Caesarstone Ltd (CSTE) 2014 Q4 法說會逐字稿

Good day and welcome to the Caesarstone Fourth 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. You may begin.

Thank you operator, and good morning to everyone. Before we get started, I'd like to remind everyone of the company's Safe Harbor language. 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 actual events or results may differ materially.

For more information, please refer to the Risk Factors contained in the company's Annual Report on Form 20-F.

In addition, the company will also make reference to certain non-GAAP financial measures, including adjusted gross margin, adjusted operating expenses, adjusted net income, adjusted net income per diluted share, adjusted net income attributable to controlling interest, adjusted EBITDA and various metrics that may be presented on a pro forma basis. The reconciliation of these non-GAAP measures to the most directly comparable GAAP measure can be found in the company's fourth quarter earnings release, which is posted on the company's Investor Relations website.

With that, I am pleased to now turn the call over to Yos Shiran, Caesarstone's Chief Executive Officer. Yos?

Thank you, Allison. Good day and thank you everyone for joining us to discuss our fourth quarter. We had a solid finish to a strong year. I would like to start with some highlights for the quarter. Sales increased 17% over last year to a new fourth quarter record of $113.6 million. Adjusted EBITDA grew by 16% to $28.1 million in the fourth quarter. Adjusted net income was $21 million, up 20% versus last year's fourth quarter. Adjusted net income per diluted share was $0.59 versus $0.49 in the fourth quarter last year.

This was a strong finish to the year and in line with our expectations. We believe the demand for our products remains strong and our brand remains a clear leader in our markets. Caesarstone continues to be recognized for its high quality, innovative and inspirational design and excellent service. As we begin 2015, we are excited to see continued quartz growth in our main markets, launching new and differentiated products led by our Supernatural series, expanding capacity at our new manufacturing facility in Richmond Hill, Georgia and strengthening our global brand.

Now I would like to give an update on each of our major markets both for the quarter and the total for the year. Fourth quarter sales in the United States grew 43.1% to $49.6 million. The United States has been both our largest and our fastest growing market. For the full year, sales in the United States were $185.6 million, an increase of 50.4% over the full year of 2013.

We believe our growth in the US demonstrates that the quartz material conversion story is happening as we had expected. Our growth also displays our leading position in the marketplace. We'll continue to see a strong opportunity for growth in the US market and we believe our new manufacturing facility will further enhance our service level and time-to-market in the US.

Australia sales in the fourth quarter were $28 million, up 15.1% compared to the prior year. On a constant currency basis, Australia was up 24.3%. For the full year, Australia sales grew 19.6% to $107.5 million. On a constant currency basis, the full-year growth rate was 27.4%. Australia remains a solid market for us.

Canada sales in the fourth quarter grew 14.8% to $13.8 million, up 25.6% on a constant currency basis. For the full year, Canada sales grew 17.6% to $57.9 million. Full-year growth was 26.2% on a constant currency basis. We expect to see continued strong growth in Canada.

Sales in Israel for the quarter were $8.9 million, down 15.9% versus last year. On a constant currency basis, sales were down 9.3%, resulting from a weak housing market. For the full year, Israel sales were down 1.8% to $41.3 million, down 3.8% on a constant currency basis.

Europe sales in the fourth quarter decreased 24.8% to $5 million, down 17.9% on a constant currency basis. This was primarily due to an unusual strong quarter in the prior year, when we were making up for delayed deliveries associated with the startup of our new ERP system. For the full year, Europe sales were $23.1 million, up 0.6% and up 0.8% on a constant currency basis.

Revenue in the rest of the world during the quarter was down 3% to $8.4 million, basically reflecting a challenging foreign exchange environment. On a constant currency basis, growth was 3.5%. For the full year, sales in the rest of the world were $32 million, up 10.1% and up 10.4% on a constant currency basis.

I want to note briefly that there has been press reports in Israel about an initiation among some of our employees at our Bar-Lev facility to form a labor union. We do not know what the outcome of these deliberations among our employees will be and I raise that here solely to make sure that there is no confusion as a result of these press reports.

