Caesarstone Ltd (CSTE) 2014 Q2 法說會逐字稿

Good day and welcome to the Caesarstone second-quarter 2014 earnings conference call. Today's conference is being recorded.

At this time I would like to turn the conference over to Allison Townsend of ICR. Please go ahead, ma'am.

Thank you, operator, and good morning to everyone. Certain statements in today's conference call and responses to various questions may constitute forward-looking statements. We wish to caution you that such statements reflect only the Company's current expectations and that the actual events or results may differ materially. For more information please refer to the risk factors contained in the Company's most recent Form 20-F and subsequent filings with the Securities and Exchange Commission.

In addition, the Company will make reference to certain non-GAAP financial measures including adjusted net income, adjusted net income per share and adjusted EBITDA. The reconciliation of these non-GAAP measures to the most directly comparable GAAP measures can be found in the Company's second-quarter 2014 earnings release which is posted on the Company's investor relations website.

With that I would now like to turn the call over to Yosef Shiran, Caesarstone's Chief Executive Officer. Yosef?

Thank you. Good day and thank you for joining us to review our second-quarter performance. I would like to start with some highlights for the quarter.

Sales increased by 30% to $116 million, a record for any quarter. Second-quarter adjusted EBITDA was $30.4 million up 23% compared to last year. Adjusted net income for the second quarter was $20.7 million, up 11% compared to last year with adjusted net income per share of $0.58 in the quarter versus $0.53 in the second quarter last year.

Overall this was a very good quarter with significant growth. Our performance was driven by the success of our products in the global markets combined with the strengths of the Caesarstone brand. We are operating well, controlling our costs, and growing our capacity to meet the strong demand for our products.

I would like to provide an update on each of our major markets for the quarter. Second-quarter sales in the United States, our largest market, were $47.9 million, a growth rate of 55% compared to last year. This growth is coming from a wide range of channels including an increasing contribution from IKEA. We expect the US to remain a significant growth engine.

Australia sales in the second quarter were $27.4 million, up 16.2% compared to last year. On a constant currency basis, Australia was up 23.6%. The strength we saw returning to the market in the first quarter has continued and our products are performing well particularly Supernatural with our new Calacatta and granite inspired designs.

Sales in Canada in the second quarter grew 17.2% to $15.4 million and were up 24.8% on a constant currency basis. Canada continues to be a good growth market for us even with the soft housing trends.

Israel was down about 0.5 percentage points compared to last year and contributed $9.9 million in the quarter. On a constant currency basis, Israel was down 5.2% reflecting slower housing activity.

European sales in the quarter were $7.3 million, up 61.9% compared to last year. On a constant currency basis, sales were up 55.2%. You may remember that Europe was temporarily soft last quarter due to the timing of shipments to certain distributors. The strong second quarter is a reversal of that situation. In the first half of 2014, Europe grew 10.6% on a constant currency basis compared to the same period last year.

Revenue in the rest of the world during the quarter was up 18.5% to $8.1 million. On a constant currency basis growth was 14.3%. This group continues to be healthy. Our Bar-Lev capacity expansion increased in contribution to volume this quarter. Accordingly, we were able to increase sales and at the same time build our inventory above the level of the previous quarter to service future demand.

Our new facility in Richmond Hill, Georgia continues to be on track for the first line operational in the second quarter of 2015 and the second line in the fourth quarter of 2015. I would also like to mention that we intend to start initial steps towards establishing our second building in Richmond Hill to accommodate additional manufacturing capacity in the future as needed to satisfy potential demand.

To sum up, the second quarter was the strongest quarter in our history for revenue and adjusted EBITDA. Our increased capacity in Bar Lev was a part of this performance. We are very excited for the next steps of our capacity expansion with our US facility. We feel confident with the growth and development of the business.

Thank you and I will turn the call over to Yair.

Good morning to everyone. I will now review our income statement for the second quarter.

Sales in the second quarter increased by 30.4% to $116.1 million compared to $89 million in the same quarter of last year. This is a record for any quarter. On a constant currency basis, sales increased by 32.3% relative to last year. Gross margin in the quarter was 41% compared to 49.8% last year. Excluding two factors that are affecting this comparison, our gross margin would have been 41.7% this quarter compared to 45.9% last year.

