PGT's (PGTI) CEO Rod Hershberger on Q1 2014 Results - Earnings Call Transcript

May. 8.14 | About: PGT, Inc. (PGTI)

PGT (NASDAQ:PGTI)

Q1 2014 Results Earnings Conference Call

May 8, 2014, 11:00 a.m. ET

Executives

Brad West - Vice President, Controller

Rod Hershberger - Chairman, Chief Executive Officer

Jeff Jackson - Chief Financial Officer, Executive Vice President - Operations

Analysts

Robert Wetenhall - RBC Capital Markets

Michael Dahl - Credit Suisse

Sam Darkatsh - Raymond James

Steve Dyer - Craig-Hallum Capital

Rob Hansen - Deutsche Bank

Jeremy Hamblin - Dougherty & Company

Operator

Good day, ladies and gentlemen, and welcome to the PGT first quarter 2014 earnings conference call. [Operator instructions.] And now I'd like to turn it over to your host Brad West, Vice President and Controller.

Brad West

Good morning, everyone, and welcome to PGT's quarterly and fiscal year end investor conference call. I'm Brad West, Corporate Controller and Vice President. And I'm joined today by Rod Hershberger, Chairman and CEO; and Jeff Jackson, Executive Vice President and CFO.

This morning we are pleased to provide an update on our first quarter and our outlook for 2014. Hopefully, everyone has had a chance to review our earnings release issued yesterday.

Before we begin, let me remind everyone that today's conference call may contain statements concerning the company's future prospects, business strategies, and market outlook. Such statements are considered to be forward-looking. These statements do not relate strictly to historical or current facts, rather they are based on our current expectations and are subject to risk and uncertainty.

Actual results may vary materially from those contained in the forward-looking statements. Please refer to our press release and our most recent Form 10-K and other documents filed with the SEC. We undertake no obligation to publicly update or revise any forward-looking statements.

A copy of our press release is posted on the Investor Relations section of our corporate website at www.pgtindustries.com. Included in the press release are the unaudited condensed consolidated balance sheets and statements of operations prepared in accordance with GAAP and adjusted information, which is quantitatively reconciled to GAAP. Our company uses non-GAAP measurements as key metrics for evaluating performance internally.

A detailed explanation of these non-GAAP measurements can be found in our press release, which was included as an exhibit to our Form 8-K filed with the SEC. These non-GAAP measurements are not intended to replace the presentation of financial results in accordance with GAAP. Rather, we believe these non-GAAP measurements provide additional information for investors to facilitate the comparison of past and present performance.

We will provide an overview of our performance for the first quarter of 2014, and after our prepared remarks, we have ample time to address any questions that you may have.

With that, let me turn the call over to our CEO, Rod Hershberger. Rod?

Rod Hershberger

Thanks, Brad, and good morning everyone. For those of you that might be new to our story, we are the premiere impact resistant window and door company. We serve mainly the Florida market with approximately 88% of our sales coming from our core markets. While starts in the first quarter were less than expected, industry forecasts haven’t changed and continue to call for 71,000 starts or a 30% increase during 2014.

We are well-positioned to service this demand, and expect to continue to outperform this growth. We also delivered industry leading margins and significant free cash flow. We continue to invest our cash into our infrastructure to support our growth by expanding our facility footprint with an additional 96,000 square foot building and we’ve added over 165 new employees year to date.

During the first quarter of 2014, our top line growth continued, with sales coming in at $62.7 million, up $13.2 million or 26.6% over the first quarter of 2013. This marks our highest first quarter sales since 2007 and the sixth straight quarter of at least 25% year over year growth.

This strong top line growth was primarily driven by our new construction sales, which continues to outpace the Florida housing market and by marketing programs focusing on our WinGuard products.

New construction sales grew $7.8 million, or 54.1% over first quarter of 2013, driving a shift in our mix, with new construction sales now representing 35% of total sales, up from 29% in the first quarter of 2013.

During the first quarter, Florida single family housing starts were up 1% over the first quarter of last year. However, starts in the Southern Florida coastal counties, which make up our core market and contain a higher percentage of homes priced above entry level, like have increased approximately 10% over prior year.

Additionally, during the first quarter we saw growth in the repair and remodel market, with sales up $5.4 million or 15.3% over the same period last year. Macroeconomic conditions have continued to improve in our core markets, with overall population increasing, new home inventory at low levels, and existing housing prices appreciating. These conditions provide a positive outlook for growth in both our new construction and repair and remodeling sales.

Gross margin was $19.8 million in the first quarter of 2014, an increase of $2.2 million in gross margin dollars or 12.6% from the first quarter of 2013. However, as a percentage of sales, gross margin was 31.5%, a decrease of 3.9% from the 35.4% over the first quarter of last year.

We continue to experience pressure on our gross margin due to an increase in material costs from purchasing finished glass to support strong sales growth and operational inefficiencies in both labor and scrap, resulting from hiring and training our new employees.

