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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, and welcome to the PGT Innovations Second Quarter 2020 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded.
Now I’d like to turn the conference over to Ms. Sherri Baker, Senior Vice President and Chief Financial Officer. Please go ahead.
Thank you, operator. 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 second quarter 2020 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 third quarter 2020 outlook and the impact of the COVID-19 pandemic 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 will also notice 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’m joined today by PGT Innovations’ CEO and President, Jeff Jackson. After our prepared remarks, we will be available to take your questions.
I will now hand the call over to Jeff for opening remarks. Jeff?
Thank you, Sherri, and good morning, everyone, and thank you for joining us on today’s call. I hope all of you and your families are safe and well during these challenging times. Our primary focus continues to be protecting the health and personal safety of our team members and their families.
I’m extremely proud of all our employees for doing an excellent job delivering high-quality products and services for our customers during these difficult periods when we all have been personally affected by the pandemic and related lockdowns.
Our facilities continue to operate, while our team members follow important safety protocols, including adjusting scheduled productions to allow social distancing, enhance cleaning facilities, daily temperature checks for employees and essential visitors before they enter our facility, and employees wearing masks.
We believe these enhanced safety protocols, as shown on Slide 4, have been effective at allowing us to ramp capacity to accommodate solid customer demand, while following the advice of the health authorities in trying to prevent COVID-19 transmissions at our facilities.
Our primary manufacturing facilities are located in Florida and Arizona, which have seen infection rates among the highest in the country. And therefore, we have had employees who have tested positive for COVID-19. While these affected employees recover safely at home, our manufacturing teams have adapted by adjusting staffing levels and schedules to try to minimize the impact of absenteeism on our production capabilities, while keeping our employees safe.
Despite an uncertain economy, we have achieved solid sales in the second quarter, reflecting the strength of our brands and continued momentum in both repair and remodeling and new construction markets in Florida, including a $23 million in sales contribution from our NewSouth business, which we acquired February 1, 2020.
While we are very pleased with our results for the first half of this year and with our current sales outlook, we expect to continue to prioritize preserving cash for future strengthening of our balance sheet and liquidity. We continue to look for opportunities to further reduce discretionary costs and are carefully evaluating capital expenditures, while continuing to support production needs.
We believe our current liquidity combined with our expectations regarding future growth and cash flows gives us the flexibility to adjust to the potential challenges in the market resulting from the pandemic and economic impact of COVID-19. Later in the call, Sherri will take you through our balance sheet and other financials in more detail after I give an overview of the quarter.
But first, on Slide 5. I will briefly cover our four strategic pillars that I feel are important to review each quarter. We strive to execute against these with the goal of creating long-term shareholder value for shareholders and our customers.
Our first pillar is to maintain our focus on our customers who are at the center of our business. By delivering customer-centric innovation, we expect to drive brand loyalty, recognition and ultimately growth. Our focus on customer intimacy, delivered insights that highlighted a strong desire for the R&R projects in light of the consumer spending much of their times in their homes during lockdown.
In response to that observation, we offered a consumer rebate program, which we believe resulting in us gaining a higher share of customer attention and conversion during the second quarter.
Our second pillar acknowledges that for our company to succeed over the long term, we need skilled and dedicated employees. We have always prioritized attracting and retaining employee talent; and during the challenging circumstances caused by the pandemic, our priority has been the health and safety of employees. I will reiterate that I’m very proud of the team and how they have been able to keep the business operating at a high level of performance, while maintaining focus on employee safety.
Our third pillar is investing in our business to scale operations and manufacture the best products to meet our customers’ demands. For example, over the past few quarters, we have invested in developing operational improvements at our Western business unit to increase output and reduce labor costs, driving 280 basis points of improvement versus prior year.
We continue to see margin improvements resulting from operational efficiencies we put in place across the entire manufacturing process. Although we have stated that our intent is to preserve cash and liquidity, and to that end we expect to reduce total capital expenditures in 2020. Our overall long-term strategy is to continue investing in our business to drive product innovation and increased operational efficiency.
Our fourth pillar is to strategically allocate capital. We continually assess our capital allocation priorities, which may include reinvesting in our business, making acquisitions, or paying down debt with the goal to ultimately drive shareholder value.
Earlier in the year, we completed the acquisition of NewSouth to enter the direct-to-consumer channel with a recognized brand. In its first quarter since the acquisition, we have seen over 80% order growth compared to the prior year quarter, and we expect this investment to generate strong returns as its integration within PGT Innovations continues.
Next, turning to Slide 6. I will review the key messages for the quarter before Sherri provides further details on the financials. We reported a solid second quarter with total sales up 2% over prior year quarter, which was ahead of our internal forecast, overcoming many challenges created by the pandemic and its adverse economic impact.
