Ferro's (FOE) CEO Peter Thomas on Q2 2016 Results - Earnings Call Transcript

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Ferro Corporation (NYSE:FOE) Q2 2016 Earnings Conference Call July 28, 2016 10:00 AM ET

Executives

John Bingle - Treasurer and Director, Investor Relations

Peter Thomas - Chairman, President and Chief Executive Officer

Jeff Rutherford - Vice President and Chief Financial Officer

Analysts

Jermaine Brown - Deutsche Bank

Mike Sison - KeyBanc

Rosemarie Morbelli - Gabelli & Company

Mike Harrison - Seaport Global Securities

Matt Skowronski - Longbow Research

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Ferro Corporation 2016 Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Thursday, July 28, 2016. I would now like to turn the conference over to John Bingle, Treasurer and Director of Investor Relations. Please go ahead, sir.

John Bingle

Thank you. Good morning and welcome to the Ferro Corporation 2016 second quarter earnings conference call. Joining me on today’s call are Peter Thomas, Chairman, President and Chief Executive Officer and Jeff Rutherford, Vice President and Chief Financial Officer.

Our quarterly earnings press release was issued last night. You can find the release, including reconciliations of reported results to non-GAAP data that we will discuss this morning and supplemental slides for the call in the Investor Information section of Ferro’s website, www.ferro.com.

Please note that statements made on this conference call about the future performance of the company may constitute forward-looking statements within the meaning of federal securities laws. These statements are subject to a variety of uncertainties, risks and other factors related to the company’s operations and business environment, including those listed in our earnings press release and more fully described in the company’s Annual Report on Form 10-K for December 31, 2015.

Forward-looking statements reflect management’s expectations as of today. The company undertakes no duty to update them to reflect future events, information or circumstances that arise after the date of this conference call, except as required by law. A dial-in replay of today’s call will be available for 7 days. In addition, you may listen to a download or replay of the call through the Investor Information section at ferro.com. Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of Ferro is prohibited.

Before we begin the call, I would like to clarify a statement in the press release from last night. In the release, we indicated that our prior adjusted diluted EPS guidance was $0.93 to $0.98. We gave this guidance at the time of our last earnings release, but subsequently updated the guidance to $0.95 to $1 per share when we acquired Pinturas Benicarló. Our current guidance of $1 to $1.05 includes the expected results from this acquisition.

With that, I would now like to turn the call over to Peter.

Peter Thomas

Thanks John and good morning everyone and thank you for joining us today. As you saw in our earnings press release, we delivered another strong quarter with increased sales, significantly higher gross margins and continued growth through acquisitions. We generated strong increases in key financial metrics as we continued to transform our company through our value creation strategy. Our performance reflects the benefits of our disciplined approach to executing on our priorities and positions us well for the remainder of 2016 and beyond.

In the second quarter we delivered a 14.6% increase in net sales on a constant currency basis. A 33% adjusted gross profit margin, up from 29% last year, an increase in the adjusted operating profit margin of nearly 440 basis points to 15.2% and adjusted EBITDA of $57 million; a 51% increase over the last year; a 19% adjusted EBITDA margin up from 13.9% last year; and 11.6% adjusted ROIC, excluding acquisitions on less than 1 year; and we completed our second transaction of the year with the acquisition of Pinturas Benicarló, a manufacturer of specialty organic coatings for the container glass market. All-in-all, it was pretty good quarter. And although we continue to face some economic headwinds in some markets, we are enthusiastic about our prospects for the rest of the year. Based on the strong quarter, we are increasing our adjusted EPS guidance to $1 to $1.05 per diluted share.

So let me recap the quarter for you. If you turn to Page 3 of the conference call presentation deck, you will see a chart illustrating our quarterly sales trend. Net sales for the quarter were $298 million compared with $259 million last year. Our base business was flat year-over-year while acquisitions owned less than 12 months contributed $39 million to sales growth. This trend is in line with our prior guidance. Note however, the historical data shown here, excludes divested businesses and product lines. So the 2015 sales exclude our Venezuela operations, which we sold in the fourth quarter of 2015. You also see on this chart our improved profitability trend. Part of the increase in profitability is being driven by higher gross profit margins in all of our reported segments. As I stated before, our consolidated adjusted gross profit margin improved by approximately 400 basis points to 33%. In the quarter, we benefited from increased sales volume, improved manufacturing efficiencies, product reformulations and lower energy and raw material costs.

