Libbey Inc. (NYSEMKT:LBY)
Q2 2016 Earnings Conference Call
August 04, 2016 11:00 AM ET
Executives
Kim Hunter – VP, IR
Bill Foley – CEO
Sherry Buck – CFO
Analysts
Lee Jagoda – CJS Securities
Jeremy Hamblin – Dougherty
Steph Wissink – Piper Jaffray. Steph Wissink
Chris McGinnis – Sidoti Company
Jeremy Hamblin – Dougherty Company
Operator
Good morning. My name is Mike, and I will be your conference operator today. At this time, I would like to welcome everyone to the Q2 2016 Libbey Earnings Conference Call. [Operator Instructions] After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]
I will now turn the call over to Kim Hunter, Treasurer and VP of Investor Relations of Libbey. You may begin your conference.
Kim Hunter
Good morning, everyone, and thank you for joining us for Libbey’s second quarter 2016 earnings conference call. Libbey’s press release and supplemental financials were distributed this morning and are available on the Company’s website in the Investor Relations section. We’re hosting a live webcast of today’s call, which can be accessed on the same section of the website. The replay of today’s call will be available on our website for seven days.
Before we get underway, I would like to say that this conference call will contain non-GAAP financial measures, including adjusted EBITDA, adjusted EBITDA margin, free cash flow, trade working capital and our debt net of cash to adjusted EBITDA ratio. Reconciliations to the nearest U.S. GAAP measures are available in our press release and supplemental financials.
Also, the call will contain forward-looking statements under the Securities Act of 1933 and other federal securities laws. These statements are based on current expectations, estimates and projections about the market and the industry in which the Company operates in addition to management’s beliefs and assumptions. Forward-looking statements are not guarantees of performance and actual operating results may be affected by a wide variety of factors. For a list of these factors, please refer to the forward-looking statement notice included within our SEC filings.
I would now like to introduce the members of the management team here with me today. Bill Foley, our Chief Executive Officer; Sherry Buck, our Vice President and Chief Financial Officer; and Ronni Smith, our Vice President and Corporate Controller.
I will now turn the call over to Bill.
Bill Foley
Thanks, Kim. Hello, everyone, and thank you for joining us for a review of our second quarter 2016 operating and financial results. First, we’re very pleased with the fact that our food service business continued to demonstrate strength of our marketing position with its 13th consecutive quarter of volume growth. Also, despite sales being down on our retail and business-to-business channels, we are pleased to deliver strong adjusted EBITDA results and a year-over-year improvement in free cash flow during the quarter. In addition, during the second quarter, we made solid progress on a number of our near and medium-term priorities.
Before Sherry gets into the financial results, I’d like to provide you with a progress report on the initiatives we established earlier this year. As a reminder, our priorities remain as follows, strengthening our organizational capability to drive growth by developing innovative new products, building stronger and closer relationships with our customers, and simplifying our business that we perform more efficiently and effectively. Let’s start with a few examples of the ways in which we are innovating today. During the second quarter, we attended the National Restaurant Association show where we were able to demonstrate our new approach, the way in which we go-to-market to our food service customers. The restaurant industry is evolving as consumer taste fragment. Restaurateurs are looking for unique ways to attract customers, and we’re directing our marketing to support emerging trends as they grow in importance.
Our customers are increasingly looking to us to help them better understand how consumer interests and behaviors are changing on a real-time basis. We’re helping them present trend right experiences that resonate with today’s consumers. Our customers are asking us for innovation for new ways to take products and design to market to help them compete in a very competitive space. For the first time, we showcased ways distributors and restaurateurs can use our products in real-life environments. We demonstrated how to use our products to provide on trend presentations across the broad range of emerging restaurant formats. This was also the first large-scale introduction of our Masters Reserve product line to the mass audience of food service distributors. We have now launched 45 new shapes and this includes a variety of products that are in line with bar and restaurant trends including mixology, whiskey, bourbon and beer-tasting trays to name a few. By the end of year, we anticipate having over 70 new shapes ready for the market.
