably put those in that order of priority.

--------------------------------------------------------------------------------

Kenneth Robinson Zener, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [20]

--------------------------------------------------------------------------------

Okay. The second question is, I think you said flat RNR outlook is what you're looking for in '20, you expect to grow above and beyond that as you have historically. So, really how do you balance the risk to return of investing, promotion, regional expansion and brand awareness?

It's really just running the business in a way that will give you better operating leverage, A.

And then B, can you go through the process that you made, in order to make these investments, knowing it would obviously impact your earnings outlook. Again I think this was something you were communicating last quarter.

--------------------------------------------------------------------------------

Unidentified Company Representative, [21]

--------------------------------------------------------------------------------

Yes, we'll both take a stab at that. I think, let me address thoughts on how we're going to grow this business, to start with. In Florida, obviously from a mix standpoint, we see the new construction R&R. As you all know, R&R has been historically stronger margin profile for us. And so, as that mix shifts from the core legacy business, we shift our cost structure.

That's what we did in the third quarter, when we saw the R&R business continuing to be flat to incredibly tough comps in the past, we shifted the cost structure and we've taken an annualized $4 million of the cost of the business. So, we will continue to grow margins there despite the mix, it may be delayed in any given quarter based off a hurricane hitting us, or the R&R market not turning as quickly as we want it.

But, as we demonstrated, we react and react accordingly when it comes to the cost structure. From the Western standpoint, it's a different business. That's where there is more growth opportunity in, what I'd call and what I mentioned, emerging markets. So, that product is still expanding into new territories in, the amount of territories is significant, relatively speaking.

You got to remember PGTI, we've been in Florida for 40 years, next year is our 40 year anniversary. And we have that market, that's our core market and Western is just different in terms of their ability to expand and scale into new areas. And we're using that as a platform to increase top line sales. That will come over time very profitably, but that mix in that shift will change and we will adjust, just like we do historically with our cost base, we'll add cost if we need to, there'll be periods where we invest just like I said, we invest in direct labor and fixed cost here in Western.

Well, that impacted margins, but we expect that investment to pay off next year because again, the growth in both 3700 series vinyl product line to simulated steel, the commercial business, all are growing and we want those dollars. That throws a new mix into the plan. Initially that new mix requires operational improvements and refocusing, that's what we're doing now. Nothing is broken. It's just a different mix that we got to figure out how to make the same amount of money on, no different than we've done historically at PGT. So, we're more of the investment mindset here at Western versus cost out because we want to grow this business and we see the potential to scale it.

--------------------------------------------------------------------------------

Sherri Baker, PGT Innovations, Inc. - Senior VP & CFO [22]

--------------------------------------------------------------------------------

Yes, the only other thing I would add is that, keep in mind that hurricane Dorian came in late August, which would have been well after we came out with our last round of guidance. So, that clearly would not have been something that we anticipated in the last guidance range, but because we have historically seen the ability to drive further awareness, we felt it's prudent to make that short-term investment for the balance of what we expect to be future growth. So, you will see that happen. And that at least answers that other prongs of the question, but I think continuing promotional efforts, particularly where we can incent our dealers to grow their business as well, those are things that we're looking at literally as we speak. So, there is multiple different kinds of ways that we can run promotions and investment, a lot of that will really depend on what's going on in the marketplace and what we think will drive the best sales and EBITDA.

--------------------------------------------------------------------------------

Kenneth Robinson Zener, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [23]

--------------------------------------------------------------------------------

Understood. I could ask one more question. So, obviously, there was a deal that closed today implying your valuation is below another transactions in the space, I think that's supportive both of you, but if I could just drill down into the WWS a little bit. I think your answers have been very complete, I just want to keep going. In WWS, you mentioned the labor fixed costs said incremental margins, when you talked about WWS in the past, trade is having a significant capacity (inaudible). Obviously, it's a very attractive plant that you acquired. It seems like this growth is going to be largely constrained by kind of that incremental headwinds, labor shifts and all the stuff that's been an issue characteristic. We think you're going through that process right now, to talk about your visibility to see that these issues are more transitory in nature versus structural. Can you just expand on the custom product and windows? So, is it metal versus vinyl, is a large builder, their first commercial, should we see it and gross margin pressure, or would we see it in SG&A? And can you just comment on 4Q gross margins? You saw 150 basis point drag in 3Q. Is that going to be half that in 4Q? Thank you very much for your patience.