In the second quarter of this year, we recognized a $0.8 million provision adjustment related to taxable employee fringe benefit as a result of settlements with the tax authorities and the National Insurance Institute in Israel. Also I remind you that in the second quarter last year following our ERP system implementation, we accounted for $3.5 million in official change in the value of our inventory. Once you exclude these factors, the decrease in gross margin would have been 4.2 percentage points.

This was driven primarily by currency impacts, a significant increase in business with IKEA related to fabrication and installation activities which comes with the lower gross margin and to a lesser extent, by an increase in all material prices.

Operating expenses in the second quarter work $24.1 million or 20.7% of sales versus last year $22.1 million which was 24.8% of sales. This reflects the scale related benefits of our increased volume and mostly offset the lower gross margin.

GAAP Operating income grew 5.9% to $23.6 million compared to $22.2 million in the second quarter of last year. Excluding the items I just mentioned and the secondary offering costs in both periods, operating margin would have been 21.7% compared to 22.8% last year.

Adjusted EBITDA in the quarter, which eliminates the items I described before, share-based compensation and the excess cost of acquired inventory and other nonrecurring items, increased by 23.3% over prior year to $30.4 million, a margin of 26.2% versus last year's margin of 27.7%.

Foreign exchange fluctuation drove a significant swing in finance expenses which was $1.4 million of expense in the second quarter this year compared to $0.4 million of income in the same period last year.

Our taxes in the second quarter were $3.4 million, 15.2% of income before taxes compared to last year's rate of 11%. Excluding a $0.34 million tax adjustment related to prior year's income tax settlement with the tax authorities, tax rate would have been 13.6%.

Adjusted net income attributable to controlling interest in the second quarter increased by 11.2% to $20.7 million, 17.8% of revenue compared to $18.6 million last year, a 20.9% margin. Adjusted net income per diluted share in the quarter was $0.58 compared with $0.53 last year.

Our June 30 balance sheet was strong with cash and short-term bank deposits of $80.3 million. This is $10.5 million below our Q1 cash balance reflecting our capital spending for capacity expansion and increased working capital. Our inventory went up by approximately $15 million compared to year end enabling us to better serve the growing demand for our products which was achievable due to our continued strong manufacturing and our additional capacity.

As we mentioned in our press release, we have decided to increase our investment in the US manufacturing facility to approximately $115 million versus our previous estimates of $100 million. This is mainly to accommodate the improvement in operations including updated machinery for higher manufacturing capacity.

With respect to our 2014 guidance, following our second-quarter revenue and the increase in manufacturing capacity and in our inventory, we are increasing our full-year revenue guidance from a range of $420 million to $430 million to a new range of $435 million to $445 million. We are also increasing our 2014 adjusted EBITDA guidance to a new range of $112 million to $117 million from our prior range of $108 million to $113 million.

Thank you and we are now ready to open the call for questions.

(Operator Instructions). Stephen Kim, Barclays.

It is John filling in for Steve today. Just wanted to start on the gross margins. You indicated three factors that affect raw materials and the impact from IKEA as pressuring your gross margins this year. Can you maybe size up those three factors, how much each contributed to the 420 basis points of compression?

The biggest factor was FX with slightly over 2% impact. IKEA was significantly less than that and the raw material price was even less than that, even less than IKEA.

Got it. And you had impressive leverage on the operating cost. Is the current run rate of $24 million of SG&A a level you are comfortable with for the second half or should we see a sequential increase in SG&A dollars spent just associated with the planning of the Richmond Hill facility?

I don't think that the Richmond Hill facility will affect SG&A dramatically in the second half of 2014. I think that there's two things regarding SG&A. From this quarter you have to take out the follow-on offering expense that will not repeat itself and on the other end, we expect some increase [M&S] in the US for the second half.

Got it. All right, thanks, guys.

George Staphos, Bank of America Merrill Lynch.

It is actually Alex Wong sitting in for George. Thanks for taking the question and congratulations on a solid quarter.

First question regarding growth in the US, obviously a very solid growth there. Can you just provide a little more color on the relationship with IKEA and also what you are seeing from and end market growth standpoint right now?