We also launched three new ceramic dinnerware lines, reflecting important design trends, including an expansion of our artistry collection with a new line from Schonwald. Each of these introductions represent great new looks that customers are very excited about. These lines will be available for shipment in October. Overall, the feedback received from the show was tremendous. A number of customers told us that it was great to see our innovation and see us taking an even greater leadership role in the market. To continue on the innovation front, we recently launched completely new product development and innovation process in three of our four regions, which starts with a disciplined and structured approach for bringing new products to market. It includes robust market, customer and consumer analysis with key decision points throughout the process, but are designed to support our margin and growth objectives. We’re putting this new process to work immediately. Following the results of a comprehensive market research study we conducted during the second quarter, we’ve identified a number of new product concepts and now have them in development. We expect to be able to showcase some of these products at the Housewares Show in early 2017.
I’d like to caution that for competitive reasons, we’re not in a position to go deeper into the specific of products that are in development. But the critical take away is that we’ve significantly amped up our connection to customers and consumers through both qualitative and quantitative market research. It’s already providing better insights on how we need to develop both product and market opportunities. We’ve made significant changes in the way we’re doing business, and we’re implementing different processes with product innovation being a top priority, and we’re building it into our everyday work. We also believe we’re making strong progress on the customer relations front. We have taken a number of steps that enhance how we serve our customers. For example, we’ve launched a new sales opportunity pipeline measurement tool and are in the first phase of developing a CRM system. We’ve reengineered our sales compensation system to be certain that we’re incenting our sales organization to achieve the outcomes we want. We’ve also begun to redesign our back-office practices, so they were able to respond to customers’ requests faster. Each of our business segments, food service, retail, and B2B are getting the same emphasis because there are opportunities in each. It’s extremely important that everyone we do business with realize just how much we value our customer relationships.
Now I’d like to provide an update on our simplification effort. Key objective here is to remove non-value-added complexity and streamline our supply chain and product portfolio. One of our first steps was to perform a global review of our entire product line. We believe the depth and breadth of our product line is certainly an important competitive advantage. It had gotten overly complex, however, resulting in a product portfolio with underperforming SKUs. During the second quarter, we performed an extensive analysis to identify products that didn’t contribute significantly to our top-line performance and we took strategic action to rationalize our global portfolio. Those are grassroots effort that included the sales, marketing and finance teams from each of our four regions. As a result of this work, we were able to reduce the number of SKUs by 20%. This effort was undertaken to position us to more effectively manage our product lines going forward. It also serves to reduce product line complexity for a sales team, which will allow them to better focus their time and effort on the types of product that matter most to our customers.
The SKUs we’re eliminating represent a variety of product lines and families and we do not expect this to have much of an impact on future sales. As a result of this strategic decision, we recorded a pretax non-cash charge of $6.8 million, which negatively impacted net income during the quarter. Sherry will provide more detail on that later, but we believe these actions were important to simplify our business and help us operate more nimbly in the future. In conjunction with the new product development process, we have implemented more robust procedures around adding SKUs to our portfolio, so we’re more actively managing the product life cycle of our entire product line.
Another important area of focus within our simplification efforts is the optimization of our manufacturing capacity. This is particularly important given the high fixed cost nature of our business and the overall excess capacity in the glass industry. Beginning of this year, we had over 20 furnaces in our global manufacturing network, with various levels of capacity and production capabilities. Each requires routine rebuilds and maintenance over the life of the asset. We shared during our first quarter call that we have a furnace rebuild planned in EMEA this year. I would like to share a little more color about this rebuild and how it aligns with our simplification objective as well as improving the returns in our EMEA segment.
Our Netherlands plant has historically operated four small furnaces. As we evaluated our furnace rebuild schedule and planned investments, we made the decision that rather than rebuilding three furnaces that were scheduled to rebuild in 2016 and 2017 as per our normal schedule, we would shut down two furnaces and rebuild only one. The melting technologies that are being installed, the rebuild furnace will have a lower energy cost profile and will provide for more efficient operations.
As of the beginning of the third quarter, one of the pre-existing furnaces has already been shut down. A rebuild project is in progress and the rebuild and additional furnace shutdowns are expected to be completed by mid-2017. This action will improve EMEA’s ROIC as a result of lower operating costs and reduced asset base going forward. Additionally, in our Latin America region, we have elected to shut down one furnace in the third quarter rather than rebuild within the normal schedule. To ensure that we can serve our customers in both of these regions without supply disruption, we have already built inventories in anticipation of these actions. So, as you can see, we’re looking at simplification strategies across a number of work streams and we expect that these will help drive improved returns and better plant utilization over the midterm. The goal is to improve our operating performance and start making what we can sell rather than selling what we can make. We’ll continue to evaluate auctions to simplify our operations moving forward and will provide updates on progress as more details become available.