--------------------------------------------------------------------------------

Unidentified Company Representative, [24]

--------------------------------------------------------------------------------

Great questions too. Just a comment on Western in general. In 2018, the split between custom and volume was roughly 50-50 and volume implies exactly ways volume means, is a lot bigger runs, lot easier run through a plant, no different than we have volume runs at PGT at times for bigger projects. So, custom versus volume, volume just typically flows better. That mix, because we've introduced new products into our portfolio of Western again to grow top line, that mix has shifted over time. In 2019, that mix is more 60 - 40. 60% cost 40% volume, but that custom category includes items like simulated steel, the new 3700 vinyl, there is a lot of stuff now that is coming out, that we have to adapt the plant to.

We still have capacity there is capacity in the plant. That's not the issue, the issue is flow through the plan and (inaudible) to staging, that's our plant flows and operates. That's what we're heavy into right now and adjusted because we feel the top line is going to even more accelerate in 2020. So, we need to make the investments now so we can capture that at a more profitable level. I think, in terms of profitability, all the initiatives, whether it's the ones we do at PGT in terms of cost reduction, to technology upgrades, to full better through our plants, to the ones we do at Western, to investing, and how production is made here.

All of those are investments that I feel will drive incremental margins and no concern at all that we can be at 20% EBITDA comp. That is definitely over time doable and I see that coming. It's just a matter of investment or not.

--------------------------------------------------------------------------------

Sherri Baker, PGT Innovations, Inc. - Senior VP & CFO [25]

--------------------------------------------------------------------------------

And the only other thing I would add just as you're thinking about Q3 to Q4. Keep in mind that historically in the legacy business, there is probably a 2 full percentage point delta and EBITDA margin between Q3 and Q4. So, as you're thinking about the quarters, just make sure that you're taking that into account as well.

--------------------------------------------------------------------------------

Operator [26]

--------------------------------------------------------------------------------

(Operator Instructions) We'll go next to Phil Ng, Jefferies.

--------------------------------------------------------------------------------

Philip H. Ng, Jefferies LLC, Research Division - Senior Research Analyst [27]

--------------------------------------------------------------------------------

Can you share some insight, how the backlogs have progressed through the year. And had backlogs leveled off, and it's started to move in a positive direction?

--------------------------------------------------------------------------------

Sherri Baker, PGT Innovations, Inc. - Senior VP & CFO [28]

--------------------------------------------------------------------------------

I will actually take that one. So in Q3, the backlog last year was $104 million, Q3 from this year was $72 million. So, it's down 31% and we were seeing, I'd say kind of similar comps earlier in the year, though even maybe slightly above that.

The Q4 backlog for last year was $64 million. So, as we talked about earlier on the call, that was where we were really getting more operationally efficient and kind of eating through that backlog. So, you will probably see a more normalized backlog exiting Q4 and into early Q1.

--------------------------------------------------------------------------------

Philip H. Ng, Jefferies LLC, Research Division - Senior Research Analyst [29]

--------------------------------------------------------------------------------

Helpful, but sequentially, have things kind of level off, or maybe that's not a good way to think about it just because your business is seasonal in nature?

--------------------------------------------------------------------------------

Sherri Baker, PGT Innovations, Inc. - Senior VP & CFO [30]

--------------------------------------------------------------------------------

I think if you take that into account, it's been sequentially very similar performance, normalizing for those increase Q2 and Q3 sales. So, I think what you've seen in 2019 is a fairly stabilized backlog. You're just really having the factor in the overlap, particularly what we saw in Q2 and Q3, which were the biggest backlog quarters of last year and then it started to taper off in Q4.

--------------------------------------------------------------------------------

Philip H. Ng, Jefferies LLC, Research Division - Senior Research Analyst [31]

--------------------------------------------------------------------------------

Got it. Okay, that's helpful color. And I think, Jeff, you flagged early, you expect flat to low single-digit growth in the market for 2020. The comps are still pretty tough in the first half of next year, considering the trends you've seen them back out this year. When do you expect volumes to actually inflect positively next year and any insights that you can share that gives you confidence with your outlook?