In general, during the fourth quarter, we continued to execute well and increased our manufacturing throughput. As we look ahead, while we experience temporary inefficiencies and startup costs, particularly in the first and third quarters, our capacity expansion in the US would allow us to increase volume, better allocate inventory, to serve demand and enable us to capture more of our global opportunity.

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

Thank you, Yos, and good morning to everyone. I will start with our income statement for the fourth quarter. Sales in the fourth quarter increased by 17.4% to $113.6 million compared to $96.8 million in the same quarter of last year. On a constant currency basis, sales increased by 22.7% versus last year.

Gross margin in the quarter was 43%, the same margin as last year. Significant favorable mix related to our differentiated product and benefits of scale were offset by negative exchange rate fluctuation, strong growth from IKEA, which include lower-margin fabrication and installation revenues, and to a lesser extent, an increase in quartz prices.

Operating expenses in the fourth quarter were $25.9 million or 22.8% of sales versus $21.8 million last year, which was 22.5% of sales. Operating leverage was offset by increased general and administrative expenses. I would like to note that in addition to other items, we began to incur G&A costs associated with building organizational infrastructure in anticipation of opening our new manufacturing facility in the United States.

Operating income grew by 16.3% to $23 million compared to $19.8 million in the fourth quarter of last year. Our operating margin for the quarter was 20.2% of sales, roughly in line with 20.4% in the same period last year.

Adjusted EBITDA in the quarter, which eliminates share-based compensation expense, the excess cost of acquired inventory and other non-recurring items, increased by 16.1% over the prior year to $28.1 million, a margin of 24.7% versus last-year margin of 25%.

Finance income in the quarter was [$0.8 million] compared to finance expense of $0.4 million last year. This difference was primarily due to foreign exchange fluctuations.

Our taxes in the fourth quarter were $3.3 million or 13.9% of income before tax compared to last year's tax rate of 12.1%. Adjusted net income attributable to controlling interest in the fourth quarter increased by 20.3% to $21 million or 18.5% of revenue compared with $17.5 million last year, which was 18.1% of revenue. Adjusted diluted earnings per share in the quarter were $0.59 on 35.45 million diluted shares. Last year, adjusted diluted earnings per share were $0.49 on 35.39 million diluted shares.

Now I would like to note some of our full year financial performance highlights. Sales for the full year were up 25.5% and up 28.4% on a constant currency basis. Gross margin was 42.4% in 2014 compared to 45.5% last year. Once we exclude the $3.5 million beneficial change in the value of inventory related to the ERP implementation from last year and a $0.8 million unfavorable provision adjustment related to (inaudible) taxable employee fringe benefits in this year, the decrease in gross margin would have been 190 basis points. This primarily reflects a negative exchange rate impact and our growth from IKEA, which is the lower gross margin from the installation and fabrication component. Both factors were partially offset by positive differentiated product mix and scale benefit.

Operating margin was 21.2% this year, in line with our operating margin of 21.3% last year. (inaudible) an improvement of 110 basis points, if we exclude the one item I just mentioned in the gross margin discussion and reflects strong leverage of our operating expenses.

Our adjusted EBITDA grew 27.1% to $116.6 million, a 26.1% margin, up 40 basis points versus 2013. Adjusted diluted earnings per share grew by 28.3% to $2.33 and we drove operating cash flow of $76 million.

Our year-end balance sheet was strong with cash and short-term bank deposits of $54.3 million, after capital expenditures of $86.4 million primarily for our US facility, and after $20 million dividend paid in Q4. We are pleased with this strong performance.

With respect to our 2015 guidance, taking into consideration, among other items, the current exchange rates and the temporary inefficiencies associated with opening our new US manufacturing facility, we are expecting revenue to in the range of $515 million to $525 million, and adjusted EBITDA in the range of $123 million to $129 million.

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

Thank you. (Operator Instructions) Stephen Kim, Barclays.

Hey, guys. Yeah, just wanted to sort of follow up on two things. First of all, I had a little bit of difficulty understanding the adjustment you gave to the gross margin. I was wondering if you could just repeat that again for us. And then secondly, Yos, you mentioned I think that there would be some startup costs that you anticipate, I think, in the first and third quarters of this year. I was wondering if you could quantify those for us in your outlook, particularly for EBITDA. Thanks.