Before I wrap up my initial remarks, I would like to briefly touch on our retail initiatives. I will make sure it’s clear that we’re continuing to apply significant effort and resources to address challenges we’re facing in our retail channels. Several of the initiatives we’ve already discussed will help us win here. We’re operating in one of the most competitive environments I have ever seen. It’s hard to say how long this competitive price environment might continue, but we believe Libbey is well-positioned to succeed long-term, and we’re doing everything we can to compete effectively, while protecting profitability.
As we’ve indicated earlier, given the nature of the retail selling cycle, it’s going to take some time for us to see the growth we believe is possible from our new product development efforts. Despite the challenges we faced, we did see some positive developments during the second quarter. Last quarter, we mentioned that we won some new business in the Latin America region, which came as a result of some organizational changes we had made. These competitive wins help drive further retail sales growth in Mexico during the second quarter. Even with a strong headwind from currency, we were able to deliver a 3.6% net sales growth in our Latin America retail channel. On a constant currency basis, our year-over-year Latin American retail sales growth was almost 17%. We expect to see a continuation of strong results in our Latin America retail channel. It has been very encouraging to see that we’re able to have quick success following several difficult quarters in this region. We anticipate that we’ll continue to make progress here for the balance of the year.
Now I’d like to turn the discussion over to Sherry Buck, who will further detail our second quarter results, and provide an update on our balance sheet and capital allocation. Sherry?
Sherry Buck
Thank you, Bill, and good morning, everyone. I will review our second quarter financial results in each of our operating segments, which are U.S. and Canada, Latin America, EMEA and Other.
We recorded net sales for the second quarter 2016 of $207.9 million compared to $214.1 million for the second quarter of 2015, a decrease of 2.9% year-over-year. Excluding currency impacts, net sales were down 0.7%. In the U.S. and Canada segment, net sales were $126.2 million compared to $127.4 million in second quarter 2015, a decrease of 1%. Food service sales remained strong during the quarter, growing 3.9% versus last year, but were offset by a reduction in net sales in the retail channel. Business-to-business sales in the region were up slightly compared to the prior year quarter. Net sales in Latin America were $40.6 million compared to $44.6 million in second quarter 2015, a decrease of 9%. Excluding currency impacts, net sales were up 1.4% year-over-year. And as Bill mentioned, retail sales in our Latin America segment grew 3.6% or 16.9% when adjusted for currency, due to strong retail sales volumes. We anticipate continued strong Latin America retail performance in the second half of the year.
Moving to the EMEA region, net sales in the segment were $31.3 million compared to $32.1 million in second quarter 2015, a decrease of 2.7%. Excluding the impacts of currency, EMEA net sales declined 4.4%, primarily due to softness in the food service and business-to-business channels. Europe is the largest glassware market in the world, with about 35 competitors. The current slow growth environment has led to excess capacity and intense price competition. Before I review our Other segment results, we’d like to provide some additional detail regarding our exposure to Europe following the outcome of the recent Brexit vote. The Brexit vote caused volatility in the global financial and foreign exchange markets. While the outcome of Brexit is unclear, we expect minimal direct exposure as we do not have operations in the United Kingdom. As a reference, EMEA represented only 15% of our total Company revenue, and sales to the UK represented less than 2% of total Company net sales during fiscal year 2015.
And moving to results of our Other segment, which primarily represents our operations in Asia-Pacific, Other net sales were roughly flat at $9.8 million in second quarter 2016 compared to $9.9 million in the comparable prior year quarter, reflecting a decrease of 0.3%. Excluding currency impacts, net sales increased 5.7%. Moving back to the consolidated income statements, gross profit during the second quarter was $50.4 million compared to 56.9 million in the prior year quarter.