Now turning to our segments, if you will turn to Page 8 of the conference call deck, you will see our results Performance Colors and Glass. On a constant currency basis, net sales declined by approximately 2.3%. The reduction was primarily related to lower demand for products used in electronics applications and to a lesser extent, for products for decorative applications. Demand for automotive related products continue to be strong with net sales in this product line increasing by 7.5%. Despite the overall sales decline in this segment, the gross profit margin continued to improve, reaching a level of 38.3%. For the second half of the year, we expect this segment to meet our prior net sales guidance of low single-digit sales growth on a constant currency basis. For the full year, we expect constant currency sales for this segment will be relatively flat and that the segment’s annual gross profit margin will improve by 150 basis points to 200 basis points compared to the level achieved for the full year in 2015.

On Page 9 of the conference call presentation, we cover our Pigments, Powders and Oxides business. For the quarter, constant currency sales more than doubled to $61 million with Nubiola adding $31 million in the period.

Excluding acquisitions on a constant currency basis, the PPO segment increased sales by 1%. For the quarter, the adjusted gross profit margin improved to 36.5% compared with 30.9% last year. For the full year, we expect base sales growth, excluding acquisitions, in the mid single-digit range. The full year gross margin is expected to improve by 250 to 300 basis points compared with last year’s adjusted rate of 31.2%.

And for the Performance Coatings segment as you can see on Page 10 of the slide deck, constant currency sales for the quarter increased by 7.1%, including the results of Al Salomi, which contributed approximately $6 million to the quarter. Excluding acquisitions, constant currency sales increased by 2.2%. For tile, we continue to see a nice rebound from what we experienced during 2015 with improvements in Indonesia, Thailand, China and Egypt as well as strong growth in Mexico. The segment adjusted gross profit margin also improved quarter-over-quarter, increasing to 27.9% from 25.5%. For the year, we expect constant currency sales growth, excluding Al Salomi in the mid single-digit range and anticipate Al Salomi will add approximately $25 million. This higher growth of the Performance Coatings segment in the second half depends on the continued rebound in Asia and North Africa. For the full year, we expect total gross margin to improve 100 to 125 basis points compared with the segment’s 2015 reported gross margin of 24.5%.

So to sum up, we had a very good first half of the year. Our global team produced strong results. We delivered increases in our key financial metrics and we are successfully integrating our recent acquisitions and benefiting from their contributions to earnings. Having said that, there are ongoing challenges. Economic conditions in Brazil and Argentina continue to be difficult. Currencies continue to be volatile and the economy in Turkey maybe adversely impacted by recent events. Consequently, although we are optimistic about the remainder of the year, we recognized there are risks in the second half that could jeopardize our growth.

So with that, I will turn the call over to Jeff.

Jeff Rutherford

Thank you, Peter and good morning everyone. Recently, we implemented a different format for our quarterly conference call to reserve more time for your questions. In keeping with this, my comments this morning will be brief. I will discuss a few noteworthy items in the quarter and then provide an overview of our increased 2016 guidance. The major adjustments in the quarter, which were reported as one-time items and have been excluded from adjusted earnings, include the following.

During the quarter, we recorded $800,000 of restructuring charges, primarily associated with continued integration of the Nubiola acquisition and we recorded $4.8 million in SG&A primarily associated with third-party M&A and acquisition integration costs. In other income and expense, we recorded a $700,000 charge primarily associated with the finalization of the purchase price adjustments for the Vetriceramici acquisition. During the quarter, working capital from continuing operations was a use of cash of $29 million with receivables and inventory accounting for the majority of the change increasing by approximately $19 million and $10 million respectively.

The increase in accounts receivable was primarily related to a sequential growth in sales and a shift in our sales mix towards customers principally within the Performance Coatings segment with longer payment terms. Inventory increased across many of our manufacturing facilities with the Americas accounting for the largest increase. The increase in the Americas was driven by an upturn in manufacturing activities in anticipation of higher demand in the region in addition to higher inventories in Colombia associated with a shipping disruption caused by a transportation strike. We expect working capital levels will decline in the second half of the year and are forecasting that working capital will be a use of cash for the year of approximately $20 million.