--------------------------------------------------------------------------------

Jeffrey T. Jackson, PGT Innovations, Inc. - President, CEO & Director [32]

--------------------------------------------------------------------------------

I think first quarter will be another tough comp year, although I do think is possible to still produce growth. Second quarter of next year, I think you'll see a market change, why do we think that? One, I think the amount of growth and the initiatives we have in our Western Windows systems. Some of those will actually come to fruition starting in the second quarter of 2020. Also, several of the new initiatives we've got on the plate at PGT should be fully implemented and in place by the second quarter of 2020.

So, I look at the second quarter as a potentially good turning quarter, a good gauge on how we're doing execution-wise.

--------------------------------------------------------------------------------

Philip H. Ng, Jefferies LLC, Research Division - Senior Research Analyst [33]

--------------------------------------------------------------------------------

Okay.

--------------------------------------------------------------------------------

Sherri Baker, PGT Innovations, Inc. - Senior VP & CFO [34]

--------------------------------------------------------------------------------

I'm just going to add just for the benefit of the Group. Because this is probably the first time that we've really used some external data to start talking about the market. So, we have been partnering with John Burns over the past, call it, 4 to 6 months.

And one thing that I think was really important to us was to get a better sense of the market that is specific to our business. So, when you're seeing all of these national housing starts and permits and all of these other numbers that are interesting on a high level. What was more important to us is that we really needed to make that actionable and specific to our business. So, we have been working with them to really take what they're seeing market-by-market and apply it to our business. And where we compete, so that when we start quoting a market, it is really more relative to PGT legacy and to Western.

We feel it's just a better indication of our business, as opposed to maybe those super high national levels that you would historically see in other publications. So, we're still working through this, but we do feel, let's say, it's a better metric. And so, we felt at this point in time, because we're getting an early read of 2020, we at least wanted to give you what we're seeing as early indications. And then, we'll continue to really dig into that as we get into early 2020.

--------------------------------------------------------------------------------

Philip H. Ng, Jefferies LLC, Research Division - Senior Research Analyst [35]

--------------------------------------------------------------------------------

Got it. Just one last one from me, on the margin side of things, it's got noticeably in the back half of this year. Part of that is some investments you're making in this mix dynamic. It's unclear to me if that all reverses largely next year? But just given your outlook on sales and inflation as well, do you expect margins, EBITDA margins to be up next year and how we should think about directionally and how that inflection could materialize in the coming quarters?

--------------------------------------------------------------------------------

Unidentified Company Representative, [36]

--------------------------------------------------------------------------------

I mean, yes, year-over-year I expect our EBITDA margins to improve. And we're not at a point where we can comment on how much that would be. Kind of like Sherri said, once we get a feel for R&R presence into 2020, and are executing initiatives against that to grow that segment because it is a very profitable segment for us. And, once we get a feel for the new mix we've had in 2019 through product launches at Western. Once we get to what we can produce those more efficiently, that will also drive that margin. If you look year-over-year, I do think there will be improvement in our EBITDA margins.

--------------------------------------------------------------------------------

Philip H. Ng, Jefferies LLC, Research Division - Senior Research Analyst [37]

--------------------------------------------------------------------------------

Okay. What about some of the things that are with your margin down in the back half? Some of these mix investments in promotional, do you expect that the split to be more neutral in early next year? If that's going to linger a little bit into early 2020?

--------------------------------------------------------------------------------

Unidentified Company Representative, [38]

--------------------------------------------------------------------------------

It will linger somewhat into 2020. Again the plan, in mix doesn't change over a quarter. But, we look at the long term, we're going to go get the sale and we'll figure out how to make it profitable in the future, if we have to. But we're going to get the sale, we're going to grow the top line knowing how we leverage from cost structure and what we need to do.

I do think the investments may especially in Western Windows Systems. Those will linger if you will, until volume starts coming on those, more volumes starts coming on those product launches. But as they do, we're going to be an incredible great position to leverage that. So, I see that lingering, linger is a bad word, but going into the first half of the year, but definitely turning around by mid next year.