Gross profit as a percentage of net sales decreased in the second quarter to 24.2% from 26.6% last year. The $6.5 million decrease in gross profit was a result of 6.8 million charge in connection with our product portfolio optimization initiative. As Bill mentioned, we made a strategic decision to reduce our SKU count by 20% during the second quarter. Gross profit was further reduced by additional depreciation expense of $2.9 million, driven by increased CapEx investments in prior years such as our new ClearFire technology and adjusting asset lives on furnaces that are being shut down. Partially offsetting these were lower pension and healthcare costs of $1.8 million and favorable pricing on natural gas of 1.2 million. Second quarter selling, general and administrative expenses were $30.7 million, down approximately 16% or $5.7 million versus last year due to reduced marketing and labor and benefit expenses.
Also, second quarter 2015 included a $3 million reorganization charge, which did not repeat in 2016.
As a result of these factors, as detailed in Table 1 of today’s press release, adjusted EBITDA was $39.8 million compared to $34.5 million in the comparable prior year quarter, an increase of over 15%. And our adjusted EBITDA margin for the quarter was 19.1%, a 300 basis point year-over-year improvement. Interest expense was $5.2 million for the quarter as compared to $4.5 million last year, primarily due to higher interest expense from our interest rate swap that became effective in January of this year. Our effective tax rate was 43.5% for the second quarter of 2016, compared to 14.4% for the second quarter of 2015. The change in the effective tax rate was primarily driven by a smaller proportion of pretax income in lower tax rate jurisdictions in 2016, a valuation allowance in the United States in 2015, which resulted in pretax income that generated very little tax expense and an un-benefited 2016 pretax loss in the Netherlands due to a valuation allowance.
Net income was $8.7 million for the quarter compared to $14.4 million in the prior year ago quarter. The decrease is primarily attributable to an increase in our effective tax rate. We had available capacity of $92.6 million under our ABL credit facility as of June 30, 2016, with no loans outstanding. We also had cash on hand of 46.4 million at June 30, 2016. Trade working capital, which we define as inventories and accounts receivable, less accounts payable was $219.4 million as of June 30, 2016, which was 2.2 million less than June 30, 2015, the decrease was a result of lower inventories and accounts receivable, partially offset by lower accounts payable.
And during the quarter, we invested $5.7 million in CapEx, compared to $16.6 million in the second quarter of 2015. The reduction was mainly the result of prior-year investments in our ClearFire technology. Depreciation and amortization amounted to $13.4 million in the second quarter of 2016 compared to $10.5 million in the second quarter of 2015 due to previously discussed factors. With regards to capital allocation for the second half of 2016, we remain committed to a balanced approach with our near-term priorities being to continue investing in the business, maintaining a strong and financial — flexible financial profile, with a long-term target debt net of cash to adjusted EBITDA ratio of two and half times to three times, and lastly, returning free cash flow to our shareholders.
During the second quarter, we chose to prioritize debt reduction and made an optional debt prepayment of $5 million as part of our plan to move our debt net of cash to adjusted EBITDA ratio toward our long-term target range. At the end of the second quarter, our ratio was 3 times, which is within our goal range as detailed in Table 5 of our press release. Further, we returned $3.3 million of cash to shareholders through our dividend and share repurchase programs. We paid a quarterly dividend of $2.5 million, which reflects the 5% increase in our 2016 annual dividend rates of $0.46 per share. And we repurchased approximately 45,000 shares at an average price of $17.77 during the quarter. We remain committed to returning 50% of free cash flow to shareholders during the period 2015 through 2017.
Finally, as mentioned in our press release, we are reconfirming our adjusted EBITDA margin outlook of approximately 14% on lower net sales. We now expect net sales to be down 1% to 2% year-over-year on a reported basis as a result of softness in our U.S. retail channel, continued pressure on the peso, and overall macroeconomic conditions. As we think about how the second half will play out, we are expecting a seasonably weaker third quarter and a stronger fourth quarter compared to last year. To provide a little more context, Q3 will be unfavorably impacted by channel mix, lower manufacturing activity and rebuild of variable compensation.
Adjusted selling, general and administrative expense as a percent of net sales is expected to be in the low 15% range for the full year. Our cash flow outlook assumptions are mostly unchanged. We expect capital expenditures to be at the low end of the range of $50 million to $55 million. We expect trade working capital to be about flat in dollars with the prior year as temporary inventory builds related to furnace activities approximately offset reductions and other trade working capital components. Pension expense is expected to be approximately $9 million in 2016 with cash pension contributions now approximating $9 million. Depreciation and amortization for the full year 2016 will be around $49 million, slightly higher than our previous direction, driven by factors discussed earlier in the call. Cash interest should be in the range of $21 million to $22 million and we currently believe cash taxes will be around $5 million to $7 million.