Okay. So in 2013, we had a one-time credit associated with the evaluation of our inventory of around $3.5 million related to the time of day of the implementation, so therefore the beneficial results one-time for 2013. This year, there was a one-time negative $0.8 million gross margin associated with some employee taxable income. So if you exclude those two one-time impacts, the ongoing margin went down by 190 basis points.

Okay. Got it. That helps. Thank you for that. And about the --

To the other question, Stephen, yeah, so we intend to start production in our sixth line, the first in the US, during Q2 and we incur a lot of cost in Q1 before we make any production. The same phenomenon will occur in Q3 ahead of production in Q4. So this will negatively impact the EBITDA. In Q3, of course, it's a stronger quarter and we will already have some production from the US factory, but in Q1, there is no production, but still we incurred a cost. So this is something we mention. Everything is calculated into the guidance, but the distribution between the quarters of course could be affected by that.

Can you quantify that for us a little bit more precisely, Yos?

Steve, when we take the US, there are two things. One is the startup costs in Q1 and Q3 ahead of each line in operation and then there is the fact that there is a learning curve and the lines will not start in 100% capacity. So if we are comparing the difference on the inefficiency, the temporary inefficiency of the US lines in total compared to the Israeli line, this is an EBITDA drag of around $11 million for 2015.

$11 million?

Yes.

Okay, great. That's very helpful. And then just my last question relates to your quartz supply contracts. Are they US dollar denominated or are they denominated in shekels?

Most of them are denominated in US dollars.

Okay. Great. Thanks very much guys.

Thank you.

Michael Rehaut, JPMorgan.

Hi, it's actually Will Wong on for Mike. I was wondering if you guys could talk about what the impact of FX was on the quarter, and also what level of headwind you are expecting in your full-year guidance from FX. And also if you could remind us of the amounts that you hedged, and also what the swings in each of your major currencies, the Australian dollar, Canadian dollar, the shekel and also the euro have on earnings?

Yes. So regarding Q4 first, the revenue impact in Q4 was $5.2 million compared to the same quarter in 2013 and the -- of exchange rate impact and the EBITDA impact was approximately [$2.3 million].

$2.3 million?

With regards to this year, 2015 guidance versus 2014 average. So the overall impact of the exchange rates, the current view of the exchange rate as they are now, they are impacting our guidance by $35 million -- approximately $35 million in revenue and approximately $13 million in EBITDA.

Now, if I were to compare the exchange rate that we see today versus the average exchange rate of 2014, then the Australian dollar depreciated by 13.3%, the Canadian dollar weakened against the US dollar by 11.2%. Those are both detrimental both for revenue and for EBITDA for the company. Euro and NIS also depreciated versus the dollar. Euro depreciated 13.8% and shekel depreciated by 8.1% versus 2014, the current rate. The depreciation of the euro and the NIS are detrimental to revenue, but favorable to EBITDA. And as I mentioned, the total impact we estimate is $35 million for those exchange rate fluctuations, $35 million in revenue and approximately $13 million in EBITDA.

Okay, thanks. That's very helpful. And can you talk about the impact of raw materials, primarily quartz and resins and what impact that had on the quarter as well as what your outlook is for 2015? And also just going forward, can you talk about where you plan on sourcing quartz for the US facility and if there is any cost differential between procuring in the US versus other areas?

Yes. For Q4 2014 versus Q4 2013, quartz prices went up and this caused around less than 50 basis points impact on gross margin for Q4. In 2015, we expect some additional pressure from quartz pricing, again, not much, less than 50 basis points. And on the sourcing I will let Yos answer.

Yes. So regarding quartz, it looks there are some good opportunities for sourcing quartz in the US. However, until this is finalized, which is not 100% sure, we will continue to purchase quartz from Turkey and other places. We expect Turkey to still be relevant for some of the supply to the US factory, and this means that we will pay more for quartz until we find a good local quartz supplier. So it seems that there are good opportunities in the States, but as we start, we'll buy from Turkey, which will increase the quartz prices compared to Israel, because of the [price].