Additionally, in order to gain share in both the new construction and repair and remodel markets, we utilized aggressive pricing on certain large projects. These new revenue streams, which cause us to buy additional outside glass, will help increase volume for a new glass facility coming online at the end of the third quarter.

Also, while margins will be impacted in the short term, we will solidify these relationships with our value proposition for long term gain. At PGT, we pride ourselves on our exceptional customer service before, during, and after the sale. As market demand increases, tight project schedules become increasingly important, and our customers in both the new construction and repair and remodel markets embrace the importance of our value proposition and the consistent quality and on-time delivery we provide.

Our selling, general, and administrative expenses as a percentage of sales declined to 21.3% compared to 26.3% in the first quarter of 2013, as we continue to experience strong leverage in this category and a reduction of $1.2 million in amortization expense compared to 2013.

During the quarter, we generated net income of $3.4 million compared to net income adjusted for gain on the sale of the Salisbury plant and related tax impact of $3.2 million in the first quarter of 2013.

EBITDA came in at $7.6 million or 12.2% of sales, up $400,000 over prior year, after adjusting for the gain. We expect our second quarter sales to continue to benefit from our go-to-market strategy as we are currently estimating a year over year increase of approximately 21% to 24%.

With that, I’ll turn the conference back to Brad, who will review the results for the first quarter in greater detail.

Brad West

Thank you, Rod. In the first quarter, sales grew 26.6% over prior year, and we generated a 12.6% increase in gross margin dollars. We leveraged revenue growth during the quarter to reduce selling, general, and administrative expenses as a percentage of sales to 21.3%, compared to 26.3% in the first quarter of 2013, and finished the quarter with EBITDA of $7.6 million, representing 12.2% of sales.

Our cash ending balance for the quarter was $30.8 million, and we generated $3.5 million in cash from operations. As stated in our press release, we reported net sales of $62.7 million for the first quarter of 2014.

Breaking down our sales drivers compared to 2013’s first quarter, we have WinGuard sales of $45.0 million versus $35.4 million, an increase of $9.6 million, or 27.2%; vinyl nonimpact sales of $5.2 million versus $3.9 million, up 33.3% over the prior year; aluminum nonimpact sales of $6.8 million versus $5.3 million, up 28.3%; architectural system and storefront sales of $1.2 million versus $800,000, an increase of 50%; and Eze-Breeze sales of $2.7 million versus $2.4 million, an increase of 12.5% over prior year.

Gross margin dollars increased $2.2 million to $19.8 million for the first quarter of 2014. However, as a percent of sales, gross margin was 31.5% versus 35.4% in the fourth quarter of 2013. Our decrease in gross margin as a percentage of sales was 3.9% and was driven by the negative impact of large project pricing in order to gain share, as well as a shift in mix towards new construction, combined to reduce margins 210 basis points.

The cost of purchasing finished glass units from our third-party supplier to meet the demand from sales growth negatively impacted margins by 170 basis points. Employee-related costs, including increased health insurance costs of over 57%, negatively impacted margins by 130 basis points, and operational inefficiencies related to training and hiring new employees negatively impacted margins by 100 basis points.

These factors were offset by leveraging our fixed costs and higher sales of 100 basis points and the impact of the price increase announced at the end of the quarter 2013, which improved margins by 120 basis points.

As we’ve discussed in previous calls, we are addressing our internal capacity constraints for glass processing to reduce our reliance on outsourced finished glass units by constructing an additional glass processing plant neighboring our current campus. We are on track to commence operations in our new facility near the end of the third quarter 2014, and we estimate this initiative will improve our gross margins by approximately 2%.

Our average cost of aluminum was approximately $0.84 per pound in the quarter, and comprised of spot purchases averaging $0.77 per pound for 54% of our needs and hedged purchases averaging $0.91 per pound for approximately 46% of our needs. This compares to first quarter 2013’s weighted average of $0.92 per pound.

As of today, we are hedged at approximately 36% of our estimated needs through the second quarter of 2015 and at an average of $0.88 per pound. The cash price as of today is approximately $0.79 per pound. During the quarter, some of our aluminum hedge contracts became ineffective for accounting purchases, and as these contracts settle, they’ll be reported in other expense.

Our selling, general, and administrative expenses were $13.4 million. This is an increase of $400,000 from the first quarter of 2013. As a percentage of sales, SG&A costs declined from 26.3% to 21.3%.

Highlights within our SG&A include an increase of $900,000 in selling activities consistent with higher sales, an increase of $700,000 in employee related costs including an increase in healthcare costs. And these items are offset by a decrease in amortization expense of $1.2 million. Additionally, first quarter SG&A costs included $700,000 in customer related selling expenses and $400,000 in amortization expense, which will not repeat in future quarters in 2014.

Interest expense was $900,000, continue to $800,000 in the first quarter of 2013, and our weighted average rate for the quarter was 3.16%. This slight increase in interest expense resulted from increased debt levels in connection our new credit agreement that we entered into in 2013. This increased expense is partially offset by decreased interest rates from the new agreement and increased deferred financing costs.