Next I will provide some color to our 2016 guidance. For 2016, we expect constant currency net sales growth of 10.5% to 11.5% with the recent acquisitions contributing $90 million to $95 million of the growth and the base business providing low single-digit constant currency sales growth. Net sales for 2016 are expected to be in the range of $1.14 billion to $1.15 billion. For additional understanding of the historical components of our sales, please refer to Slides 3 and 4 of the conference call presentation.

As stated in our press release, we are expecting the remainder of the income statement items for the full year to approximate the following; gross profit margins of 30.5% to 31%; SG&A of approximately 17.5% to 18%; interest expense of $20 million to $20.5 million; other income and expense of approximately $5 million; and the adjusted effective tax rate of 27% to 28%. Based on the above and incorporating current 2016 currency exchange rates, we expect adjusted diluted EPS will be in the range of $1 to $1.05 compared to prior guidance of $0.95 to $1.

At this level, adjusted EBITDA is expected to be in the range of $190 million to $195 million. We expect that the business will generate cash flow from continuing operations of $85 million to $95 million. Cash flow from continuing operations is equivalent to adjusted EBITDA, cash items associated with operating of the continuing business, including working capital, cash taxes and interest in capital spending. Note, we have included a table in the earnings release providing the detail of this cash flow metric for the quarter. For modeling purposes, we have also assumed the following; depreciation and amortization will be approximately $45 million. Capital spending for the year will be approximately $30 million. As previously stated, working capital will be a use of approximately $20 million, cash taxes will be approximately $20 million as will cash interest will be approximately $20 million. And other cash uses including pension contributions will be $10 million to $15 million.

I would like to conclude my remarks this morning with an update on our discontinued operation. As you know, we are in active process to sell our dibenzoates manufacturing plant in Antwerp, Belgium. The facility has been classified as an asset held for sale and is reported as a discontinued operation. For the quarter, the Antwerp facility generated an operating loss of $5 million. We now expect to complete this disposition during the third quarter. As noted in our press release and 10-Q, this disposal may result in an additional impairment charge and other related expenses of up to $25 million to $30 million.

With that, I would like to turn the call back to Peter for an additional comment. Peter?

Peter Thomas

Thanks Jeff. And before beginning Q&A, I would like to pause briefly to note one more item. As you know on May 9, we announced that the Board of Directors was exploring possible strategic alternatives for the company to enhance shareholder value and had Lazard, as its financial advisor to assist in the review process. Unfortunately, the media started making comments about the review, which prompted our May 9 announcement. To be clear, this exploration of strategic alternatives actually began late last year. It was initiated by the board and was well underway before FrontFour Capital Group issued their open letters to the board. The review process was extensive and covered several options, including the sale of the company, a merger, transformational acquisitions and the continuation of our value creation strategy.

Earlier this week, the Board of Directors concluded that the best course of action was to continue executing our current strategy, focusing on organic and inorganic growth and improving profitability. To this end, we have identified efficiency optimization opportunities that are expected to improve profitability by $20 million to $30 million annually once the initiatives are implemented over the next 3 years. We will provide additional details concerning these initiatives as plans are finalized and we advance on these initiatives likely before our year end earnings.

In addition, we will continue to assess and pursue acquisitions, including transformational opportunities to enhance our growth and profitability and improve our market positions. In assessing the option to sell the company, the Board of Directors determined that the proposals received undervalued the company. As we have said consistently ever since A. Schulman expressed interest in acquiring the business back in 2013, we are open to strategic alternatives, including the sales, but we will not sell the company at a discount to intrinsic value. The focus of this call is on our second quarter performance and our outlook for the remainder of the year and we will not provide additional details concerning the strategic review process. So, I thank you in advance for cooperating in this regard and limiting your questions to the performance of our business.

This concludes our prepared remarks. And I will now turn it over to John for the Q&A session.

John Bingle

Thank you, Peter. Operator, we are now ready to begin the question-and-answer session. Please repeat the instructions to assist our guests and we will then take the first question.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of David Begleiter of Deutsche Bank. Please proceed with your question.

Jermaine Brown

Hi, good morning. This is actually Jermaine Brown filling in for David. A few questions. In regards to these optimization opportunities, can you provide some color on the areas of the business or any specific regions that they are targeted towards?