I would now like to pass the call back to Bill for some closing comments. Bill?
Bill Foley
Thanks, Sherry. In summary, we are making progress with our actions to address challenges across the business and we’re operating well despite a difficult competitive environment and an equally tepid global economic climate. Enhancing our product offerings, building strong relationships with our customers and simplifying the business remain critical objectives for the Company. Executing on these objectives will significantly improve the long-term health and growth profile of our business, and the operational improvements we’re currently driving will position us well to leverage sales growth in the future.
Now, I’ll turn the call over to questions.
Sherry Buck
We would now like to open the call for questions. Yes.
Question-and-Answer Session
Operator
[Operator Instructions] Your first question is from Lee Jagoda from CJS Securities.
Lee Jagoda
So just starting with your comments regarding retail in the back half, can you give us some more detail of what’s causing the headwinds particularly in the U.S. versus what should be a relatively easy comparison?
Bill Foley
Yes, there are a couple of things that are happening. One of our large customers is rebuilding a new inventory management system. So they have dialed back POs quite a bit in anticipation of just bleeding down some inventories. So that’s got a near-term effect, but in terms of our relationship with that particular customer, we’re getting additional placements, and we expect to be able to grow on a year-over-year basis. But we got to work through their efforts as they change their system and their buying practices. That’s one of the issues. There is reduced cavity — capacity and shelf space in this category overall. And I think, probably, the bigger issue, or perhaps the biggest issue overall is the shift from brick-and-mortar to e-commerce transactions. That’s the one that I think has most retailers concerned, and a lot of disruption going on at point-of-sale as well.
Lee Jagoda
Okay. And then, on gross margins, if I look at your guidance, it implies that gross margins in the back half are going to be at or below last year’s levels. Given you’re taking some melting capacity out, how should we think about capacity utilization or pricing as the driver of gross margins?
Sherry Buck
Hi, Lee, this is Sherry. So, based upon the guidance that we have, if you look at our first half performance, our gross margins on an adjusted basis are 24.9%. And we would suggest our gross margins would be slightly lower in the second half. Some of the contributors to that, as we look at the back half, we would — there’s some manufacturing activity where we’ve talked about there are some ace furnace that we’ve shut down here in the beginning of Q3, we also have some scheduled downtime in some of the furnaces still installed there. And we would expect favorable impacts related to kind of sales margin from a mix standpoint.
Lee Jagoda
Okay. One more from me and I’ll hop back in queue. In terms of the furnace rebuild, we appreciate the incremental details there. As it relates to the reduction in melting capacity, the announcements that you’ve made, does that complete what you think will be the eventual reduction melting capacity. Or are there more opportunities to further rationalize the footprint?
Bill Foley
I think this is the first step. We’re looking at the business on a holistic basis. We are not prepared to talk about more at this point in time, but as we work to find that appropriate balance, we’ll be able to share as details develop. I mean, we’ve got active work going on sort of across the globe to make sure we’ve got the right capacity and balance with demand. So, stay tuned is about what I can tell you at this point in time.
Operator
The next question is from Jeremy Hamblin from Dougherty.
Jeremy Hamblin
I wanted to just go over this product portfolio optimization a bit more. So the call out here in your EBITDA reconciliation table is about $6.8 million. What was the split of that between gross margin impact and SGA impact?
Sherry Buck
Hi, Jeremy, this is Sherry. So the $6.8 million, it was basically a reduction in gross margin and a reduction in inventory. No SGA impacts.
Jeremy Hamblin
So this is all gross margin? Or you’re saying that there was a charge in here?
Sherry Buck
Yes. So it was — its part of our simplification efforts, and we believe that we have a very broad and deep product portfolio, which we think is a competitive advantage for us. But it had gotten overly complex. So we did a lot of analysis of our global portfolio, really looked at the performance of SKUs within there and identified what we’d call underperforming SKUs that weren’t contributing very much to our topline. And we made a decision that we would discontinue certain of those SKUs, and it was about 20% of our active SKUs. So what that basically means, we’re going to either sell or dispose of these at a lower price than we normally would. And so we took a charge and reduced our inventory and a charge to gross margin.