To mitigate the risk of rising interest rates, we hedge a portion of our debt. This includes a forward starting swap, which will set the LIBOR portion of our interest rate calculation of $40 million of our debt at 2.15% beginning in September of 2014 until the end of the term.

Our tax expense in the first quarter was $2.0 million, and represents an effective income tax rate of 37.0%, which is lower than the statutory rate of 38.8%. This rate is lower than the statutory rate due mainly to the estimated impact of the section 199 manufacturing deduction. As a reminder, we are expecting to become a cash taxpayer during 2014.

We had net income in the first quarter of $3.4 million, or $0.07 per diluted share, versus $3.2 million, or $0.06 per diluted share in the first quarter of our prior year, after adjusting for the gain on sale of the Salisbury plant and the related tax impact.

EBITDA was $7.6 million for the first quarter of 2014, versus adjusted EBITDA of $7.2 million for the first quarter of 2013. This increase of $400,000 is due primarily to $4.0 million attributable to higher volume and $1.2 million resulting from the impact of our price increase.

Offsetting these factors was large project pricing as well as the shift in mix towards new construction of $1.5 million, an increase of $1.5 million for employee related costs, an increase in material costs of $1.1 million due to the purchase of finished glass units, and the $700,000 impact of operational inefficiencies resulting from recent hiring to meet increased demand for our product. A reconciliation of net income and EBITDA which I have just discussed has been included in our earnings release for your reference.

Turning to our balance sheet, as of March 29, 2014, our net working capital, excluding cash, deferred income taxes, and current debt, was $25.1 million, which increased $2.3 million during the quarter, driven mainly by increases in AR and inventory to support sales growth.

DSOs decreased to 32 days at the end of the first quarter, continue to 35 days at the end of our subsequent quarter, and in line with 32 days at the end of the first quarter 2013. Inventory turns increased to 11.8 from 11.4 at the end of our subsequent quarter, and have increased significantly from the 10.0 at the end of the first quarter 2013. This improvement is primarily due to managing our lead times on raw materials purchased from our suppliers and holding inventory in check as sales grow.

Our free cash flow for the quarter was $1.9 million, mainly driven by EBITDA, excluding noncash items such as stock compensation of $8.1 million, offset by an increase in working capital of $2.3 million due to higher sales demand. We also paid $3.2 million in capital additions, mainly associated with our glass plant expansion, and cash paid for interest was $700,000.

At this time, I will turn the call over to Jeff for some summary remarks.

Jeff Jackson

Thanks, Brad. As Rod stated above, this marks our highest first quarter sales increase since 2007, and the sixth straight quarterly increase of at least 25% year over year growth. To keep up with this demand for our products, we’ve added over 165 employees this year, and over 400 employees in 2013.

Currently, our base is 1,582 employees. The last time our sales run rate was at this level, we had approximately 2,200 employees, which shows the successful of our restructuring efforts during the downturn.

We are working hard to get our new folks up to speed, but do anticipate continued inefficiencies in the second quarter as we continue to hire employees to meet the estimated 21% to 24% increase in sales.

We have implemented specific initiatives towards training our new employees in both production consistency and quality. We will continue to monitor this progress through various performance management practices and matrices.

Also, our new construction sales grew 54.1%, which significantly outpaced the Florida housing market. As we continue to invest in our customer relationships and PGT brand, we believe a normalized housing starts in Florida for our current population of approximately 19.5 million is around 110,000 starts a year. The long term outlook is very positive.

Our company generates strong free cash flow, as a result of our higher than average industry margins and our low maintenance capital requirements. In 2013, when excluding working capital increases necessary for higher sales, we generated free cash flow of approximately $27 million. This year, we will generate enough cash flow to fund our entire construction of our new glass plant operations.

Our cash flow gives us the opportunity to invest in brands, expand operations when appropriate, and absorb market fluctuations when they occur. Looking into the second quarter, we continue to see double-digit growth. We expect to capitalize on improving economic conditions, especially in Florida, our core market, as well as capitalize on investments in consumer promotions and advertising.

In fact, sales in April represent an increase of approximately 24% over the same period a year ago. Based off current orders and our backlog, our estimated top line sales for the second quarter is a range of $76 million to $78 million, continue to top line sales of $62.8 million in the second quarter of last year.

We have consistently outperformed our markets, and we will continue to focus on taking share, improving operational efficiencies, and seeking growth opportunities to grow the footprint within the window and door industry.

In the short term, EBITDA margins will likely remain in the mid-teens, as we will see some overflow from our first quarter large project pricing into the second quarter and we continue to address inefficiencies in labor and material usage.

Lastly, we are excited about the opportunities our new glass plant will bring as it becomes operational at the end of the third quarter of 2014. This will both improve margins on incremental sales and help secure our customers and better serve them into the future.