Despite the unfavorable economic impact on the national economy from lockdowns and the general fear in economic uncertainty created by the pandemic, our total organic sales for the second quarter were down only 9% as compared to prior year quarter. Breaking this down further, in our Southeast business unit, primarily consisting of Florida, sales were down 7% versus prior year quarter.
In our Western business unit, sales were down 19%. We believe sales were down more in our Western business unit due to the pandemic-related shutdowns in some of our core Western markets, including California, as an example, which had the lengthier and more restrictive shutdowns than other markets in the Southeast. Offsetting these organic declines during the quarter, our NewSouth business unit contributed $23 million in sales.
Breaking down sales by channel. In the repair and remodeling channel, we saw a decline of 10% year-over-year in organic sales. Based on our order entry patterns in the second half of the quarter and in July, we are expecting sales growth in the repair and remodeling channel in the back-half of the year.
In the new construction channel, organic sales for the second quarter declined by 9% year-over-year. This was largely driven by our Western business unit, which saw a 19% decline versus prior year quarter. In our Southeastern business unit, new construction sales proved more resilient with Q2 sales up 4% versus prior year.
Based on our recent order entry patterns, we’re expecting sequential improvement in organic sales in our Southeastern business unit. In markets in the back-half, assuming our channels and markets are not unfavorably impacted by any additional or new government restrictions related to the pandemic, and that there is not a material change in the economy in Florida, neither of which we expect at this time.
Our gross profit grew by 2% versus the prior year quarter, driven by slightly higher sales and our continued focus on controlling discretionary costs. Adjusted EBITDA margins declined roughly 3% to 17%, primarily driven by product sales mix and lower sales in our legacy business units.
Going forward, we expect margins to improve as our organic sales growth recovers in the back-half of the year, and as synergies are realized at NewSouth.
Now turning to Slide 7. On the back-half of the second quarter, we began to see recovery in order entry momentum that we initially experienced at the beginning of the year prior to the onset of the pandemic. In our Southeast business unit, in the month of June, we recorded a robust 19% year-over-year growth in dollar value of orders. This brought total growth in orders for the full quarter to 7%. We continue to see similar significant growth in July.
In our Western business unit, the dollar value of orders in the month of June was down 12% year-over-year, as recovery in order entry is slower in our Western core markets. For the full quarter, dollar value of Western orders were down 20%. In July, the Western business unit saw similar order pattern as June.
Our NewSouth retail orders increased over 80% year-over-year, bringing its backlog to $37 million at the end of the second quarter. In addition, we are still on track to open our Houston store in the back-half of this year. This growth continues to underscore our belief that NewSouth was a great acquisition and complementary to PGT Innovations’ existing business model.
Based on the trends we have seen, April appears to be the low point for order entries. Excluding NewSouth, our total backlog was up 50% as compared to prior year quarter to approximately $115 million. Much of that backlog is driven by this 60% increase in backlog in our Southeast business unit, but also due to backlog increases of 3% in our Western business unit.
I would also like to take a moment to highlight the work we’ve done developing sales initiatives that have contributed to our success, even during the challenging markets. To realize our goal of establishing PGT Innovations as a national leader in the premium window and door markets, we have made a number of strategic acquisitions to expand our footprint and go-to-market strategies.
Earlier this year, we added NewSouth to develop a direct-to-consumer channel, both within the State of Florida and along the coastal states. In support of this objective, we’ve worked towards growing and developing our internal creative teams to drive awareness through a mix of traditional advertising, as well as digital channels, in addition to our television advertising.
I believe that our ability to capture sales in this challenging market that we faced in 2020 is enhanced by our overall marketing approach. As I stated earlier, we have ran a successful consumer promotion in our core market of Florida and are very pleased with the order entry we saw as a result of these efforts.
Earlier this year, we announced plans to expand our repair and remodeling markets in the Western business unit by opening a new division called Skye Walls, which we will have its own retail locations. In addition, we continue to open up new dealers dedicated to selling Skye Wall products, primarily in the Phoenix, Los Angeles and Las Vegas markets, where Western has strong brand recognition.
While its contribution to results was modest in the second quarter, we are encouraged by the early signs and success of our Skye Walls division. And believed that overall, long-term has the potential to create meaningful incremental growth in the Western core markets.
And now, I’ll turn the call back over to Sherri to review the quarter in greater detail. Sherri?
Thank you, Jeff. Now, turning to Slide 8, I will give more detail around our financial results. For the quarter, we reported net sales of $220 million, which reflects the strength and resiliency of our organic business being down only 9% year-over-year during an extremely challenging macroeconomic environment. Our 2% year-over-year growth in revenue benefited from the $23 million sales contribution of NewSouth that Jeff mentioned earlier.