Okay. Got it. And then just last question. I was wondering if you could share with us your outlook for the US in terms of what you're seeing with the commercial versus residential as well as new construction versus repair remodel activity? Thank you.

I don't think there is big difference from last update. So in general, the market is growth and we continue to perform well and between the different elements, it is more or less what we know. So in the States, revenue stem from home starts is about 25%, renovation 60% and commercial, 15%.

David Goldberg, UBS.

Thanks. Good morning everybody. My first question, given the robust growth that we're seeing in the US quartz market, do you have any insight into what your competitors are doing? Are you seeing anybody kind of step up their efforts to try to gain market share? It seems like you guys are probably growing faster than the overall market. So I'm just wondering about the competitive response now.

Hi, David. So it's a good question. However, we don't share objective numbers regarding that. We definitely have inside continued [dimension], but this is something that we keep inside. What we have is the Freedonia reports and hopefully we still will have new reports issued by Freedonia, so we will have a better, let's say, a better Freedonia picture of what is going on.

But just anecdotally from people selling the product in the US and from what you're hearing, you're not really hearing about a change in the competitive behavior?

I think that overall, also according to publications in magazines, you can see that overall the quartz penetration continues to grow and the acceptance of quartz continues to grow and quartz becoming the preferred products for countertops in the States, but -- and there is a lot of activity from all angles, of course, what we do, what others are doing, and also quartz from China and other places. However, as I said, we don't have -- we don't know how to quantify it.

Okay, got it. My other question was about the potential cost of this unionization in Israel, Yos mentioned in the opening remarks. Have you guys explored what that would look like in terms of additional costs for you?

David, can you repeat please? Can you please repeat the question?

The question, I think in the opening remarks, you talked about potential efforts to unionize in Israel.

Yeah.

And I was wondering if you've looked at the additional costs that would create for you?

Well, first of all, there is no union and what we are reporting, we are reporting on attempts to establish a union by a few employees. This does not mean that there will be any union. The reason we report it is because there were some publications in Israel and we would like to -- since it happened, we would like you also to know about it. We don't know whether there will be -- if there is a new union, we don't know what would be the impact on costs, if any.

Okay. Thank you for the clarification.

Thanks.

(Operator Instructions) George Staphos, Bank of America-Merrill Lynch.

Thanks. Hi, everyone. Thanks for the details. Congratulations on the year in the progress. I guess, the first question I had, to the extent possible in this kind of form, can you update us on how your new products, Supernatural etcetera are doing in the marketplace, if not with numbers, perhaps a bit more qualitative discussion? And I had a couple of follow-ons.

Hi, there, George. So the Supernatural series continues to do very well in most of our markets. We are excited about the launch of the Calacatta in the States. We already introduced the Calacatta, but it was quite a soft launch. Now we are gearing up in terms of our efforts around the Calacatta. We are also launching additional new products in the United States, a few variations of Concretes, other granite look, new granite look products, and we expect those to be received well in the market. However, of course, we don't know and we'll have to wait and see. What we do see is that one of the Concrete products, and of course, the Calacatta is well received in Australia, Canada, and we expect that it will be well received in the States.

Relative to Calacatta, when do you think you'd have enough visibility to deem it a success in the US? So if you're rolling it out now, would it be a fourth quarter 2015 event? I'm not trying to be too precise here or do you think you'd have a pretty good view by second quarter?

The whole launch in general, probably we'll have some indication in the third quarter. On the Calacatta specifically, we already started to sell and it sold quite well in the fourth quarter. We expect those sales in the States to grow, and this we'll know probably in Q2, and if not, then in Q3.

Okay. Thank you for that. Second, I was hoping you could just update us if possible on your thoughts for capital spending this year. And looking at the balance sheet, recognizing it's the end of the year and you've obviously had the new lines coming on, inventory popped up a bit. Is that all associated with the preparatory work ahead of line 6 and 7 or were there some other things going on there, so CapEx and inventory levels?