--------------------------------------------------------------------------------

Operator [39]

--------------------------------------------------------------------------------

We'll go next to Truman Patterson at Wells Fargo.

--------------------------------------------------------------------------------

Truman Andrew Patterson, Wells Fargo Securities, LLC, Research Division - Associate Analyst [40]

--------------------------------------------------------------------------------

Jeff, Sherri, just hoping to dig in a little bit more in your fourth quarter EBITDA guidance. It looks like EBITDA fell 12% in the third quarter, but it looks to be intensifying in the fourth quarter. I think you, said at the midpoint of your guidance, is that a declined 25% year-over-year in the fourth quarter, but it seems like these hurricane Dorian sales headwinds likely peaked in the third quarter. Same thing with the investments and the rebates for the hurricane awareness probably peaked in the third quarter. You all removed about $4 million in costs. Just hoping to understand why that intensified in the fourth quarter? Is it the Western Windows product mix? You also mentioned some fixed investments. Just trying to understand the big pieces, why it did kind of deteriorates from here?

--------------------------------------------------------------------------------

Sherri Baker, PGT Innovations, Inc. - Senior VP & CFO [41]

--------------------------------------------------------------------------------

Yes, I think the Western Windows product mix is probably the first. Second, she will also have just the volume impact that will show up in EBITDA. So, that will also be a factor, because we did also reduce the topline guidance, so you have to factor that in, as well. And then, it will just be the continued product mix and legacy with R&R and new construction that we don't see changing dramatically. It will be very similar to what we're seeing with R&R down more, than what you are seeing in new construction. So I'd say it's more of the same, but maybe in that particular order.

--------------------------------------------------------------------------------

Truman Andrew Patterson, Wells Fargo Securities, LLC, Research Division - Associate Analyst [42]

--------------------------------------------------------------------------------

Okay, thank you for that. Just kind of piggybacking off, of the fourth quarter EBITDA range is pretty wide by 20% from the low to the high. Could you maybe walk us through what pushes you to either end of this range?

--------------------------------------------------------------------------------

Sherri Baker, PGT Innovations, Inc. - Senior VP & CFO [43]

--------------------------------------------------------------------------------

Yes, I think a lot of it is really trying to see how this product mix flows, if it comes in any different then we will certainly look at that. But from an investment perspective, we will have some of the cost coming in from the promotion pieces. Outside of that, I think the bigger pieces is probably how much improvement we're able to make in the Western business, particularly around those incremental labor investments and an efficiency flow. So, that's probably the bigger of the (inaudible) and then the continued product mix in legacy.

--------------------------------------------------------------------------------

Truman Andrew Patterson, Wells Fargo Securities, LLC, Research Division - Associate Analyst [44]

--------------------------------------------------------------------------------

And Truman, just so you know, what I challenge my team with, basically as we in 2019 going into 2020, if mix did not change, in other words, if new construction is basically what we've said, single-digits, R&R does not come back and is relatively flat, how do we at PGT court legacy produce a 20% EBITDA company? And so, we reacted to taking cost out to try to adjust as we enter into 2020 and there is a couple of more initiatives, quite frankly, that you're going to hear about when we come out in the first quarter. But, the goal is to see the market as it is, make sure we can hit our margin profile within this changed market and help drive initiatives to actually grow and be even better.

So that's a tall order, no doubt, but again, we feel confident the cost reduction initiatives that we've taken and could still take, and the potential to execute the sales initiatives we have will drive incremental margin improvements.

--------------------------------------------------------------------------------

Sherri Baker, PGT Innovations, Inc. - Senior VP & CFO [45]

--------------------------------------------------------------------------------

And I only want to add one incremental thing on the$ 4 million of cost reductions that we did in legacy business, that was taken within the quarter. So, it is not as simple as dividing $4 million by 4 and saying you're going to get full million on that, that will not be the case. They were executed on a stairstep basis, so it will be less than a full quarter in Q4. So, the predominant amount of that benefit will be coming in 2020.