Selling, general and administrative expenses increased by $10 million compared to the prior year quarter, primarily driven by the addition of the SG&A for NewSouth following its acquisition in early February and higher incentive compensation, partially offset by lower selling, marketing and distribution expenses.
Gross profit for the quarter was $74 million, or an increase of nearly $2 million, reflecting the $4 million increase in sales, partially offset by the unfavorable mix, resulting from sales declines in the products of our legacy businesses.
Direct labor costs as a percent of sales decreased approximately 90 basis points as compared to the prior year period, excluding NewSouth, primarily as a result of operational enhancements at Western. On previous calls, we have discussed the investments in process improvement to reduce direct costs associated with custom products.
Now that these initiatives are up and running, we are seeing the positive impact on labor costs. We’ve also created an enhanced reporting in dashboarding, which allows for significant efficiencies in the scheduling of labor resources and workflow on the production line.
Additionally, at Western, we have achieved improvements in our shipping process that have yielded 70 basis points of improvement in distribution costs for the second quarter, as compared to the prior year quarter. In July, we completed the closure of our Orlando plant and transferred the production of our WinDoor and Eze-Breeze products to our Venice and Tampa manufacturing facility.
Going forward, we expect to achieve an annualized cost savings of approximately $3.5 million as a result of that consolidation. Adjusted EBITDA for the quarter was roughly $35 million, compared to adjusted EBITDA for the prior year quarter of $41 million, or a decrease of 15%, driven by product mix and reduced sales in our organic businesses.
This was partially offset by sales from NewSouth and lower overall margin, primarily driven by the commercial channel as we work to build capacity in future quarters to meet the robust customer demand we are experiencing, as well as driving future operational efficiencies from the processes we have in place today in our legacy businesses.
Excluding one-time tax items, our effective tax rate for the quarter came in at about 22%, roughly in line with our full-year estimate. We reported adjusted net income for the quarter of $12.5 million, or $0.21 per diluted share, compared to $18.7 million, or $0.32 per diluted share in the second quarter of 2019.
Turning now to our balance sheet. As we have previously communicated, we believe it is important that we maintain a strong balance sheet to carry us through this period of uncertainty and ensure the company is well-positioned for the eventual economic recovery.
We ended the quarter with net debt of $331 million, a $30 million decrease from the first quarter. Also recall that earlier in the year, we issued $50 million of senior notes to help fund the acquisition of NewSouth, bringing the aggregate principal amount of senior notes due in 2026 to $365 million.
We have no other significant debt maturities with only a term loan maturing in late 2022. This term loan was $64 million at the end of the second quarter. But given our current liquidity, we were comfortable making $10 million in total pay down since the end of the second quarter.
As of quarter-end, we had total liquidity of $174 million, including a cash balance of $98 million, plus $76 million of unused capacity on our revolver. We maintained a net debt to trailing 12-month adjusted EBITDA ratio of approximately 2.4 times inclusive of the NewSouth acquisition on a pro forma basis.
Due to the impacts of the pandemic on the economy and our sales in the West, we were required to assess the fair value of our Western Window Systems trade name for possible impairments.
During the quarter, we recorded an $8 million non-cash impairment charge, driven by the unfavorable macroeconomic factors in our core Western markets related to this intangible asset. Our accounts receivable remains steady and have not yet seen any material change in days sales outstanding or significant increases in bad debt expense.
Now, turning to Slide 10. We show this slide each quarter, because it’s important to highlight our track record of reducing leverage by prepaying debt after completion of significant acquisitions. This will continue to be a priority for us going forward once we transition out of our capital preservation mode that we believe is necessary until we have more visibility on the general economy and the potential impact from the COVID-19 pandemic on our business.
On Slide 11, I would like to review PGT Innovations’ capital allocation priorities. Last quarter, I communicated that because of the business uncertainties related to the ongoing pandemic, our primary focus for 2020 would be to preserve cash and that we would minimize capital expenditures where possible until we have better visibility.
As we have described, our sales pipeline remains strong at this time and we continue to enjoy solid free cash flow. However, because of the difficulty in making longer-term forecasts, due to uncertainty regarding factors such as the duration and severity of the pandemic, we expect to maintain our conservative position towards capital allocation priorities until there is more certainty around the direction of the economy.
I will now review how we think about capital allocation in general over the longer-term. Our first priority remains internal investment in projects expected to drive revenue, reduce cost and increase our returns. We’ve been active on the trend in prior quarters and made a number of incremental improvements as part of our focus on creating shareholder value.
Our second priority is our commitment to debt reduction and maintaining a strong balance sheet. We expect to maintain a conservative leverage profile with a range of two to three times net debt to EBITDA, with a preference for staying at the low-end of that range. Given our healthy cash flow in the second quarter and our strong liquidity position, we chose to make the $10 million in debt prepayment since the end of the second quarter that I previously mentioned.