Peter Thomas

Yes. Sure, Jermaine. It’s Peter. As we said maybe about 3 years ago, we mentioned there will be a time actually in our strategic implementation, particularly with the sale of so many businesses and the acquisition now of about 6, was up over 167 different cost reduction programs over the past 3.5 years, there would come a time that we would have to tighten up and pull some strings to become more optimized with all those moving parts. So, what you are seeing is just an answer to that remark on a few years back. So, what you would find is a global optimization efficiency program that includes everything from tightening up procurements, supply chain, logistics making sure that all the manufacturing facilities are providing the right yield and as well as making sure that the right products are produced in the right pieces of equipment and in right manufacturing locations around the world. So, this is something that we have been actually working on for about 3 years conceptually and now is the time for us to go ahead and pull the reign. So, you should think of this as a – what we call our SBL model, which is our smarter, better and leaner model that’s really been scheduled for this part of the implementation of our value creation strategy anyway, time to do it.

Jermaine Brown

Understood. And then in terms of the M&A, how is the pipeline looking?

Peter Thomas

The pipeline is actually wonderful. As we have mentioned before and I will mention it again, right now as you heard us say, we have near-term targets that are valued at anywhere between $60 million to $150 million in revenue. We are actively engaged in various stages with about 21 of them. We have further discussions along the acquisition path of about four or five of them. And we also have three larger revenue opportunities. Some larger, one might consider to be a transformational type of an acquisition. So our pipeline is robust. We are fully engaged. We have a lot of momentum. We would be the buyer of choice in many of these. And if I can, we would say they are always to lose. So we are very, very optimistic about the forward activity with our pipeline. As we have been, again we have made six acquisitions in the past 16 months. So we do have momentum there.

Jermaine Brown

Understood. And one more if I can. Can you just provide some more color on demand trends within the tile coatings by region?

Peter Thomas

Sure. Here is the good – actually, we have a lot of good news and if you want to be specific around tile. Last year, we had a lot of challenges, particularly in the Asian areas with Thailand and Indonesia which actually hurt our revenue in all at about somewhere between $25 million to $27 million. So if you do the math that represented roughly or pretty close to over 2% of our yearly revenues. So that’s the problem with a lot of small numbers with those areas taking a hit like that. But right now in Indonesia, we are doing quite well. If you look at Indonesia, if you look at the first half, Indonesia for us was up 12%. Thailand is up 6%. Vietnam was up 29% and Malaysia, which is a newcomer for us, is up 6%. This is all in volume, in new units through the manufacturing facility. So Asia is doing actually quite well. If you blend it all together, first half we are up about 10% volume. If you look at MENA for the first half, Egypt is doing quite well. We are up about 27%. And I think we mentioned that last year that coming into the first and second quarter, we will see an up-tick in MENA, particularly in Egypt. So that’s also a strength for us. Now as it relates to Western Europe, this may surprise you, but our indigenous sales shift to it, if you will, in Spain and Italy are up in volume for the first half of the year. Spain was up actually 11% and Italy is up 9%. The sour spot for us this year is Latin America and let me – again I would say for us, we are all of somewhat disappointed about Brazil and Argentina. And unfortunately, they become our Indonesia and Thailand of last year. So as we are sitting for the first half of the year, our volume for those two areas is down and everybody else not just us, there is no loss of share. We are down with about 32%, 33% in volume which translates into revenue of about $18 million. So you can see already for the first half of the year the sourness of Latin America. And think about it on an annualized basis if this continues which we don’t think it’s going to be for that magnitude which is for the first half the year that represents 1.5% of our annual sales.

So with the exception of Latin America, we are actually doing pretty well and we actually feel really, really good about the second half and particularly in Mexico. And I want to isolate Mexico from Latin America, it’s up 8%. Mexico is wonderful. I think you have been hearing us mention that for the past two or three calls. We are really positioned well. The Mexican government is supporting construction. Our tile business is strong, porcelain enamel is picking up. And of course the automotive industry is still doing well although it is decelerating a bit. We do see it. But still over last year, we are doing quite well. So all-in-all, for the tile business we – our strategy has positioned us quite nicely for the future. We have repositioned that business to the high end of the market as well as the high end of the middle cut where there is less competitive intensively and we have also positioned ourselves to be aligned with the fastest growth areas, including North America, which North America is up about 14%. So we feel really, really good about the repositioning of that business. And if you remember from the third quarter call last year, we did emphasized how much we like the business and everyone needed a chance to let this thing just state and turn into what it’s turned into which is pretty good for us.