Jeremy Hamblin
And you’re saying that all of that flowed through on your reported numbers, not your adjusted numbers on your gross margin line item?
Sherry Buck
That’s correct.
Jeremy Hamblin
Or some of that an impact of sales or?
Sherry Buck
When you look at the Table 1 that you’re looking at on the adjusted, that is all going through gross margin on a reported basis.
Jeremy Hamblin
And so what were your adjusted gross margins?
Sherry Buck
For Q2, basically, that is the only item. It’s the major item that goes from reported to adjusted. So it would be 27.6% adjusted.
Jeremy Hamblin
So more than 120 basis points up year-over-year?
Sherry Buck
That’s correct.
Jeremy Hamblin
So as I look at your guidance though for the second half of the year, and I look at your EBITDA margin guidance, it implies about 12% to 12.2%, how do I — I mean that is quite a step down from both expectation and from where you just were. I mean, that’s even below the first quarter, which typically is by far your lowest quarter in terms of margin. How should I be thinking about that on a longer-term basis? Because that is such a step down. Is that a reflection purely on just the retail business or are there other factors that I need to be thinking about? Because I know Q3, you’ve got some impact from currency and still a little bit in Q4. But for the most part, we’re moving past that. How do I think about that? I mean, because as I’m looking out into next year, and I think expectations are for like 15% EBITDA margins, that’s not even in the ballpark.
Sherry Buck
So, Jeremy, I’m not sure I quite understand the 12.2% that you’re referencing. So let me recap what our full year guidance is. Net sales will be down 1% to 2%, SGA in the low 15%, and our adjusted EBITDA margin of approximately 14% for the full year.
Jeremy Hamblin
Understood. And so my math on that is you’re guiding to 806 million to 814 million on sales, with 113 million to 114 million of adjusted EBITDA. And I’m assuming that you’re including the number from the second quarter. So that would imply the back half of the year is $51 million in EBITDA versus the 62 million and change that you just did. So that’s $51 million of EBITDA on second half sales of 415 million to 423 million. So that’s, that calculates to 12% to 12.2%.
Sherry Buck
Yes. So our, the charge for the portfolio optimization, we’re taking that as a special item. So as we’re talking about our adjusted EBITDA, we are excluding that. And I say kind of mathematically, you’re right. Our first half, our EBITDA margin is about 16%, and for us to have approximately 14% for the full year, would suggest that our EBITDA margin will be lower in the second half versus the first half. So some drivers of that would be related to currency impacts. There is also lower manufacturing cost. And then we are also, as we talked before, we have rebuilding our SGA related to the bonus. Last year, we, virtually a lot of it impacted in Q3, where we adjusted that and had a much lower SGA in the third quarter. And our second half, you’re seeing the significant impact of rebuilding the bonus year-over-year basis.
Jeremy Hamblin
Okay. And so, just remind me then, we should be thinking about gross margins as a little lower than what you just saw in the first half of the year? Is that correct?
Sherry Buck
Yes. Yes, that would be correct.
Jeremy Hamblin
So that was 22, and that’s on a, my confusion, I think, is just on this adjustment that you included in the table, because I’m assuming that, that $6.8 million, that gets you to your adjusted EBITDA for the second quarter that you called out as 19.1% or 39.8 million. So I assume that, that’s what you meant in your adjusted guidance of 14% for the year. Does that not include the 6.8 million, should I back that out?
Sherry Buck
The 6.8 million is not part of our adjusted EBITDA guidance.
Operator
And the next question is from Steph Wissink from Piper Jaffray. Steph Wissink. Your line is open.
Steph Wissink
Just a follow-up to Jeremy’s earlier question on the SGA and gross margin balance for the back half, were there any costs in the second quarter that were deferred, just given that you were taking a closer look at your SKUs and optimizing, and simplifying? Should we assume some of those costs of maybe marketing come back in the third and fourth quarter?
Sherry Buck
As we look at the back half, I mean, we will still see some reductions in our marketing expense. Obviously, as we’re trying to also work on the initiatives that Bill spoke about, we will continue to spend there. But if you want to think about our SGA in the third and fourth quarter, I would characterize it as it would probably be in a range of $30 million to $33 million in each quarter. And in third quarter, specifically, as I spoke with Jeremy about, is the rebuild of our variable compensation, a big portion of it.