Our third priority would be strategic acquisitions that are accretive, generate strong returns and allow us to expand into new markets or channels. We expect that our primary focus for the remainder of 2020 will be preserving cash, maintaining liquidity and optimizing our manufacturing assets, along with the integration of NewSouth. We continue to expect that future potential acquisitions will most likely occur in 2021 or beyond.
And finally, in lieu of giving full-year guidance, I will provide a limited outlook for the third quarter. We expect Q3 consolidated sales to be in the range of $225 million to $235 million, growing by 14% to 19% compared to the third quarter of 2019.
This third quarter outlook assumes that we do not experience any significant additional or new pandemic-related government restrictions that would adversely impact our businesses and markets, and that there is no material degradation in the economies of our core markets due to the pandemic-related factors.
While we are constantly looking for opportunities to reduce cost, we expect our cost structure generally to align with the resources required by our sales forecast and the requisite need to provide an appropriate level of service to our customers, including reasonable delivery times.
As Jeff mentioned earlier, assuming our markets do not experience any significant challenges related to increases in the number or severity of COVID-19 cases, the implementation of additional or new government measures in response to the pandemic or significant degradation in the economies of our core markets, we expect to see a continued recovery in order trends and related sales throughout the remainder of the year.
We are constantly monitoring order entries and evaluating trends and projected sales. While we are currently working toward expanding production, we have the flexibility to reduce our cost structure in the event our analysis indicates a need to do so.
And now, I would like to turn the call back over to Jeff for some closing thoughts. Jeff?
Thanks, Sherri. Today, I’ll conclude my prepared remarks by reiterating PGT Innovations investment thesis, which has not changed despite the economic uncertainty ahead of us. We are a national leader in strong brands and growing categories.
Second, we have a history of product innovation and we intend to maintain our advantage as leaders in our industry through R&D, hiring and retaining the best talent and making the right acquisitions.
Third, we will continue our work towards improving operational efficiencies that drive margin expansion for the long-term.
Fourth, we are striving to execute a comprehensive strategy that we believe will create long-term value for our shareholders and customers.
And finally, we believe our diversified product portfolio allows us to capture profitable growth in our targeted markets.
I want to close once again and thank all our team members continue to deliver incredible performance during these very uncertain times. Together, we’ll get through this current environment and be stronger in the end.
At this time, I’d like to turn the call over to the conference operator to begin Q&A. Operator?
I’ll now begin the question-and-answer session. [Operator Instructions] First question comes from Philip Ng of Jefferies. Please go ahead.
Hey, good morning, everyone, and congrats on a really impressive quarter and good to see the recovery progressing nicely. I guess, Jeff, to kick things off, has it been hard to hire labor, just given some of the unemployment benefits out there? And now that you’re ramping production back up, how should we think about the lag on converting the orders and backlogs you’ve called out? And how are lead times right now? Is it pretty much back to normal?
Good morning. Thanks for the comments on our results. Yes, it continues to be difficult hiring labor. Quite frankly, that’s our biggest opportunity in the third quarter to ramp up capacity – production capacity to meet demand. As you know, we’re into hurricane season, and I think I just read where the second name hurricane was named and heading towards Carolinas.
So, demand is there, and we are ramping up as quickly and as safely as possible. I think being in Florida and Arizona where the amount of positive COVID cases have taken place, it’s been a tough sell and folks are, if anything, a little bit more hesitant in terms of employment. The continued government stimulus does not help. Quite frankly, it makes it much more difficult. But we are hiring, and we do provide a great place to work and go into the market very heavily to add the right people to increase that capacity.
Do you have any more color?
Yes. I would also just add, Phil, that, that we continue from an overall HR perspective to do things like drive-through job fairs, but we advertise very heavily. We have an incredibly attractive benefits package compared to the majority of the manufacturers in the peer space.
So, raising visibility to PGTI employees [Technical Difficulty] employees has been a main focus for us and we’re starting to see the fruits of that come to fruition, but definitely labor is a factor that will play into how quickly we are able to ramp our capacity backup. But we are anticipating that will grow our capacity somewhere in the 5% to 10% range as we go through Q3 with the intention to continue to grow that through Q4, and really dependent on how we’re able to ramp that labor in.
Okay.
And then just a little color on lead times, little color on lead times to your second part of your question. They’re still extended right now. Quite frankly, we did the social distancing. We’ve staggered shifts. We’re doing everything we can to keep our employees’ health and safety as top priority.
So that has impacted lead times to a certain degree. Our hiring capabilities have – are improving but still challenging. I think the biggest thing challenging all building product companies, I think, but that I’ve heard is supply chain. You’re starting to feel some of that disruption now more than ever. They’re having labor shortages due to plant closures. And just, in general, there has been a strain on supply coming in, and that’s impacting our lead times as well.