So I think as to the CapEx, Yair will address it. As to the inventory level, what you see is that we are building inventories towards Q2. So we try to operate and manufacture all the time to obtain the maximum throughput that we can. So it caused us a little bit of growth in the inventory, and we see it as a positive thing. We expect that this may go down, especially in the first half of the year, because we don't have enough capacity gears. However, towards the second half, we hope that the startup of line number 6, the first line in the States, will help us in terms of servicing the market. So this is as far as the inventory regard.

Okay. Thank you.

Regarding --

Yeah, just about the CapEx. So Yair will address it.

Regarding CapEx, we invested this year around $86 million in cash for CapEx, most of which went for the US factory, and the next significant thing was the completion of the line 5 in Israel. We are expecting our 2015 CapEx to be approximately 25% below that level, but that is before we may have additional money for the phase two of the US plant, which we are currently reviewing. And once we will make decisions, we'll announce an update on that.

Understood. And then my last two questions, I just want to make sure I understood, foreign exchange, based on your current analysis, the negative impact to EBITDA is a $13 million effect or a minus $30 million effect? And then could you update us on the silicosis litigation? Thanks and good luck in the quarter.

So the FX impact is, again, $35 million on revenue and $13 million on operating income or EBITDA for that matter.

That's what I thought. And silicosis?

Silicosis, nothing new to report apart of what we said in the past. We continue to deal with it, and probably it will accompany us in the next few years, but there is nothing new.

Thank you very much.

Thank you.

Michael Dahl, Credit Suisse.

Good morning. This is Patrick Murray on for Mike. Within guidance, could you give us a sense for how much revenue is assumed from the opening of the US plant this year?

Well, we are not breaking out how much revenue will be from each plant, but you should assume, again as we said, the first line in the US will be operational in Q2, the second line only in Q4, and there will be significant learning curve. So I think that with that, you can assume something pretty close to (inaudible)

Okay, thanks. Then with respect to the revenue guidance for '15, it seems like a nice increase given the FX headwinds. Is this suggesting a strong expectation for the rollout of Calacatta or other high-end products? And how should we think about the product mix impacting price going forward in 2015?

No, I think the guidance takes into consideration more of the current level with, of course, increase of the collection, but there is nothing special that is built into it apart of what you already know. And of course, the most significant impact is the FX and the startup of the factory.

Okay. And then just one more, if I could. Could you talk a bit about how dealer inventories look right now, and if you've been able to get some incremental supply of the popular lines in there? Thank you.

Pardon, can you repeat the question?

Sure, sorry. Could you talk a bit about how your dealer inventory channel, how inventory looks there and if you've been able to get more supply of the popular product lines in there?

The dealer inventory -- are you relating to the stone suppliers in the States or the different licensees around the world?

Yeah, I guess specifically in the United States, but if you have comments about around the world too, that would be great.

So I don't think there is anything. Again, no significant changes. We suffer here and there for -- because of short inventory and also because of (inaudible) importing to States, but as far as inventory regard, there is nothing special there.

Okay, thank you.

John Baugh, Stifel.

Thank you. Good morning, Yos, Yair. I was wondering if we could talk just about the plant startup here. I assume the lines, each will be similar capacity of about [$100 million]. Could you just tell us roughly what the startup time in months is to get the full capacity in Israel? And how you think about that maybe slightly longer with the US line 6 and 7?

So what we expect for the lines in the States is that it will take us at least six months until we get to the full capacity and maybe longer. We don't know yet. We have to wait and see. So far the project in the States was done according to the schedule, and hopefully, of course, the ramp-up in production will also reflect a good performance.

The Israeli line number 5 just in the last quarter, I think, reached to full capacity, but it was a different way of doing things. I don't know if you recall, but we started with one part of the line and then we added another part to the line. Part of it was quite innovative and it took us more time than we usually expect. So anyway, going back to the States, take three, six months until we get to a reasonable and stronger performance there.

And Yos, would you be starting line 6 early in Q2, late in Q2, middle of Q2? And then if you could talk about the plan in terms of how the machinery maybe similar or different, the process you already touched on the quartz supply, people, anything that's different from, say, line 5 in terms of the US capacity?