With that, I’ll conclude, and we’ll be happy to answer your questions.

Question-and-Answer Session

Operator

[Operator instructions.] Our first question is from Robert Wetenhall of RBC Capital Markets.

Robert Wetenhall - RBC Capital Markets

After the addition of the new glass [unintelligible] this year, you should be able to produce about $280 million in revenue, which is in line with current consensus estimates this year. So how do you think about the need for additional capacity after the current plan is finished, in light of expectations calling for continued growth in Florida housing starts?

Rod Hershberger

As we look at future capacity and potential constraint needs, within the glass facility itself, what we’ve done, by adding tempering and cutting capacity, we feel we can meet the tempering and cutting needs up to about approximately $320 million, $330 million or so, in sales.

The next kind of constraint we run into when we value add to glass is in laminating and insulating. So what we’ll do most likely, given our sales run rate, by the fourth quarter, first quarter of next year, we will start adding equipment associated with those two value-adding processes.

And what we did strategically was build that glass plant facility big enough, 96,000 square feet I think it is, where it will hold additional equipment as we run into those capacity constraints. From an assembly standpoint, what we feel we’ve done in the past and what we think we can do now based off our product professional, is from an assembly standpoint, we think we can get up to about $330 million to $340 million of sales out of our assembly plant.

Jeff Jackson

Just to put it in perspective, the new facility we’re building for glass is a little bit larger than the existing one that we have, so we’ll have room to add a lot of equipment in that facility, plus we have additional acreage right beside that that we can expand as we need it, also. So from a land standpoint, we’re in good shape. From a footprint standpoint, on glass, we’re in good shape, and we have room to grow in the manufacturing portion of it, the assembly of the frames, if we need to.

Operator

Your next question is from Michael Dahl of Credit Suisse.

Michael Dahl - Credit Suisse

I can appreciate how difficult it is to manage a business that’s growing this sharply, but clearly has seen the gross margin pressures for about a year now, and now the large project pricing. So hoping you can be as specific as possible about the whole large project issue. What are they, how long will it take for this business to flow through, what percent of the mix do you see this as going forward? And how do you plan to raise the margin profile on business like this over time?

Rod Hershberger

The large project sales are projects that we entered into in Q4 and Q1 mainly, so they represent sales in Q1 and Q2. It wasn’t a substantial portion of the total sales in Q1, about $3 million. And it was both new construction and R&R. The new construction projects were also not just residential, they could be condos. And on the R&R side, they were typically multifamily or condo, kind of replacement.

We do expect to see this still have the same impact, not in the second quarter to the same degree as in the first quarter, but it will bleed out during the second quarter. And we are no longer as aggressive as we were in the first quarter attacking certain competitors to gain these sales. But what these sales represent are new relationships and new opportunities for us to grow, especially if you consider the commercial market and the condo market and the growth that we’re seeing there.

And as a margin profile, we believe that this is short term in nature and temporary. In terms of the mix component, we did see growth in new construction, going from 29% to 35%. And a good portion of that growth came from the contract that we gained with big home builders in the state, a lot of which was to get their nonimpact production or sales.

And as a result of those sales, that has added to the mix component, since our nonimpact products don’t come at the same margins as our impact margins do. But in terms of the margin profile on large projects, about 110 basis points of the 210 basis points is what we estimated impacted our first quarter.

Michael Dahl - Credit Suisse

And then to tie it together, then, how should we think about gross margin progression through the year? Can we still get to the 34% or 35% range by year-end?

Rod Hershberger

As the glass plant comes up online, we have said that that is a 2% increase. So that absolutely will help a great deal, when we see that come online. That would be the key component. Until we get to that point, I think it’s going to be difficult to get to the 34%/35% number.

But certainly, once we have that glass plant online and we get those two points back, those numbers are certainly in reach. We have the operational efficiencies that we’re working on, and 100 basis point impact in this quarter is actually one of the lower impacts that we’ve seen since this time has begun, and we’re continuing to make strides there.

So we feel that that’s not a long term margin pressure, just a short term, as we keep employees in line for the new glass plant. And ultimately, when the glass plant comes online in the fourth quarter, we should be able to see those margins back to that 34% to 35% range.

Operator

Our next question is from Sam Darkatsh of Raymond James.

Sam Darkatsh - Raymond James

As a follow up to the last question, the 2 points of gross margin from the glass plant, what is the incremental depreciation from the glass plant, just so we can get a sense of what the overall accretion might be once it’s up and running?

Rod Hershberger

The total purchases of that glass plant will total about $14 million. That breaks down to about $2 million of land, about $7 million of building, and about $5 million of equipment. Obviously, the building depreciation is a little immaterial. So the $5 million of equipment will begin to appreciate in earnest next year. And that will probably be about $750,000 to $1 million of depreciation per year on the equipment. It ranges between 5 to 7 years.

Sam Darkatsh - Raymond James

So maybe $200,000 or $300,000 a quarter for extra depreciation, then?