I think in general want you see is like we said in the past the results of the implementation of our strategy you see the quartz story unfolding in the US. IKEA of course is reflected also in our PR is going very well and continues to grow. Overall we feel that our strategy works, our new product are succeeding very well in the market and we feel confident that we are in the right direction.

Thanks for that color. Maybe just wondering if you could provide some granularity around the opportunities that you have learned over the last few months around the incremental $15 million spend on the Richmond Hill facility and then also on the plans around the second building, any anticipated impact in 2014 guidance that we should be thinking about?

So I will start with the first part. So as to the $15 million, most of this recent increase has to do with maximizing our throughput and operational efficiency in the facility. So this is to that end. The rest of your question, are you referring to the capacity that we are building or I just would like to be sure that I understand your question?

So just around the second building, if you could talk about what the setup is right now at Richmond Hill and what the timing of that we should expect relative to the 2014 guidance, any impact on that?

So just again to reiterate, in 2014, the only addition to capacity is line number 5 in Bar Lev and then we expect next year to have additional two more lines, one in the first half of the year and the other one in the second half. So this will be lines 6 and 7 and will be the first two lines in the States.

According to what we see now, we started to plan and fixed this toward the additional expansion and we have room in the same area in Richmond Hill to build another two lines, lines 8 and 9 but this is still relatively far from today. However, we need to start to take care of it. This is of course involved our estimation of future demand and may vary but according to the current demand, we need to start to work on it.

Great. Just a last question, how is the supply chain functioning in your quartz procurement from Turkey? Are there any issues that have arisen given the outbreak of geopolitical tensions in the region? Thanks very much.

No, we have a long relationship with the Turkish suppliers. It has never been affected by political issues and there are no issues.

(Operator Instructions). Michael Rehaut, JPMorgan.

Good morning, everyone, and congrats on the quarter. The first question I had was just looking at the US growth and opportunity which continues to be fantastic and obviously driving your results here, I was hoping if you could just take a step back if possible and just give us a sense at this point perhaps as you look at the first half of 2014 if you could give us a rough sense of how your sales is currently breaking down across the different end markets, residential, commercial, new, repair, remodel and where you think the biggest opportunity is in terms of the different end markets over the next couple of years?

So according to our last estimation and I would like to emphasize that we don't have solid data so it is only our analysis, we believe that home starts account for about 30%, sales innovation, about 55% and commercial 15%. This is the situation in the States. It is a little bit different in Canada, Australia and Israel where the home starts -- in Canada and Australia the home starts play a bigger role, around 40% give or take and commercial is smaller, about 5%. So this is just to mention I would like also to mention that we saw this quarter also a positive trend in Australia and Canada in addition to the States.

Now trying to look forward to the next few years, again I think one important point is that we build our plans according to the material conversion story and with having said that, I cannot say a lot more than what we say in our guidance in terms of the future growth.

I appreciate that. Certainly when you talk about starts, you are talking about single-family and multifamily apartments as well?

Yes.

Okay. Now the second question just on the -- the SG&A leverage continues to be very powerful for the Company and as you continue to grow the business, do you expect further leverage potential going forward? We have certainly seen a lot over the last couple of years and it is certainly something that we are expecting and just wanted to get a sense for it would seem to me that is an opportunity where you can continue to drive further leverage. Obviously it is going to be difficult for you to give us an idea in terms of how much but directionally, is it still fair to think that there is more leverage opportunity on SG&A as you continue to grow the topline like you have?

I believe that there is potentially additional leverage as we grow and also in line with the IKEA business that we talked about before which is shifting a bit our model towards somewhat lower gross margin but an increased OpEx leverage as well.

Okay, great. Just one last one if I could. You have talked in the past about roughly 95 million per line in terms of capacity. Is that still the way to think about it and could that change at all as you continue to introduce some higher-priced products?

Yes, I believe that today we are closer to north of 100 million, probably around 105 million and the increase that we saw is a mix of the fact that our differentiated products are becoming bigger in the sales mix ongoing throughput improvement that we are able to take out of our current lines plus adding the IKEA (inaudible) installation and publication component which is not generated by the line itself but taking account in the blended rates.

So the IKEA business mix just lends to a higher price per sale you mean? Higher sale per unit? (multiple speakers)

Yes.

Okay. But mix and throughput are the biggest drivers at this point of the increased line capacity?

I think also it contributes. I didn't measure exactly how much is each component.