Basically the lines are quite similar generally speaking to line number 5. Line number 6 is relatively simple. Line number 7 will be a little bit -- with some add-on. Apart of that, there are no big differences. The lines are going to be newer. So hopefully, we could expect that down the road we will be able to produce a little bit more. As far as the staff and the people there, everything looks fine. And I think it's fair to say again for the sake of calculation, if you can relate to the mid-quarter starting point. However, again, this is not mathematics. So it could vary.

Great. Thank you. And my final question. Are you assuming here any polyester release in 2015 to help offset some quartz inflation? Thank you.

So regarding polyester, so far we haven't seen the reduction that the poly prices would subject, no way near that. We did see some reduction and we baked it in the current guidance. If there will be further, then we will be better off, but we are not sure about that.

Thank you. Good luck.

Michael Rehaut, JPMorgan.

Hi, guys, it's Will again. Just a quick question on the tax rate. Going forward, just given the share from the US [and as] the sales is increasing, just wondering how we should think about the tax rate here in 2015?

Yeah, it's actually the guidance that we previously gave in our discussion when a line (inaudible) full capacity for the full year, we laid around $3 million of additional tax compared to a Bar-Lev line. It appears to be still accurate, but let me make it easy on the next year. We are expecting taxes next year to go up from around 14.5% this year to something between 17% to 19% next year.

Okay. Great. Thank you.

Stephen Kim, Barclays.

Hey, guys. It's actually John filling in for Steve on this one, really quick. So you guided that you're expecting a $35 million headwind on the top line from FX. If you apply the margin that you guided, I would have thought that the EBITDA impact would have been something closer to $8.5 million in 2015, but you guided to $13 million headwind from FX on EBITDA. What are some of the additions outside of just the translational impact of FX that would increase that headwind?

Well, the $13 million is strictly an impact of FX, nothing else. We didn't add to this anything. We didn't try to couple many things. So that is just FX. So probably we have some differences in the way we calculate it, but remember this, if you take the 20-F from 2013, it won't be as accurate because we go in Canada, we go in Australia. So the exposure becomes bigger as time goes by and we dwell in those regions.

Got it. So is the implication that the non-US business is going to have meaningfully higher margins than the US business in 2015, just because of all the incremental costs that you're incurring with the plant startups?

Again, John, can you repeat the question?

Yeah. So I am just wondering, is that implying that if the profitability in the US is going to come down pretty considerably in the near-term just because of these incremental costs and that it's something that you would expect to snap back in 2016 once the plants are at full operating capacity?

Yeah. So that is pretty accurate. So what we said is that there was a $13 million of FX impact and $11 million of temporary inefficiencies related to the opening of the new line, most of which we hope will go away next year. After the learning curve we may be not to end 100%, but will probably be a lot better than 2015.

Okay. All right. That's helpful.

Will Wong, JPMorgan.

Hi, guys. Last question. Regarding the FX headwinds, are you able to raise price in some of the areas where you're seeing big headwinds like Australia and Canada just to offset some of that?

Yeah, we are able to raise prices and we do it according to what we believe is rise compared to the hurt in margin for us, and of course, for what the market can absorb. So it's not immediate and it's not that -- if there is a change in the Australian dollar, we'll immediately raise prices, but we raised prices last year and we do relate to that, but it's not immediate and the changes in the Canadian and the Australian dollar, at least especially in the last few months was relatively sharp. So it takes time to digest and also we'd like to see what is the trend.

Okay. So within your revenue guidance, you haven't baked in any price increases for 2015 currently in those areas?

We did some. What you see is after what we expect to do in the different markets.

Okay. Great. Thank you.

Thanks.

Thank you. With no further questions, I'd like to turn the conference back over to Mr. Yos Shiran for any closing remarks.

Thank you all for joining us today. We are pleased with our fourth quarter and 2014 year-end results. As we head into 2015, we are excited for the opportunity for continued growth globally. We intend to continue pursuing the developments and launching innovative products with inspirational design. We expect to operate our new production facility and better service our markets and the demand for our products, and we aim to [leverage on] our strong brand. We believe that we have the right strategy to further promote our business and position in the markets going forward. Thank you again for your support and time, and have a good day. Bye.

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