Rod Hershberger

$300,000 at the high end, I would say.

Sam Darkatsh - Raymond James

Okay, so you’re looking at it, at a current run rate, somewhere between $1 million and maybe $1.25 million or so, and incremental EBIT once it comes online?

Rod Hershberger

Incremental depreciation expense against the EBIT, yes.

Sam Darkatsh - Raymond James

I’m talking about 2 points of gross margin coming on a $76-77 million sales run rate, less the $200,000 or $300,000 of depreciation, right?

Rod Hershberger

It certainly depends on the sales level that you apply against the 2%, but yes.

Sam Darkatsh - Raymond James

And then can you talk about the acquisition pipeline? What are you seeing out there? How fertile? What do the multiples look like? How willing are folks to sell? And what type of debt to EBITDA ratio would you be comfortable operating on a post-deal basis should something come to fruition?

Jeff Jackson

Some of those are pretty tough to answer at this point, but we’ll take a good shot at it. The pipeline is larger now than I’ve seen it in probably in the last six, seven, eight yeas put together, through the downturn.

People are seeing things turn around, and companies that had targets for returns, I think, are pretty active in the marketplace. But it’s really early in the marketplace. We’re seeing opportunities at a much greater rate, and we’re looking into some of those opportunities, but it’s really early in the process right now. Numbers that we’re hearing, and it depends if it’s a public company or a private company when you’re looking at it, but good company multipliers probably in the 7x EBITDA.

Some people would like to see a little bit more depending on how the company is performing, depending on the size of the company and depending on where they’re at. And the companies are really spread out.

It’s kind of interesting that some of them are a little more local in nature, some of them are national in nature, some of them are localized to the geographic area that they’re in. And we’re seeing them pretty much all across the nation in almost all of those categories, from a couple of national players to a small kind of mom and pop, $10 million to $40 million companies.

So the opportunities, I think, are definitely going to be there. So it’s going to be incumbent upon someone to take a really close look and understand how that fits, how the financing works. I think there will be a lot of work done on making sure that it’s accretive.

You know, everyone likes to talk about synergies and cost savings, and I think you’ve got to be really careful when you do that, because it’s tough to prove what you really can do and what each company brings to the table, and how you put that together and make sure that it’s accretive and you don’t factor in too much fluff to make it work.

Jeff Jackson

A little bit more comment on the leverage part. Right now we’re a little over 1x. I’m personally comfortable going up to 3.5x, maybe 4x, depending on the potential candidate. We do generate, as you know, strong free cash flow, so that’s not an issue. And assuming we get a nice company in terms of its EBITDA performance and we enhance that, it will even make it easier to pay that debt down over time to deleverage.

So we will be very picky on the type of candidates we look for. We’ll look for, obviously, their EBITDA and their margin profile, because we do not want to damage our current margin profile. If anything, we want to enhance it as we look at these candidates.

And in terms of trading multiples, I’ll expand that a little bit. We’ve seen them all the way from six to maybe a high of nine. And it all depends on scale and position they currently have in the market.

Sam Darkatsh - Raymond James

Are you saying that you would like for it not to be margin dilutive? Can we then infer that you would be primarily looking at impact businesses from an acquisition standpoint?

Jeff Jackson

We would be looking at specialty businesses from an acquisition standpoint, impact being one of those.

Rod Hershberger

We would have to be convinced that it would not be margin dilutive. And I hate to put a timeline on it, but approximately, by the end of the first year we’d have to be able to look at the company and make sure that if the margins aren’t quite there, that it’s a very clear path to get there.

Sam Darkatsh - Raymond James

And you’re talking EBITDA?

Rod Hershberger

Yeah, EBITDA. And to a certain extent, gross margins. Let’s say, in your words, it is an impact related acquisition. Right away, with our glass plant coming online in the third quarter, we’ve got instant volume. And obviously, doing our own glass, that’s an immediate savings of 10% or so from the incremental sale, which will be obviously accretive to the transaction. So there’s definitely some upside out there, opportunities out there, and we are looking.

Sam Darkatsh - Raymond James

How important is the location geographically to you, meaning Florida versus non-Florida?

Rod Hershberger

You know, 50-50. What’s more important is the company itself and the brand and the product and the market they serve. So we’re not just looking at geographic. Obviously, Florida is in our backyard, so we’d probably be able to I won’t say nail it, but be a lot more successful at something in our own backyard. But there are also some very attractive outside the state opportunities that could generate higher margins as well.

Operator

Your next question is from Steve Dyer of Craig-Hallum.

Steve Dyer - Craig-Hallum Capital

Just a couple of follow ups. Most have been answered. How do you think about EBITDA margins after the glass facility kind of gets up and efficient and running? Is it still reasonable to think kind of upper teens or is that going to be kind of too much to ask as you look into next year?

Rod Hershberger

No, I think upper teens is very reasonable once the glass plant is up and running.