Jermaine Brown

Thank you very much.

Operator

Our next question comes from the line of Mike Sison of KeyBanc. Please proceed with your question.

Mike Sison

Hey, guys. Nice quarter there. Peter, can you maybe give us a thought – you have done a really nice job turning the business around. Your EBIT margins 2Q were impressive 15%. So, what’s the next sort of two to three years step as you and the board think about creating more value here, what type of growth do you think the business can get to? What type of profitability? Maybe give us a little bit of a taste of the longer term essential at Ferro.

Peter Thomas

Well, we could do it in a couple of different ways. Certainly, we are at a state with our acquisition profile that maybe doing something transformational would be something that we really need to consider. Now, if we end up looking to get some of those types of acquisitions – by the way, we do have a spectrum of transformational opportunity that could really step change the business and add to that third leg of color solutions or it could complement more intensely the glass side of our business or even do more as it relates to performance coating. So, we have created a wealth of optionality for this company. If we do something like that, you maybe able – based on our analysis, you maybe looking at gross margins where – by the way, we have had about – we believe we have had a 200 basis points structural change with gross profit this year. So, if you do something transformational based on what we are looking at, looking at a range of 500 to 700 basis points improvement in gross profit. It’s something that’s probably more real than not. If we don’t do a transformational acquisition, then we are moving down the path of incrementally improving the high end of each of our platforms you would consider to see this roughly 200 basis points structural improvement for the business for the next couple of years.

Jeff Rutherford

Hey, Mike. And to answer the question differently, if you look at our base model and factor in what we talked about today, the incremental cost reductions and efficiencies and when that’s going to be built into that model. And you go out – let’s go out 3 years, what you are going to – what our models would say and how we model is that we are looking for GDP plus on the top line. So, our weighted average GDP by our ship-to locations is somewhere slightly north of 2%. So, you take that 2.5% to 3% sales growth during those periods that the cost efficiencies, the incremental cost efficiencies that we have announced you can get to a model within 3 years where that EBITDA margin is approximately 20%. And then as Peter said, what we do for modeling for growth is we model on $100 million of incremental invested capital over that time period based upon the criteria we have talked about it of first full year of operation of ownership, 10% after-tax return on invested capital growing to 15% over a 5-year period. So, that’s what we model. That’s what we are modeling today. And if you run those models up, you will – and factor in that $20 million to $30 million of incremental cost reductions and efficiencies, you will see where that’s going to get whatever target here you want to fit.

Mike Sison

Okay, great. And then just a couple of questions on the businesses color and glass, any thoughts on the auto side, some folks think it’s peaking, but just thoughts – your thoughts there on how you are seeing that business doing for you?

Peter Thomas

Yes. For us, it’s still doing well this year as we think we mentioned it was up 7.5%. It is – you see areas where it is decelerating. We do see it in Mexico in terms of a bit of a slowdown moving product into North American market, but where we are sitting today and I think we may have mentioned this at a prior meeting, where we are now repositioned with manufacturing in China and doing pacing in different locations, although the general market is – maybe slowing a bit, I think that we have some interesting opportunities where we still maybe able to grow at a faster rate than the market. So even though it’s slowing down, we positioned ourselves like better in China. For example, we didn’t participate in aftermarket windshields or we really weren’t in the mass market of the 1.6 million automobiles that are in China that we are now. Yes. So all those things were slowing down, we have done things for the business that will allow us to probably perform better than the market. But we do see a general – a bit of a slowdown in the automotive market. Yes.

Mike Sison

Okay, great. And then last question, the gross margin improvement in Pigments, Powders and Oxides, particularly if you compare it to ‘13, ‘14 has been pretty impressive here, is this a pretty good level to think about going forward and what do you think the risks are in that business now, because it’s been pretty solid here in the mid-30s?