I think by the mid to – probably say, into the third quarter, our lead time should be back in line to what we would say is normal. But right now, they’re still extended just due to sheer demand and our reduction in capacity related to the COVID stuff.
Got it. And then my second question, maybe a question for Sherri. How should we think about the margin profile for 3Q directionally, whether it’s sequential year-over-year? Now I wanted to understand if there are any temporary like T&E savings and just given the fact they’re ramping production, is that something we should be mindful of as a headwind as we think about 3Q margins? Thanks a lot.
Yes, great question. So sequentially, I would expect our overall EBITDA margin to improve. Clearly, we have a healthier top line expectation both from an organic and from the contribution of NewSouth.
So, from an organic perspective, we’re expecting sales to grow, call it mid-single digits. So we’re expecting that growth coming in, so you will have leverage from that. There are no unique one-time items from an overall EBITDA margin or gross profit perspective.
But I would like to call out because we did do it in the prepared remarks, but very proud of the operational improvements that we’re seeing in our Western business, particularly around their direct labor and distribution costs. So, they’ve been able to do some significant improvements and that we expect that to continue, and we also continue to expect to enjoy the aluminum tailwind that we’ve been seeing all year.
So no other, I’d say, new news outside of that, but expecting to improve sequentially as we go throughout the quarters just due to top line growth.
Okay. Thanks a lot.
Thank you. The next question comes from Michael Rehaut of JPMorgan. Please go ahead.
Hi, this is Maggie on for Mike. My first question…
Hi, Maggie.
…the first question is on kind of the demand that you’re seeing in the legacy Southeastern market. I was wondering if you could talk about kind of what – how you’re thinking about the rebound in the recent strength in terms of being maybe a release of pent-up demand? And how you’re thinking about that in terms of if that kind of growth could be sustainable through the rest of the year?
Yes. Thanks, Maggie, for the question. Yes, I think, what we saw is basically, April was our trough month related to demand falling related to the COVID situation. And so as May, June progressed, we definitely saw an increase in demand, even coming from the R&R market, which now is actually growing some.
As people have been pent-up in their homes, we’ve had like a captive audience that we’ve actually specifically targeted for marketing efforts with both digital and television advertising and it is paying off, we think, handsomely. And that’s what – that’s why you see our backlog at record highs right now.
So, yes, we’re starting to feel demand, I would say, unthought from the R&R market, as people are wanting our products and obviously, it’s hurricane season. So that’s also, I wouldn’t say, classify anything as normal in 2020, but what we typically see is R&R kind of pick up related to hurricane season and we’re seeing that as well.
On the new construction side, I think that has been a little softer, but the demand has started to pick back up. I think they have labor constraints similar to ours. And what we’ve seen, at least, in the Florida market, is that demand growing, unlike, say, California where due to the lockdown now again imposed demand is down again. So that’s been more of a up and down market, where Florida has been steadily improving monthly.
Do you have anything you want to add?
Perfect.
Got it. Thank you. And then just – you kind of hit on this a second ago with California being down again. But could you talk about if as COVID cases have spiked again in a lot of your key markets, have you seen customers kind of start to tighten back up again in terms of letting people into their homes on the installation side of things?
No.
…[Multiple Speakers] most recent spikes?
I would say, no, in terms of letting us in their homes, that’s still unthawing and getting better. We have is, for instance, in NewSouth business, we’re trying to hire more installers. So that – that’s probably more of a bottleneck versus people wanting us to come in their homes.
So right now, we’re obviously trying to produce more windows, given their backlog and higher install crews to make sure we can get that product installed. So the demands there people are starting to open up their homes across our R&R market.
Got it. Thank you.
Thank you. The next question comes from Truman Patterson of Wells Fargo. Please go ahead.
Hi, good morning, everyone, and thanks for taking my questions. Nice quarter. Just wanted to follow-up a little bit…
Thank you.
…just wanted to follow-up a little bit on Phil’s question. Last quarter, I believe, you said in the back-half of the year, the decremental op margins would be in the 30% to 35% range or negative 30% to 35%. Now that we’re actually seeing growth and we’re thinking about the revenues improving sequentially. Should we expect that to be a pretty good incremental EBITDA margin sequentially? Or how should we think about that in this, I guess, kind of a new normalized period?
I think that is still a really good modeling assumption. We were taking the bulk of, I’d say, any structural cost out throughout the quarter that we thought was prudent. Obviously, we continue to monitor and watch our discretionary costs that will continue to be our posture throughout the remainder of the year, because we believe it’s the right conservative approach to do. Outside of that, the only other factor that can play into those, as you all know, is product mix.