--------------------------------------------------------------------------------

Unidentified Company Representative, [46]

--------------------------------------------------------------------------------

And one of them, based off volume when we brought glass internally, when we insourced into our internal glass department, it was one of the initiatives, that will be based on volume. So, obviously a bigger quarter is bigger savings and fourth quarter, with lower volume, the amount of the magnitude of that savings isn't necessarily in that fourth quarter. The magnitude of that particular segment is going to be in the second quarter next year, for instance.

--------------------------------------------------------------------------------

Truman Andrew Patterson, Wells Fargo Securities, LLC, Research Division - Associate Analyst [47]

--------------------------------------------------------------------------------

Okay, thank you all for that. Just one final one, could you all give us an update on the China tariffs, as well as just general cost inflation rolling through your P&L in 2019? How much of a headwind was in '19 and does this intensify or ease a bit in 2020? I'm thinking, it seems like transportation has started to ease a little bit, aluminum seems like it's a bit lower on a year-over-year basis. So, just trying to understand the big moving parts, especially with the China tariffs really kicking in?

--------------------------------------------------------------------------------

Sherri Baker, PGT Innovations, Inc. - Senior VP & CFO [48]

--------------------------------------------------------------------------------

Yes, on the aluminum piece. We've been running, call it, in the back half essentially flat, but we expect to see tailwinds and that going into 2020, so we will see a tailwind from that, and as we mentioned in the call, we've already locked in close to 50% of our needs for next year. So, we feel good about that, but we are seeing increases in other hardware. So, there is inflationary aspect that we are seeing now and that we're also anticipating to see in 2020. So obviously, as we're building out our plans, we will be looking for ways to offset that, whether it'd be incremental efficiencies, whether it'd be pricing and we do expect some headwind, but we will clearly take action to offset that.

--------------------------------------------------------------------------------

Unidentified Company Representative, [49]

--------------------------------------------------------------------------------

And again, that's the cost side of the business, I will continue to remind you all, the biggest impact for me in my seat is the impact of foreign investment into the US. China is a significant player into the real estate market into California. We concentrate our efforts in what we call point designation states, people will move to these states and those are typically states that foreign investors will buy in, too. Florida being one of the biggest foreign investment states in the nation.

California being one of those, in China as a significant investor, Chinese are a significant investor into that little state market. That has impacted us in my opinion, more than the tariff situation or cost. We've been able to pass along in terms of cost, if needed. So, I will be glad when we do get over the half from a macroeconomic standpoint and political standpoint and get the tariff situation resolved, more so, from top-line sales growth.

--------------------------------------------------------------------------------

Operator [50]

--------------------------------------------------------------------------------

Next is Mr. Alvaro Lacayo at G. Research.

--------------------------------------------------------------------------------

Alvaro Lacayo, Morgan Group Holding Co. - Research Analyst [51]

--------------------------------------------------------------------------------

I have a question regarding just competitive dynamics. A competitor put up some pretty robust numbers in their last call and they talked about taking share and they talked about a dynamic pricing environment. Can you maybe talk to us about your thoughts on what market share for you look like and what you're seeing from any market share shift standpoint or a pricing movements on the industry as a whole?

--------------------------------------------------------------------------------

Unidentified Company Representative, [52]

--------------------------------------------------------------------------------

The competitor you're probably referring to. Their business model is geared towards commercial and a lot of them, the majority of their portfolio we don't play against. They do have a residential arm and we do go up against that particular competitor and mainly in the Southeast ends on some multifamily and condo-type projects. They are not taking share from us any more than we're taking share from them in the spaces we play against.

I can't comment on the commercial end of that. They are a significant player in the commercial side, no doubt. But I can't comment on that.

--------------------------------------------------------------------------------

Operator [53]

--------------------------------------------------------------------------------

And that concludes our question-and-answer session. I would now like to turn the conference back over to management for any closing remarks.

--------------------------------------------------------------------------------

Sherri Baker, PGT Innovations, Inc. - Senior VP & CFO [54]

--------------------------------------------------------------------------------

Hi, this is Sherri. So, thank you, everyone, for your continued interest in PGT Innovations. We look forward to talking to you early next year, and have a great rest of your day.

--------------------------------------------------------------------------------

Operator [55]

--------------------------------------------------------------------------------

The conference has now concluded. Thank you for attending today's presentation.