Peter Thomas

Yes. If you remember part of our strategy with Nubiola was to enhance our CIC business in a way by taking two market leading positions and blending them together and leveraging the synergies in a way that we increase our addressable market as well as uplifting our margin. So I think what you are getting is a validation that, that was the right strategic move. Now as it relates to sustainability, what you are seeing here is something very interesting. The Nubiola team is – are very, very good marketers and they are very, very good sales and technology hosts. So we are optimizing the synergies on the cross-selling activities and higher end applications. But what Ferro has brought to the table particularly at the COG level and why I mentioned it is that typically, the Ferro organization has a very, very strong manufacturing acumen around reducing costs, lean initiatives cycle and yield improvements and the like. So we – the Ferro competency has been brought to Nubiola in the way that we are now leveraging both the commercial and operational sides and are quite candidly, more than we even thought. So again, as it relates to those margins, we feel that they – that is in the sustainable range. Of course, you know it does fluctuate every quarter. But again as with the rest of the businesses, we will see a step change. And I think we mentioned 100 basis points to 200 basis points as we continue down the path of executing commercially and operationally. Very good acquisition and exceeding our expectations.

Mike Sison

Great. Thank you.

Operator

Our next question comes from the line of Rosemarie Morbelli of Gabelli &Company. Please proceed with your question.

Rosemarie Morbelli

Thank you. Good morning and congratulations on a great quarter. Peter, I was wondering about your comments regarding transformational acquisition, I understand that you most likely cannot give any details, but let’s say – and there are two that I know of, big ones out there, so let’s say, that if you are interested in one of these, how much are you willing to leverage the company in order to make that acquisition and how quickly can it be de-leveraged?

Peter Thomas

Yes, so good. Yes, there are transformational opportunities out there as we have mentioned. The second thing is we will not do a transformational acquisition unless it was very, very complementary and it builds out a certain platform. So again, that will be the first point. The second point through our Board discussions I – the Board, if it’s the right deal like we have said before, we would extend I think a bit north of four is something that’s been considered that the Board – what the caveat that within a short period of time will be de-levered to somewhere where we are today in that short period of time maybe about 24 months. So, those are just guidelines. And again, it has to be special. It has to make sense and it has to be strategic.

Rosemarie Morbelli

Okay. And I also would guess that it will also be accretive regardless of how much you pay and how much leverage, correct?

Jeff Rutherford

Well, it would be accretive in EPS.

Rosemarie Morbelli

In year one, yes.

Jeff Rutherford

The important thing for us it’s going to create value long-term for our shareholders. So when we look at anything that’s – to Peter’s point, our comfort level is between 2x and 3x leverage. And we always want to be in that range. So to go over 3x we would have to be a clear value creating strategy that makes sense to leverage the balance sheet. But to Peter’s point, there would have to be a very low risk way to de-leverage under 3x in a very short period of time.

Rosemarie Morbelli

Okay, thanks. That is helpful. I was wondering if you could talk about the size of Latin America and especially the size of your business in Brazil. Other companies have said that they are beginning to see some improvement in that particular market. Are you seeing it in your world?

Peter Thomas

Yes. So, to give you a flavor, right now, between Brazil and Argentina, it represents about – on a good basis maybe last year about $70 million in revenue. And as you heard me mentioned, we are down about 18. I am not sure what other businesses are seeing something that’s improving quickly or immensely, but we are not really seeing any real pickup yet. As I mentioned, it may not be getting worse, but we are not seeing a pickup or a pickup that would occur next quarter or so from where we are positioned.

Jeff Rutherford

And the first half of the year on a ship-to basis, to Brazil, they are relatively flat to slightly down.

Rosemarie Morbelli

Okay. And looking at the Middle East, we have issues in Turkey and then Egypt has grown tremendously, but don’t you think that some of the turmoil is going to eventually affect that particular part of your business?

Peter Thomas

Yes. We mentioned in the script that we kind of made a comment about the events in Turkey, but we have an interesting situation in Turkey. Again, we benefit from the long and small numbers here. And we have been repositioning ourselves in Turkey with the acquisition of our two and of course now with the complement of Al Salomi where we can start seeding Tayo and PD from low cost production in – from Egypt. So we have been building that business incrementally and nicely. And even though there is that turmoil, we don’t feel that it’s going to do a lot of damage to us here. In fact, I will tell you an interesting story. Within Russia actually, our Russian business was actually not so bad, because the Russians didn’t want to buy from the Turkish folks, but they ended up buying from us even though we are positioned in Turkey. So, there is kind of an interesting dynamic there. But in the big scheme of things, how we are positioned with the law of small numbers, we don’t believe it’s going to have a material impact on us and the way we have been seeding in the last two quarters with porcelain, enamel and tile, in fact, we feel even better about Turkey over the balance of the year.

Rosemarie Morbelli

And if I may ask one last question, could you bring us up to date on the digital inks and the switch to water base versus solvent base and what is happening with pricing and volume?