Okay. Great. Thanks very much. Congrats again.

John Baugh, Stifel.

Good morning and congrats on a great quarter. I wondered if we could talk about a couple of your more mature markets, Australia and Canada, which have both had less robust economies. You are still growing there. Could you give us a sense, are those market share gains, are those mix benefits or are those penetration of quartz, all of the above? What is allowing those markets to continue to grow against some headwinds?

First of all, the (inaudible) in Australia is a bit different. In Canada we experienced relatively soft housing market in Australia. The situation is getting better after two tough years so I think to start with Australia, it is driven again first and foremost because of the quartz story. Second, our products there. And third, the situation in the market. We don't know and we don't have information about our market share compared to the others and we are very concentrated and have enough to concentrate on our business which is growing and we have to take good care of.

In Canada, I think the same as Australia without this situation of the market which doesn't help. On the other hand again, we see a lot of success coming out of our new products, our new designs especially of course the Supernatural and the now also the granite inspired designs and those two markets are performing very well. In Israel, we saw a little bit, a little weakness in this quarter. It is a very mature market. We don't expect huge movements neither up nor down in Israel.

Thanks for that color. Then as it relates to IKEA in the US, you were in I know a bit of a service deficit last year. Are you caught up? Are you fully where you want to be? I know it is rolled out in their stores but wondering what the incremental growth from the second quarter run rate of IKEA is moving forward?

If you are relating to our inventory issues last year so this is solved almost totally, almost totally solved. In general I think IKEA I believe also maybe the customers get used to the products more and more and the cooperation is very good. It probably also has to do with what IKEA is offering part of the countertop and overall it looks very good.

I know you probably won't comment but I was just curious, is this program from IKEA's perspective going so well that they may contemplate it internationally and once you are in a better service position with capacity that that is a big opportunity or that is just too far out in the future?

I think it is a part of North America market which is one thing. I think globally there is no connection at least with what we see now to the rest of the world and in many countries it is a country by country thing. So I don't see at the moment any impact or any relation of what is happening in the states to other markets.

Thanks for that color. Good luck.

Mike Dahl, Credit Suisse.

Thanks and good quarter. Was wondering if you could give a little more color going back to the capacity, first, the increased investment on the first two lines in the US. Should we also expect that that means you are putting those lines in a position to produce some of the higher end products quicker than you may have previously expected to do so?

I think that relating to these two lines the increase has managed to do with new machinery that we bought that can produce better product or can help, it is part of a line so it is not all the line, it is specific parts of the line that can produce better products, also a little bit faster. It also has to do with additional -- a piece of building that we decided to add. It has to do with the showroom that we decided to add and to do in a more fancy way and to a much smaller extent, also additional money that we had to invest for example infrastructure.

Overall it may well be that it will allow us to improve the throughput. This is what we believe. However, I cannot quantify it at this moment. So the intention is of course to allow us to increase throughput but we still need to wait and see.

And are some of these, are some of the things that you are doing at the US plant, would you say that would put them on par with your existing plants or even more modern? If more modern, is this something you could look at doing as far as retrofitting some of your other existing lines to also increase throughput on those?

It is more modern but I don't see -- there are basic things that we can do. There are also in Israel there are on each side there is specific constraints so we need again to take care of side-by-side. Then we cannot for example change the site in Sdot-Yam to be the same as the site in Richmond Hill. This would be our most advanced site and we expect for the medium-term to operate in a higher throughput than the one the average of what we do in Israel.

Got it. And lastly, I guess, as you think about bringing on all this capacity, I guess your success in the US is probably getting tougher and tougher for competitors to ignore. So are you seeing others start to also increase their capacity plans or how are you seeing the competitive response right now?

There are also other competitors that increase capacity. According to what we know, there are very little of them and we may not be aware of everything. We don't see a straight reaction to what we do. Again, we may not know but there is nothing specifically that we know that was done in order to [cope] with Caesarstone.

Okay, thank you.

Lars Dollmann, Adelphi.

Congratulations. A couple of questions from my side. On the market share in the US, do you have any guess how much market share you were gaining?

No, as we said before, we don't have an objective data about market share. It is very difficult to assess and to quantify. I also mentioned that what we see is we see a very strong business and we need to take care of. Market share is important but it is not very important in the short term so we don't have a good way to assess it in the absence of an objective data.