So in the second quarter, just with particularly our production builder and new construction, you know that those – when production builder is lower than custom, that’s a bit of a gross margin headwind.
But as we move throughout the year, and our expectation is that some of these markets begin to improve, because really, the bulk and the majority of what’s driving any of the decreases in Western is really all macro-driven, it is not really the underlying health of the business. So as those markets begin to come back online, those should be brought – those should actually be mix positive and favorable from a gross margin perspective.
Okay. Okay, thanks for that. NewSouth orders are up 80% year-over-year. Can you just give a little bit more color as to what’s going on there, I mean, that’s really strong growth? Is it more store openings, aggressive marketing? I mean, what’s really driving that?
I’d say a couple of things. One, we’re tracking a metric now, given our retail storefront of same-store sales. So the stores they previously opened are up 50% year-over-year. So really healthy demand on existing stores. The stores, they’ve opened in both Charlotte, the Panhandle, and we say Houston will be built and finished out in the back-half of this year. We’re – they’re currently building it out as we speak.
We expect definitely more incremental demand from those stores as they get more known into their markets. But the biggest thing is, I’ll draw your attention is kind of their secret sauce of marketing. They’re very heavy TV lead generation machine. They run marketing and promotional campaigns and track leads very aggressively and identify the related installed base to push those leads into homes.
So I think a combination of their – of the business model in itself, it just works incredibly well. And that’s why you’re seeing the sales growth. You had everyone at home. All their marketing efforts are targeted at those people sitting there watching either FOX News or CNN, whatever your preference is and picking up the phone. And the local stores are aggressive in their efforts to follow-up on those leads.
And then with production capabilities, which have improved since we bought the – closed the acquisition, we’ve increased production capabilities for both residential and the commercial lines, but we have more room to go and we’re driving that improvement. So that would be their sauce. It’s the marketing efforts and aggressive follow-up on those leads.
I would add, though, too, just unique to what Jeff has said. The 80% order growth, I think, might be unique to the second quarter just because of that captive audience that is there. So we are certainly expecting continued robust order growth as we’re moving throughout the year.
But we do believe that there was some demand acceleration that came in as a benefit of that captive audience and that very directed advertising. So I’m still continuing to expect healthy growth that maybe not at the same pace as what we saw in Q2.
And that’s reflected in our Q3 guidance. Basically, we’ve built in the NewSouth growth adjusted for what our thoughts could be in Q3 versus Q2 along with organics.
Okay. Okay, fair enough. And then just for clarity, third quarter NewSouth revenue should be above what they reported in 2Q, that $23 million, correct?
I’d say, roughly in line.
Okay. Thank you.
And remember the one uniqueness that is slightly different than our legacy business is there is – the bulk of their revenue will come in at the time of installation, which is a little bit different than what you see in our core legacy business. So as we’re starting to eat through that, that backlog and that pipeline of orders, we talked about earlier in the call, that will play a role in a factor into the timing of the sale.
And that’s why I also mentioned that, we’re trying to hire staff up that installation business. The other thing you got to also consider a NewSouth and we’ve been pretty clear about this is the retail business is really what drives the performance of that brand. And if you look at just the retail business alone, it’s upper – mid to upper teens EBITDA business. The commercial business, however, is not. The commercial business is, I would say, less – way less than 10%, sometimes 5% EBITDA.
So we are literally trying to exit portions of that business that are non-profitable. So you also got that in terms of sales volume in the Q3 year-over-year You got also to – take into account. So we’re not entering – we’re not aggressively pushing that commercial business like they did in Q3 of last year.
Gotcha. Thank you for that, and good luck on the upcoming quarter.
Thank you.
Thank you.
Thank you. Next question comes from Keith Hughes of Truist. Please go ahead.
Thank you. A question on SG&A. It was up year-over-year about the same in the second quarter as it was in the first, and the revenue growth is a good bit lower. Can you kind of talk about what happened on costs on the quarter? And what do you think it’ll look like in the third?
Yes. But Keith, the bulk of what’s driving the SG&A is actually the addition of NewSouth. So that, that is the majority of what you’re seeing in the SG&A increase. We did actually have some SG&A decreases in the legacy business as we were beginning to reduce those discretionary spends exiting in the second quarter and going into the third quarter.
We’ve also readjusted our selling expense at our Western business to be more in line with what we’re seeing on top line sales. So I’d say, you have the increase of NewSouth, partially offset by some of the cost control measures that we put in place.
And the cost work you’ve done on Western, can you give some examples of the types of things you’ve done? And has that been in response solely to the weak revenue, particularly in California? Or is that more structural changes from how they’ve historically operated?
Yes. It’s more – Keith, it’s a good question. It’s more structural changes to how they’ve historically operated. That business was growing and introducing a lot of new products and trying to scale up those products. I think we were struggling. And so we’re more operationally focused now.