Peter Thomas

Sure. Well, for us of course, volume continues to move up as the market is growing. In fact, we may be growing a bit more. The reason why that is, is we have that reformulation acumen in a way as price points drop. We know how to reformulate those products in a way that we can meet the price points while still generating higher gross profit dollars and that process continues. Although the competitive intensity exists, it’s not as robust as it has been for the past 2 years. So in fact, with the Vetri model, we have been able to support our digital ink business at the higher end of the market in a way where there is less competition. So, our inks business continues to do well even with the competitive intensity. As it relates to the next generation, I think you are referring to. There is two pieces. There is a water compatible intermediate introduction stage and then of course the water base. So, the water compatible formulation has been commercialized on our side from us. And we have a certain level of sales that’s not significant. And the demand for those products really hasn’t gained a lot of traction yet, but we are ready with the formulations when the time comes.

Rosemarie Morbelli

Thank you very much.

Operator

Our next question comes from the line of Mike Harrison of Seaport Global Securities. Please proceed with your question.

Mike Harrison

Hi, good morning.

Peter Thomas

Good morning.

Mike Harrison

Peter, I think one of the factors behind this push to look at strategic alternatives with this idea that the market wasn’t appropriately rewarding you for the progress that you have made on margins, for the progress on the return profile and that the market also isn’t valuing acquisition driven growth as much as organic growth, which you guys have struggled with. So with that in mind, I think you addressed it a little bit, but can you talk about how you guys see yourselves improving the growth profile of the business and in particular, the predictability of growth going forward in a way that the market starts to reward you and reward your shareholders for this progress?

Peter Thomas

Yes. I think your assessment was pretty spot on. And actually drove our Board of Directors even early last fall around the discussion of really you vetting out strategic alternatives in the business. We were having a very good run. We didn’t feel like we will being rewarded appropriately. We felt that way. We heard it from our shareholders. The market was telling us that. We have the small-cap kind of stigma about that with low liquidity. And we were cognizant of that. So we thought it was appropriate for us to really bet on every strategic option. And as I am sitting here and everybody is sitting here, they can tell you that we had well over eight or nine Board meetings around this topic. It was the center of attraction and discussion and we hit that very hard. Now at the end of the day, it’s all about the intrinsic value. We have been very clear as one of the options was, we are not afraid of the transaction, but someone has to pay the intrinsic value of this business based on the modeling that we do and what we see in front of us. We see a lot of growth with our acquisitions. We are introducing new products which I can get into. It’s unfortunate that South America this year, or Asia last year, is taking away from the visual of our organic sales growth, because we are introducing a lot of new products. But at the end of the day, with an $18 million hit for the first half in Latin America, it skews our revenue growth even though our volume looks pretty good. So with that, with cross-selling activities, new product introduction, the four or five acquisitions that we have lined up that are ours or a big transformational opportunity. And with each one of those acquisitions remember what we have said. Part of that is if it’s a smaller acquisition, it has to be at a high end good margin and it has to expand the addressable market in a way that we can grow at a faster rate. So it’s just taking time for us to gain the traction around the growth part of the strategy. And once it gains traction like we are starting to see now, we feel pretty good about the growth levels that we have been discussing since day one here.

Mike Harrison

Alright. Thanks for the additional detail there. I was wondering on the color and glass business, the weakness that you have seen outside automotive and outside construction, some of the decorative areas and maybe container glass, when do you see that run its course and can you talk about what efforts are underway to reverse some of the weakness that you have seen there?