Steve Dyer - Craig-Hallum Capital

And would you anticipate that there’s going to be a similar hiring push with that as well? I know that sort of hamstrung you with margins the last several quarters in the primary facility, but is that going to result in a big staff-up as well?

Jeff Jackson

You know, in any given quarter, like the first quarter we open it up, I would say sure, we’re going to continue to hire. We are hiring now, and in hopes to leverage those hires into that glass plant. Unfortunately, you have to start further out, given the sheer magnitude of people we’ve hired. What we’ve learned is it takes more than the traditional six months to get a production worker up to speed. It’s more like close to nine months to a year.

And so with that knowledge now in mind, after a year and a quarter of this kind of growth, with that knowledge in mind, we are proactively hiring for that glass plant. And so some of the results, unfortunately, you see in the first quarter is just that, it’s an investment into the future. When it works, it’s going to leverage extremely nicely.

But with that said, given the amount of turnover, in just the industry we work in, I do anticipate hiring still in the third quarter of this year and into the fourth quarter, assuming the growth continues, albeit hopefully not at the same pace of hiring that we’ve had.

Rod Hershberger

One of the things we’ve talked about in the past, and we continue to see, is that when we’re growing in that mid-20% and above range, we’re having to hire a lot of people and bring them in and train, and it’s hurting our margins to a certain extent.

We’ve seen that pretty consistently, even to the point where when we have months that are a little bit flatter, we see margins go up, because we’re not necessarily adding as many employees in a given month or two. So what Jeff was talking about, we’ve definitely been able to see and we’ve been able to prove out with our performance. So going forward, we think we’ll see that.

Maybe as a note, we’ve hired 500 and some employees in the last 15 months or so, so almost half of our manufacturing employees are around a year or less, and that’s a pretty big digestion to have for any company, I think, and we’re seeing a little bit of the results of that. But we’re very confident with what we’ve seen in periods of time through that 15-month period, that we can perform very well.

Jeff Jackson

I’ll give just a little bit more color to that, just to help bridge it with some data. During the fourth quarter, our direct labor was 10.4%, which was a good number. We know we can beat that, actually, over time, however. This quarter, it was 11.1% of sales. During the fourth quarter of last year, we had a net hiring of about 14 people. During this quarter, our net hiring was 118. Net meaning after people had left. So when we get to a levelling out point, we will run extremely efficient.

Rod Hershberger

Yeah, even just replacing turnover is not that hard to do. It’s when we’re growing and adding people that it becomes a little more difficult.

Steve Dyer - Craig-Hallum Capital

So more near term, I guess, on the gross margin line, should we sort of think about kind of more low 30s, 31/32, as opposed to more mid, at least until we get that glass facility up and running?

Jeff Jackson

Yes, until the glass facility is up and running, I would definitely think lower mid than middle mid. April has already improved in terms of gross margin by about 80 basis points. But you know 32, 33 gross margin until the glass plant is up and running, that’s what we’re shooting for.

Steve Dyer - Craig-Hallum Capital

And then just kind of a couple of off the beaten path. The commercial business, any thoughts or commentary therapeutic? I know South Florida commercial real estate doing quite well as well. Any sort of a renewed push into that area for you guys?

Rod Hershberger

We’ve actually put more feet on the street. We’ve added a couple of sales reps that really focus on what we call the commercial market. To define that for us, it’s really the condo market, high-rise condos and that type of thing, as opposed to an office building or something that may take curtain wall or something in it.

So we’ll get the storefront on the bottom. One of the things that we see is the product lines that we have get us into those buildings, and the focus on condo boards and architects and engineers that are speccing those jobs are getting us more jobs. And, you know, not a huge portion, but part of that was the result also of our price push that we talked about in the fourth quarter and first quarter that affected us a little bit.

But the ability to get in there and now, instead of pricing things to get on the job, we’ve got some of those jobs, we get specced on those jobs. There’s a lot of difference when you’re bidding a job when you’re specced by the architect and the engineer than when you’re walking in and you’re other, and you’ve got a bid against someone that’s had that job before.

So we’ve seen significant success in that. It doesn’t all play out immediately, because a lot of those jobs, when you’re dealing with condo replacement, or even condo building, we’ll be working on jobs for a year or two before they actually come out of the ground or get replaced. But we’re pleasantly pleased with our success in that category.

Steve Dyer - Craig-Hallum Capital

And then lastly for me, R&R, you’re obviously going to start anniversarying some pretty tough comps there. What’s your general feel on kind of the R&R market and your role within it? I know refis have obviously come in a lot, to the extent that that drives that business. How are you feeling about that business? Can it go into the summer?

Rod Hershberger

As we all know, living in Florida, we’re about three weeks away from hurricane season. A whole lot different driver than I think the rest of the country gets to see. So there’s a lot of awareness with storms, and even though we haven’t had one for eight years, we are aware that they come, and people that live here are pretty aware, but even newcomers that come in ask a lot of questions.