Steph Wissink
And so how far did that variable compensation come down the last couple of years, just based on…
Sherry Buck
On an annual basis, total between SGA and cost of sales is about $8 million. And what flowed through SGA year-over-year was about $6 million — would be about $6 million, with it mostly being in the back half.
Steph Wissink
Were there changes to the accruals or the performance thresholds that allows you to kind of refund the bonus of the variable expense line, just given that the overall sales performance is still trending slightly below your plan?
Sherry Buck
Yes, so, what we do is the metrics that we’re measured on is our net sales growth and then cash earnings. And during the course of the year, we evaluate our plans and we make adjustments accordingly.
Steph Wissink
Should we read into the signal that you’re rebuilding your variable compensation as positive indicator for kind of the back half in terms of sales performance if your incentive model is built on those two components?
Sherry Buck
Yes, so, just maybe some context behind that. So last year, we didn’t meet our internal performance metrics on a lot of the levels. And so we reduced our accrual related to last year’s performance. And so we are expecting to be much more in line with the goals that we have. And so on a year-over-year basis, just in the PL, we’re accruing more expenses related to our forecast that we’ve provided here on a year-over-year comparable basis.
Steph Wissink
And then on the gross margin, just help us appreciate the relativity and the mix of your segment. So in the back half, there is typically a step down sequentially coming off of the second quarter. But can you just talk a little bit about the back half mix and what you are assuming relative to maybe the prior year in overall blended margin rate?
Sherry Buck
Yes, so our comment on the call is we’re expecting to see unfavorability on — if you look at our seasonal business, typically our third quarter would be higher in gross margin than our fourth quarter. What we said in our prepared remarks is that it’s going to be seasonably unfavorable in the third quarter and there are couple of factors driving that, so one of those would be around channel mix. We’re going to be seeing a stronger channel mix in — well, see more B2B, which is a weaker margin. So you’ll have a more unfavorable impact on channel mix related to the USC business. We will have some lower manufacturing activity. Part of that is downtime related, and some of the activities we’ve shared around the furnaces, and then the compensation that we talked about. So those are the things that are making Q3 not in the normal seasonality pattern as in prior years. So that it would be lower in Q3 and higher in Q4.
Operator
The next question is from Chris McGinnis from Sidoti Company.
Chris McGinnis
I may have missed this because I got on a little late, and I apologize. But I did hear some comments about e-commerce, and I was wondering can you maybe talk about how you’re repositioning maybe the Company a little bit to maybe take advantage of that market? Or how are you reacting to the changes in the marketplace to accommodate that market?
Bill Foley
Yes, it’s pretty clear that e-commerce is having more than a little impact on brick-and-mortar retailers. And so we are in the very early stages of addressing that. And frankly, for competitive reasons and because we’ve got a lot of we typically have a number of our competitors listening to this call. I don’t want to go into a lot of detail here. But safe to say that we are in the early stages of addressing that issue.
Chris McGinnis
And then, secondly, just on the retail markets that you talked about, is more of it, seemingly, the issues you’re having in the retail, is that rebuilding the relationships at this point or I know that you mentioned one customer-specific issue, but outside of that, can you maybe just talk about what’s happening in retail? Is it more on the competitive landscape? And again, I missed this as well, I apologize.
Bill Foley
No, no, it’s okay. I would say that our relationships are improving across a broad cross-section of customer types in each of our channels. But I would say that, specifically, the thing that’s probably more challenging today is we have a couple of very irrational competitors who are pricing product at what we would view as significant negative gross margins. And in some cases, we’ve chosen to pass on some business because it was, the prices were just, silly, frankly. And so we’ve been very careful where we wanted to take business and where we wanted to pass because as you know, once you got that business, it’s hard to go back and get a price increase. So if you get yourself locked in to too much negative margin business, then that over the long-term continues to be a strangle. So it’s just, more than anything, it’s probably e-commerce, and sort of hypercompetitive pricing from a number of competitors.
Chris McGinnis
And then, just your comments on overcapacity in the industry, how much overcapacity is there you think? And how long will it take to kind of readjust in the environment today?