Peter Thomas

Yes. I wanted – we should think about what that weakness really is. And I am sure we have mentioned this during the last call. We have some – that business is the most technology driven for us. And there are times where we end up having an introduction of a product that we might not fully understand from our customers what the real demand might be or what predictable order pattern might be. And one of those products is a low temperature coal fired ceramic material that we discussed. That goes into a very, very sensitive military application. And we launched that product in really gain traction in 2014 where our sales were about $14 million. Last year, they hit about $23 million. And this year, we are trying to get a good order pattern for this particular product. And it’s very difficult to getting information because of the sensitive applications and we are down about $7 million for the first half of net sales, $7 million for the first half of the year. So unfortunately, if you take that product out of the equation and also I think I mentioned last time that we have promotional opportunities through the course of the year in any given year it could be $5 million to $10 million. And unfortunately that promotional campaign is lower and it was with maybe I can’t be specific on the manufacturer, but let’s call them tumblers or certain type of whiskey bottles or whatever that case maybe and those campaigns are not there this year. And when you add all those together, those two things in particular, that represents about $10 million to $11 million of revenue. So, there are parts in that business that are high-end and unpredictable like that, because of the technology as well as campaigning and promotional activities. So, those two were just off course, which means maybe next year, they come back on course. So, it’s really hard. So, all-in-all, there is nothing structurally wrong with that business. You can see the margins are still going up because of mix. And that team is delivering new higher margin products by the way in the portfolio and we feel that the second half of the year it’s going to level out and we are going to see that business deliver something that’s pretty representative of what it should be neutralizing those two issues. Nothing structural, we are not losing share.

Mike Harrison

Alright. And then the last thing I wanted to ask about is porcelain enamels, you talked about strength in that business. I think it’s been a while since we have heard that. So, can you talk about what’s driving that strength and how sustainable it might be into the second half?

Peter Thomas

Yes, porcelain enamel, without getting too strategic, I think that business is what it is. It typically runs with appliances. It would have a – whatever that market grows we grow. We have a leadership position. But one of the challenges is how do we expand geographically and of course, you have heard us say that, Al Salomi is going to play a big role in that with the low cost position. We were very North American and Eurocentric around porcelain enamel, which we are by and large a larger leader, if you will. But in terms of hitting the Middle Eastern market or Eastern Europe or maybe strengthening our position in Asia, we wanted to make sure we had a good cost position before we did that. Of course, the acquisition of Al Salomi does do that. So, for the last couple of quarters, it’s performing well because we are seeding those areas with our high-end products in a way that we have mentioned, we have smelters coming on stream at the beginning of the fourth quarter for PE, where we can further see and establish those seedlings from a low cost position in the Middle East. So, we feel that we have step changed that business in a way and we put ourselves in a better chance to outperform the market growth as it relates to the applications for that business over the next couple of years.

Mike Harrison

Alright, thanks very much.

John Bingle

Operator, we have time for one additional question.

Operator

Very well. Our last question comes from the line of Dmitry Silversteyn of Longbow Research. Please proceed with your question.

Matt Skowronski

Good morning, guys. This is Matt Skowronski on for Dmitry. We have seen two quarters in a row of guidance raised now. I am just curious as to what percent or I guess what portion of that is kind of the acquisition that you may like Nubiola or Al Salomi coming in above original expectations. Can you kind of breakdown each one and just go through where they doing better than you originally expected or is this more of a general market type of guidance raise?

Peter Thomas

As it pertains to the acquisitions in Vetri now is in our comp sales growth and is doing very well. Nubiola is going to comp now in the third quarter. Nubiola is a very, very good acquisition for us and is doing better than what we originally modeled. Al Salomi is still early on. All we know is we are selling out all of its capacity. So, it’s doing well. I would say though it’s general, here is what I would say is that we are hitting our internal forecast for sales. And so we are comfortable with that. But we are doing better relative to gross profit, quite frankly. And it’s a lot of factors. And I think you have to give a lot of credit to our procurement people both direct and indirect procurement have done a fantastic job. Our plant operations people have done a fantastic job relative to efficiencies and cost reductions. And a lot of those things are coming together at one time. And it’s probably not incremental to what we thought was going to happen. It’s just happening sooner than we anticipated its happening. And so our gross profit has expanded ahead of our internal expectations. On the flip side, on SG&A, the strategic SG&A is right on track. We have – with everything we have had going on. We probably have fallen a little bit behind in functional SG&A. But it’s not permanent. It’s something that’s temporary and we will get that back. So I think the answer is, it’s the entire company is operating very well. And doing a good job, I think we have turned the corner relative to the cultural aspects of value creation. Everybody understands that creating value is not only driving sales and gross profit, but controlling costs and capital spending. So I think the entire organization needs to be congratulated on the last two quarters. We are exceeding our internal expectations also.

Matt Skowronski

Alright. Well, thank you so much.

Peter Thomas

Alright. We appreciate your time this morning and taking time out for the call. If you have any questions, please feel to give me a call. Thank you and have a good day.

Operator

Ladies and gentlemen, that concludes the conference call for today. We thank you for your participation and ask that you please disconnect your line.

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