So I think from an insurance code driven process, there’s an opportunity for us to continue to gain some share in the R&R market. Our market’s driven a little differently, I think, than the national market. So I’m not going to say we’re sitting here terribly optimistic, because we had a great year last year in R&R, but the drivers are a little different, I think, than the national market.

Operator

Our next question is from Rob Hansen of Deutsche Bank.

Rob Hansen - Deutsche Bank

I just wanted to ask about the potential for expanding the laminating and insulating capacity next year. What’s going to be the primary driver of your decision? Is mix going to be a large factor? And then would you expect there to be any impact on the gross margin or are there sources of glass that’s already laminated and insulated? Or is it going to be where it’s slower to get the product to your customers? How does that kind of play out?

Jeff Jackson

The initiative we will undertake to expand both the lamination and IG side of the business will surely be volume driven. Mix is getting better on the impact side, but that wouldn’t be the driver of the volume that we see coming in the future. We want to make sure that volume is on a sustained run rate before we invest capital in that equipment.

If we don’t, we would be buying that glass from the outside, so obviously that would be a margin hit. So when we buy the capital, you’re talking a laminating line and a [clave]. Probably $2.5 million for something like that. You know, the building’s already built. An IG line is probably $1.5 million. Again, we’d try to get the latest and greatest technology on some of this stuff, like we did with our tempering ovens.

So that’s the kind of capital. And you’ve got to keep in mind, the last time we bought those kind of lines, it’s been several years. You really leverage those lines over a long, long period of time. And our goal is to make 99% of our glass in house, so we can control both the quality, the price, and on-time delivery to our customers.

Rod Hershberger

There’s some code changes coming in Florida next year, and it should drive additional IG needs. We’re aware of that. We were actually involved in the code changes, making a lot of the proposals that drove the code changes. So we’re aware of what’s happening there, and we’ve got product that we’re ready to roll out. And it may change the IG needs a little bit. Not necessarily the laminated needs, but the IG needs. And so we’re prepared for that.

Rob Hansen - Deutsche Bank

And those code changes, are those statewide? Or are they more at the different local level?

Rod Hershberger

It’s statewide, and it’s energy codes. I say it’s statewide. It’s a statewide code that’s changing some of the requirements for energy efficiency, depending on which part of the geography you’re in.

Rob Hansen - Deutsche Bank

It looks like you’ve bumped up being fully operational in your glass plant to the end of Q3 as opposed to the end of Q4. Is that correct? And if so, what drove that?

Jeff Jackson

We’re going to turn on the switch at the end of the third quarter, fully operational. I’m expecting a couple of months of kind of training, getting things going, getting volume through, but we’ve been consistent. The glass plant’s going to be online at the end of the third quarter, and is operationally efficient as soon as possible. It will be during the fourth quarter. I can’t tell you when. It will be as soon as possible, based off our people and our training.

Rob Hansen - Deutsche Bank

And then one last one was, you know, you put out an 8-K just recently about your relationship with Royal Building Products and I believe this is in relation to changing your vinyl window platform. So I wanted to see if you could talk a little bit more about what you’re doing there and if there were any impacts on your business this quarter as a result of that.

Jeff Jackson

No real impact on the business this quarter. What we are doing, as vinyl becomes more of a predominant framing material of choice within Florida, in our core market, what we’re doing is expanding our product offering there. And we call it Ultimately Vinyl.

And we came out with obviously, you know, the French door this year, sliding glass door two years ago. So we’ve already started that effort, and our goal is to make the margins we make in vinyl equivalent or better than those that we make on aluminum. And right now, they’re not. We make more margin dollars in aluminum than we do vinyl.

So what we’re going to do is reengineer our window platform, both impact and nonimpact and basically, consolidate it to one supplier. That supplier is going to be Royal, and that’s the agreement that we filed an 8-K with.

We’ve been in design stages with them in terms of the window. It will run down the same line, for instance. It will free up plant space. That’s why I think ultimately we’ll be able to get even more production out of this plant than we’ve done in the past, because we’re going to free up some line space, square footage.

So it’s actually a positive thing. We plan on launching the first series of products the first quarter of 2015, and this should both enhance our vinyl margins as well as improve our presence in the vinyl side of the business and the industry.

Rob Hansen - Deutsche Bank

What kind of delta are you looking at in terms of the margin change?

Brad West

It depends on the product, but generally speaking, all things considered, our aluminum window versus our vinyl window, it’s generally about 5 to 7 points. So that would be the difference that we’re expecting to make up.

Operator

The next question is from Jeremy Hamblin of Dougherty & Company.

Jeremy Hamblin - Dougherty & Company

Did you give an April sales number on a year over year basis?

Jeff Jackson

Yeah, I mentioned April sales grew 24% year over year.

Jeremy Hamblin - Dougherty & Company

How did that compare to March and February?

Brad West

Year over year? March grew 22% and February grew 41%. And you didn’t ask, but January grew 18%.