For instance, we went from a temporary workforce of probably 60% temps to almost 5% temps now. So we converted folks to full-time. We’re training them, retaining them much longer and we’re getting the benefit of that knowledge staying in the plant. Direct labor has improved, I think, 140 bps…
That’s correct.
Sherri, as a result, as an example. With less people, I think, direct labor in total is down, I want to say, 70 some-odd people versus last year. So we’ve taken labor out. We’ve converted people from temps to perms, and we drill in that percentage down and we’re more efficient.
Another area was distribution. Quite frankly, we had trucks running and routes running to non-profitable locations. And we pulled back on some of those locations, just because it wouldn’t make a profit, concentrate on our core markets. And when – obviously, when we do that, we improve our distribution leverage as well. And therefore, we had roughly another 140 bps improvement in distribution. So we fundamentally – we’re fundamentally changing the way that business delivers product and goes – operationally, goes to market and improving it.
Okay. Thank you.
You bet.
Thank you. The next question comes from Ken Zener of KeyBanc. Please go ahead.
Good morning, Jeff, Sherri.
Good morning.
Good morning.
A lot of moving parts here, not only in the economy, but your business, so you’re staying focused. Congratulations.
Thank you.
Jeff, you commented on the – yes, in fact, it’s really a lot of activities for you. So can we start with the supply chain? And I tend to think about the Southeast more than the West, just because – and correct me if I’m wrong. But with the Southeast, I mean you have extrusion coming in from parts of Canada, you have your glass relationships, which is a very concentrated industry. And I think those plants are fairly close to your facility.
So could you talk about what you’re referring to for that supply chain? And also, on the production side, I know company like Whirlpool, they talked about lower capacity in their plants, because they can’t have the labor located where they usually are. So I mean, can you kind of describe, you got these backlogs coming up, but you must have people spaced out in the factory. So if you lost 20% of your capacity because of that, or just give us some fuel, please?
Yes. I wouldn’t – again, I wouldn’t say, lost, it’s still there. As we introduce technology into the factory, which even though we’ve guided, we’re going to cut our capital expenditures versus last year, still investing. I signed a couple of projects just in last quarter to automate our plants.
So as we automate, we will offset the impact, I think, of social distancing within a line. That’s just going to take a little time. So I don’t think it’s lost capacity. It’s just – we got to figure out how to get it back. We’ve had…
Right.
…we have had to space [battle one]. [ph] And the impact of labor shortage, quite frankly, and running – staffing up to, say, a three-shift operations is difficult right now, given government stimulus and people’s fears. I think all of that goes away. So I think our capacity to both technology and through calming of the environment, all comes back. It’s just a matter of time. I want to make sure I point that out.
Yes.
Secondly, in terms of our supply chain, yes, we’ve had – initially, it was hardware from China. Quite frankly, we had to retool, redo our thoughts there. And we did our supply chain, our supply team is incredible. Those – our team has worked miracles. So, we had to deal with the hardware from China. And then it was extrusions from, say, Mexico and Ecuador and other parts of outside the U.S.
And also even within the U.S., as COVID will shutdown some key suppliers and balances. Quite frankly, we had a balance issue. Again, our supply team, those guys are incredible. They’ve worked miracles to shift and find us other sources of supply. But that has impacted us.
Glass – quite frankly, glasses, I guess is our current one we’re working through. We’ve in-sourced more glass now and trying to respond internally with that problem. But our main glass supplier has struggled, ramping up, again, labor struggled, not capacity in terms of technology, the plants there, the equipments there, they’re just having a COVID. They’re down and they’re having a hard time ramping [Technical Difficulty] some of that and to make sure we can meet our demand.
But with that said, there’s still a supply strain. So that’s kind of a just an overall brush of outsourcing and supply chain.
Right. Really appreciate those comments. Sherri, if you could – you talked about margins up quarter-over-quarter. And I wonder if you might just be able to put that in perspective and I assume you’re referring to EBIT margins. But if you could just put that maybe in some type of basis point perspective or something like that.
And then specifically, because of the NewSouth acquisition, which is perhaps similar to sales to the Western, I used to have a good sense. Could you comment on like kind of how gross margins will go sequentially if we should think about the volume that’s helping you there? Or is it – with the SG&A actions that you’ve taken, is it going to be more on the SG&A side? If you could just give some flavor there? So we have the proper understanding as we enter the quarter? Thank you very much for your time.
Absolutely. So I’ll tackle the EBITDA and then I’ll go back to the gross margin. So the way I would think about EBITDA, and recall that when we were initially talking about second quarter, we expected second quarter to be the lowest EBITDA margin percent of the year. And so we expected that to be the trough of the year and that continues to be the case.
