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PGT Innovations, Inc. (PGTI) Q3 2019 Earnings Call Transcript

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PGT Innovations, Inc. (NYSE: PGTI)
Q3 2019 Earnings Call
Nov 8, 2019, 4:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day and welcome to the PGT Innovations Inc Third Quarter 2019 Earnings Call. [Operator Instructions] After today's presentation there will be an opportunity to ask question. [Operator Instructions] I would now like to turn the conference over to Sherry Baker . Please go ahead.

Sherri Baker -- Senior Vice President And Chief Financial Officer

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 two 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 three 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 -- President, Cheif Executive Officer And Director

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 four provides a summary of our four 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 a goal of driving shareholder return. In addition, we believe it is appropriate 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 five. 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 two 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 the impacted margins in the short term We view this as an investment that should ultimately result in future increased sales. The second investment impacting impacting gross margin relates to a continued increase in product mix in our western region toward custom products rather than our volume product lines. Our custom products continue to produce a creative margins in comparison to our legacy margins. However, we invested in both dark labor and fixed costs 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 can continue to control costs 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 three 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 six 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 2018 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 were looking at different options and attacking those markets were penetration has lived in our legacy new construction business, your 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 products, we are experiencing reduce volume 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 three 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 -- Senior Vice President And Chief Financial Officer

Thank you Jeff, Now turning to slide seven 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 either down for the third quarter of 2019 was 35 million, or a margin of nearly 18% of sales versus adjusted EBITDA, or the third quarter of 2018 a $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 $700000. 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 six million additional shares as a result of our September 2018 equity issuance partially offset by shares repurchased in the current quarter. Turning to slide eight 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 nine. 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 toward 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 two to four 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 394000 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, were labor constraints in the marketplace hinder our ability to recapture the sales in the fourth quarter and reduce large project demand in our legacy markets versus our prior expectation. The reduction in adjusted EBITDA is driven by the top line volume reduction, along with the two investments discussed earlier promotional efforts in our legacy business following Hurricane Dorian, which we expect to positively impact teacher sales and labor investments in our Western business unit, which we believe will better serve our heightened customer 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 -- President, Cheif Executive Officer And Director

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

[Operator Instructions] We'll go first to Keith Hughes at SunTrust.

Keith Hughes -- SunTrust -- Analyst

Thank you, the question is on the fourth quarter the implied guidance here with revenues is 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 -- Senior Vice President And Chief Financial Officer

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 Hughes -- SunTrust -- Analyst

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 -- Senior Vice President And Chief Financial Officer

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 -- President, Cheif Executive Officer And Director

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 Hughes -- SunTrust -- Analyst

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 Speaker

Yes I think the significant surge we saw in both 2017 and 2018 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 five 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 Hughes -- SunTrust -- Analyst

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 Speaker

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.

Keith Hughes -- SunTrust -- Analyst

Okay thank you. I'll pass it to others.

Operator

We'll go next to Michael Rehaut at JPMorgan.

Michael Rehaut -- JPMorgan. -- Analyst

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

Unidentified Speaker

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.

Michael Rehaut -- JPMorgan. -- Analyst

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 -- Senior Vice President And Chief Financial Officer

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 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 Speaker

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.

Michael Rehaut -- JPMorgan. -- Analyst

Okay thank you.

Operator

Our next question comes from to Ken Zener at Citibank.

Ken Zener -- Citibank -- Analyst

Good morning everybody.

Unidentified Speaker

Hey, Ken.

Ken Zener -- Citibank -- Analyst

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 -- Senior Vice President And Chief Financial Officer

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 two 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.

Ken Zener -- Citibank -- Analyst

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 Speaker

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 -- Senior Vice President And Chief Financial Officer

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.

Ken Zener -- Citibank -- Analyst

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 did your analysts say. 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 Speaker

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 ship deals 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 -- Senior Vice President And Chief Financial Officer

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 two 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.

Ken Zener -- Citibank -- Analyst

Thank you very much.

Operator

[Operator Instructions] We'll go next to Phil Ng Jefferies.

Phil Ng -- Jefferies -- Analyst

Hey, Jeff, are you there? 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 -- Senior Vice President And Chief Financial Officer

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.

Phil Ng -- Jefferies -- Analyst

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 -- Senior Vice President And Chief Financial Officer

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.

Phil Ng -- Jefferies -- Analyst

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 -- President, Cheif Executive Officer And Director

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.

Phil Ng -- Jefferies -- Analyst

Okay.

Sherri Baker -- Senior Vice President And Chief Financial Officer

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 four to six 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.

Phil Ng -- Jefferies -- Analyst

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 Speaker

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.

Phil Ng -- Jefferies -- Analyst

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 Speaker

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.

Phil Ng -- Jefferies -- Analyst

Okay thanks. I appreciate the color.

Operator

We will go next to Truman Patterson at Wells Fargo.

Truman Patterson -- Wells Fargo -- Analyst

Hi good morning everybody. 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 -- Senior Vice President And Chief Financial Officer

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 Patterson -- Wells Fargo -- Analyst

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 -- Senior Vice President And Chief Financial Officer

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 three causes and then the continued product mix in legacy.

Truman Patterson -- Wells Fargo -- Analyst

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 -- Senior Vice President And Chief Financial Officer

And I only want to add one incremental thing on the$four 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 four 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 Speaker

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 Patterson -- Wells Fargo -- Analyst

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 2019 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 -- Senior Vice President And Chief Financial Officer

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 Speaker

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.

Truman Patterson -- Wells Fargo -- Analyst

Okay thank you all.

Operator

Next is Mr. Alvaro Lacayo at G Research.

Alvaro Lacayo -- Gabelli & CO -- Analyst

Good morning, 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 Speaker

The competitor you're probably referring to. Their business model is geared toward 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 anymore 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.

Alvaro Lacayo -- Gabelli & CO -- Analyst

All right, that's it from me. Thank you.

Operator

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 -- Senior Vice President And Chief Financial Officer

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

[Operator Closing Remarks]

Duration: 56 minutes

Call participants:

Sherri Baker -- Senior Vice President And Chief Financial Officer

Jeffrey T. Jackson -- President, Cheif Executive Officer And Director

Unidentified Speaker

Keith Hughes -- SunTrust -- Analyst

Michael Rehaut -- JPMorgan. -- Analyst

Ken Zener -- Citibank -- Analyst

Phil Ng -- Jefferies -- Analyst

Truman Patterson -- Wells Fargo -- Analyst

Alvaro Lacayo -- Gabelli & CO -- Analyst

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