Jeremy Hamblin - Dougherty & Company

And let me just ask, then, about going after these larger projects. As this industry has really rebounded nicely, and I think both you and your competitors are also seeing nice growth, I’m surprised that it sounds like the pricing environment is actually getting more competitive, despite the fact that there’s a lot more business to be had. Or was this just truly about a strategic choice that you are making in the hopes that you will have long lasting relationships on these large projects? Can you talk a little bit more in terms of pricing and whether or not you thought you could take additional price increases moving forward on your traditional WinGuard products?

Rod Hershberger

This was strategic. When we looked at the marketplace, we looked at areas we thought we could grow and sustain that growth over a long period of time. To us, it’s really important that we never look at it by the quarter or even by the half of the year. Maybe sometimes the effect that it might have in this year, but look at it for long term.

So there are some projects out there that right now, as you look at the bid process, you’re bidding on phase one of maybe five phases. And we weren’t necessarily specced on phase one, but we wanted to go in and bid it, knowing that phase two was going to be another bid process, phase three was going to be another bid process.

But we believe our value proposition is so strong that once we get in on one phase, it allows us to bid the second one and the third one, with much less competitive bids out there. And we’ve seen that in the past. So this isn’t the first time we’ve done this, and say let’s see how it works.

This is just the opportunity to do that, as we look forward for the remainder of the year and realize we’re going to have some capacity glass-wise, because some of these projects are two-year projects or longer. And they’re not contracts in place for two years, they’re just if all five phases are going to last that long.

So very strategic, when we looked at some of those projects. Also, as we looked at some of the condos, we knew we wanted to have a bigger presence in the condo market. And the interesting thing about the condo market is you pick out kind of a signature condo and everybody knows that it’s PGT’s product in that condo. And it makes all the condos around it, particularly with success on that condo, much easier to bid.

So everything we did, pretty much, on this condo process, was really kind of a strategic focus to say, where are we at as a company, how do we make sure that we’re positioned correctly for our new glass facility, how do we make sure we’re positioned correctly for the markets that we want to serve long term, and are we confident that we can get it?

And to, I think, the latter part of your question, will pricing stick, we saw the price increase that we had last year stick pretty well for that general pricing. This was the competitive pricing that we put out there to get a couple of projects.

Jeremy Hamblin - Dougherty & Company

Yeah, no, I was asking specific to your traditional WinGuard product, whether or not you thought you had additional pricing power, and whether or not you might use that going forward.

Rod Hershberger

Again, we’ve talked about that in the past, and we think that that’s definitely an advantage for us, particularly with the market share that we maintain. And you know, last time we announced, the price increases stuck. We think the next price increase will stick also. We see competitors having some capacity constraints also. So I know that as we go forward there will be a little more pricing pressure in our market.

I think nationally, what you see is things haven’t gone necessarily as well as what people thought, so there’s a little extra capacity out there. But we’re not seeing quite as much of that in the state of Florida.

Jeremy Hamblin - Dougherty & Company

Coming back to the large project pricing and the strategy behind this, when you guys had your conference call a couple of months ago, I would say obviously people were a little bit surprised to see the degradation in gross margins to where they were. Was this something where you feel like you had communicated this and people missed it? Or is this kind of strategic choices that had been made post that call?

Rod Hershberger

We don’t give guidance. The guidance that we give is generally we’re a month in by the time we have our call, so we see what that month has done on a top line. And from a future point of view, obviously you can drive by our plant, you see a new glass facility going up, and they’re putting steel up there and it would be kind of disingenuous of us not to be talking about that, because it’s something that we’re doing. But as far as our internal strategy for how we attack the market, it’s not something that we’ve really given guidance on at any point in time.

Jeremy Hamblin - Dougherty & Company

And then just in terms of the healthcare costs, the other aspect, on gross margin drag, are those purely transitory? Is this kind of one-time, specific to Q1? Or is that something where because you’ve had so many hires, that we should be expecting those adjustments to your accruals to continue to flow through in Q2/Q3?

Rod Hershberger

When we disclosed the impact of the cost of healthcare, what I was referring to there was the actual cost above what I would consider volume driven, the cost of the new employees just on a volume basis. To us, it’s considered part of the contribution margin. But in the first quarter, we did experience cost per person, if you will, in excess of what we had in the first quarter last year, of that 57% number. And looking at the details of those claims, they were mainly several large claims as opposed to just every single claim going up by a bunch.

So we do experience additional healthcare costs, or expect additional healthcare costs, just because that’s what the industry is experiencing, that’s what the country is experiencing, but first quarter, in terms of its kind of excess of 57% growth, is more around large claims that are not likely to reoccur.

Operator

This ends the Q&A portion of today’s conference. I’d like to turn the call over to Mr. Brad West for any closing remarks.

Brad West

Thank you for joining us today, and I want to thank our employees for their continued efforts and hard work. And we look forward to speaking to you again next quarter. If you have any further questions, please call us. And have a good day.

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