Okay. And then on IKEA again and you touched it a couple of times already, so at the end of the day obviously we give up a bit of margin and then we take a bit back because your marketing spend is obviously lower. So you would say that it is okay that if I take in the profitability of IKEA sales is relatively close to the other profitability?

Yes, I would say that IKEA as a whole including the slab business and installation (inaudible) all together is within our operating income margins.

And then the next one is, you had obviously a bit of a tax impact again. We saw that (inaudible) came out and obviously decreased rates in Israel and specifically stated first time really big time saying that they have to fight against the shekel appreciation. Any view from your side in regard to the FX that it should roll off after having a couple of big quarter impacts?

You know, the shekel was very strong during the last nine months. Extremely well during the last months during this war that we had so I am not really optimistic that it will devaluate now against the dollar but I think it is everybody's guess so we will have to just wait and see.

And then one question going forward as soon as obviously you have the capacity ready, but what is holding you actually back in total from selling more in Europe?

Do you mean what prevents us from selling more in Europe?

Yes. Yes. Going forward strategically.

Strategically Europe is interesting as all the world is interesting and it is just that we have to prioritize and we are not a huge company. We would like to be a huge company but at the moment we are not a huge company. So our first priority is to focus on the states and then Australia and then Canada. Europe is a big market, very fragmented and I assume that if we invest a lot of time and money we can of course increase the business there. So we may be opportunistic about Europe if there is any special opportunity, we may pursue it but overall I don't think that we will see a lot of growth there at least the short term.

No, because obviously the priority at the moment is the US facilities, right? But then going forward probably over a couple of years time there should be the same opportunities as you have in the US coming through in the longer term in Europe?

So as I say, it is more complicated, it is more fragmented in the US. Europe is like making a business in many countries, it is not one country. We need to address it differently. As such, it is in a lower priority than other markets in the world for us.

Okay, good. Thank you.

Thank you very much.

Michael Rehaut, JPMorgan

Thanks. Just had a follow-up actually on the gross margins. Last quarter I think you stated that you expected gross margins to improve from the first-quarter level. I guess if you exclude the items, some of the one-time items it included -- I am sorry -- it improved slightly at the same time FX continues to have a big drag. So I just wanted to get a sense number one, excluding the one-time items, were gross margins kind of in line with your expectations or did IKEA perhaps -- the better than expected success from IKEA impact those expectations for the quarter itself? Just how to think about gross margins for the back half of the year?

So regarding Q2 versus Q1, I think there was two things that worked in our favor and those were the continued increased mix of differentiated product that helped slightly the gross margin in Q2 over Q1 and also FX was better than in Q1 so that was helping margin relative to Q1.

However, IKEA increased business was in margin and gross margin a bit of a drag and this one-time employee fringe benefit provision so all in all, those were two positives and two negatives [to the 0.5%] difference. Going forward I think you should conclude from our guidance, (inaudible) margin, I prefer not to break down specific line items in the income statement.

So obviously you don't want to get pegged it down. I understand that, Yair. But it seems like given the trends and everything it would seem reasonable that perhaps the second half should be similar to the first half. Is that unreasonable to think or --?

I believe that we will have higher volume in the second quarter compared -- in the second half compared to the first half and line 5 should blend better utilization going forward and higher differentiated product mix also helps. So if exchange rates won't dive down negatively all at once now, I believe kind of within our guidance, I believe that the second half will be better.

Great. Thanks very much.

I think, Mike, if you analyze our guidance, the outcome, the very simple and very one conclusion that you can get is we expect better results in the second half.

Right. No, no, I haven't worked through the model fully but I appreciate it. Obviously there is gross margin and operating leverage as well so it just wanted to make sure.

Okay. Thanks.

Thank you. At this time I would like to turn the conference back over to Mr. Yosef Shiran for any additional or closing remarks.

Thanks. Thank you for joining us. We feel very confident that we are on the right path to continue and grow our business and drive value to our shareholders. Our strategy is working well. We are growing around the world, maintaining a strong brand and building for the future.

We appreciate your attention and support and we look forward to speaking with you again soon. Bye.

Thank you. Bye.

That does conclude today's conference. Thank you for your participation.