Bill Foley
Yes, that’s a, that is the $64 question. And I really don’t know how to give you the answer and let me try to give you a little bit of color about why. In the last year, you’re clearly aware of the currency changes that have taken some barriers down about product coming from the Far East and product coming from Europe. There are 36 competitors in Europe and the European market is, it’s a very tough economy unemployment is over 10%, the issues associated with Brexit and refugees and all the other things that are going on in Europe have dampened demand. So with currency sort of normalization between European currencies and the U.S. dollar, we’re pretty attractive market. You think that’s going to go on. How long that’s going to last right now? I don’t know, and I’m not sure anybody does. I think perhaps more interesting than that perhaps, on top of those general concerns is, as I said before, we’ve got a couple of competitors who are doing things that are very irrational, and we see some reaction of that recently where they’re trying to pull back and not being able to pull back on their pricing they haven’t been able to. So we’ve chosen not to dive to the bottom with them and make sure that our relationships and our product line helps us get through that. But I don’t know how long this is going to go on. But I do know that some of these competitors have left a lot of money on the table, which over time, you hope rational pricing theory gets back on before.
Operator
[Operator Instructions] The next question is from Jeremy Hamblin from Dougherty Company.
Jeremy Hamblin
Hi, guys, a follow-up, because I think I got cut off. Just — I want to come back to e-commerce for a second. And I know that you’re averse to providing too much detail, but do you feel — when do you feel like you have competitive response to partner and be in a much better position on the e-commerce front. Are we looking at something that is potential for holiday season? Or are we looking at something that is like mid-2017 and beyond? Can you give me a better sense on that?
Bill Foley
Yes, I’m happy to. I don’t think it will be the holiday season, but I clearly would expect something in the time frames you’ve talked about.
Jeremy Hamblin
And in terms of how meaningful that could be to replacing some of this other business that’s been lost, is this something that you think can be meaningful and potentially replace all that loss business? I’m really thinking about this in context of where kind of the old Libbey 2018 plan was. And obviously that’s — those numbers are no longer relevant, but is it something where you’re thinking that can we get to $1 billion longer-term or is that no longer something that should be in our mind?
Bill Foley
No, I think it’s something that, as I said before, I’m not trying to drive to the billion just to have the billion. I think the best way for me to answer that, Jeremy, of the growth priorities this Company has in front of it today, there are two. And I think e-commerce is equally as important as what we’re trying to do in terms of innovation and drive growth through organic growth. So I will tell you that each of those objectives are getting equal weight and attention by this management team.
Jeremy Hamblin
Let me shift gears and ask one other tough question, which is on this kind of other competition in the sense of irrational pricing overcapacity et cetera, how much of this do you think have to do with the structure of currencies at the moment? How much of this is where there is tariff protection, it’s not really relevant anymore because some of these currencies have moved so much that the tariffs don’t even really protect because their currencies are down 30% or 40%? How much of it is related to a structural issue like that?
Bill Foley
Right. While I took economics, I wouldn’t say that I’m really, I’m terrific at macroeconomics and understanding what the role of currency here. I think the issue is, now it’s a part of it, but the euro is less of an issue today than the peso is. I mean, the peso, I looked at it last night, it was MXN18.88 to $1, and 18 months ago, it was about a third less. So, the peso is having a huge impact on our business right now, and we do a lot of business out of our operations in Mexico. So we feel that when we do it. I think, what, between here and there than it is from outside the –
Jeremy Hamblin
Yes, let me ask a more pointed and more specific. Specifically, in the U.S., your U.S. business, because actually the biggest downside to our model is in the U.S. and certainly, the retail side of that business, how much of this kind of irrational pricing is coming from European competition versus Asian or Latin American competition?
Bill Foley
A lot of it is coming from European competition. There the number of competitors is greater, it’s, there are 36 competitors in Western Europe alone. And so they seem to be based sort of in a death march with one another trying to fight for demand. We see some of that in EMEA when we try to get business there. And they’ve held up frankly quite well, given all the things that are going on. There’s a lot in Europe. There’s some from China, but it’s mostly Europe.
Operator
There are no further questions at this time. I will turn the call back over to the presenters.
Bill Foley
Okay. Thanks, everybody for your attention and questions today. We look forward to talking to you again at the end of the third quarter. Thanks, and have a great day.
Operator
This concludes today’s conference call. You may now disconnect.
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