From an EBITDA perspective, the way I would think about it, particularly for Q3 is, I’m expecting that EBITDA margin in the high teens. And that’s going to really be not only from an organic perspective sequentially improving, although I will say that the cost control measures that we’ve seen in both of the business units that we’ve talked about, both the Southeast and the Western has been phenomenal.
So I think that they will continue that same cost control, but particularly in our Southeast business unit, get the benefit of the incremental volume. And then we’re also expecting sequential improvement in our NewSouth business.
So as they’re continuing to get more install as we are continuing to have a heavier mix of our residential business, which the residential business for NewSouth actually has very similar EBITDA margins to our legacy Florida business. So I’m expecting improvements in that margin as well as we’re going into Q3.
From a gross profit – gross margin perspective, I’d say, your margin profile should be fairly similar. The one wildcard, I would say there is just product mix. So there is an assumption that our R&R and new construction will both continue to grow, although, we’re seeing that playing to fruition and our order entry. So I think that’s a very positive sign.
And Western perspective, we’re expecting our production builder mix to continue to improve as those macro markets begin to hopefully open up. So I’d say, similar profile would just maybe that caveat from a product mix perspective.
I appreciate that. So does that mean EBITDA in 3Q will be up year-over-year, even if it’s – I mean, up sequentially from 2Q is what I’m hearing you say clearly. But does that mean is the high teens? Is that the above last year just for a reference point?
Yes.
Thank you
For that EBITDA margins margin is – yes, sequentially and year-over-year, yes.
Thank you.
Thank you. [Operator Instructions] Our next question comes from Josh Wilson of Raymond James. Please go ahead.
Good morning, Jeff and Sherri. Congrats on the quarter and thanks for taking my question.
Good morning. Thank you.
Most of my questions have been asked and answered. But to get a little more clarity on the growth trends you saw in 2Q, as well as what you’re expecting in the third quarter, can you give us a sense of what organic volumes were?
Organic volumes in the second quarter?
As well as…
Is that your question?
Yes, I think [Multiple Speakers]
Yep, yep, yep. So organic volume for the legacy business, which would be Florida plus Western was down roughly 9% in the second quarter, with the balance of the offset being the contribution from NewSouth. And then organically for Q3, I’d say, your organic business is roughly up in the mid single digits and then with the balance being in NewSouth.
Got it. And then the savings you expect from the Orlando consolidation, I think, you guided that today towards the lower-end of the range you were giving before. Is that related to the higher sales than you expected and the difficulty finding labor? Or is there another moving piece there?
No, that’s very much what the key is. I think that is the one assumption is that, we will continue to ramp our capacity up and that we will be able to continue to improve that backlog or reduce that backlog number as we’re moving sequentially throughout the year.
Got it. And then last one for me, what is a good quarterly G&A rate now that you’ve had the impairment?
Let me get back to you on that one. I think, it was…
[indiscernible]
Yes. It would essentially be what we saw in Q2 less the $8 million for the impairment, so.
Thank you.
Thank you. A follow-up question is next from Keith Hughes. Please Go ahead. Mr. Hughes, your line is open.
Sorry about that. Yes, question – a follow-up question on your comment on high teens EBITDA margin in the third quarter. Are you saying EBITDA margins or EBITDA contribution margins in that number, I just want to make sure I have it clear?
In which piece, Keith? I’m sorry, I’m not sure I followed your question.
Yes. On the third quarter, I just want to clarify on margins, you’re expecting high teens EBITDA margins, not high teens EBITDA contribution margin. Is that – do I have that correct?
High teen EBITDA margins. That is correct.
EBITDA margins. That – and that would imply with a flattish or so maybe a little better gross margin, some pretty big SG&A leverage. Now we’re going to get – it sounds like G&A is going to be less. But is there any other things coming in SG&A in the third that would cause the growth year-over-year to be less?
The only other thing that, that would be playing into and it’s not a large number, but it is an important number is the reduction in the selling expense that I mentioned earlier on our Western business. So we did make some structural changes to align our sales structure more in line with our top line sales. So you will see the benefit of that coming into Q3 and Q4.
And you will also see margins from the NewSouth business improving as we exit that commercial business, like I had mentioned earlier, Keith. Sales-wise, it’s going to have negative impact. But margin-was, it’s going to be more enhancing.
That would be gross margin, I assume. Correct, right, Jeff?
It flows through, but yes, gross margin. But their overall EBITDA margin is going to be better as well.
Okay. Thank you.
You bet.
You bet.
This concludes our question-and-answer session. Now I’d like to turn the conference back over to Ms. Sherri Baker for closing remarks. Please go ahead.
We thank you all for joining us today and your continued interest in PGT Innovations. We look forward to speaking with you all next quarter, and hope you and your family stay safe and healthy. Take care.
Conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.