Caesarstone Ltd (CSTE) 2016 Q1 法說會逐字稿

Good day and welcome to the Caesarstone First Quarter 2016 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Allison Cain of ICR. Please go ahead.

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 Annual Report on Form 20-F and subsequent filings with the Securities and Exchange Commission.

Additionally, 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 first quarter earnings release, which is posted on the Company's website.

With that, I'd like 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 first quarter. Our first quarter was generally as expected and our business is performing well. I would like to start with some highlights. Sales increased 8.4% to $116.9 million. Without currency impact, growth would have been 12.3%. Adjusted EBITDA for the first quarter was $23 million, a margin of 19.7%. Adjusted net income was $13.3 million and adjusted EPS was $0.38. Our gross rate was strongest in Europe, Canada, and the United States, excluding our IKEA business and Australia. This performance was partially offset by continued foreign exchange pressure; and in the United States, by an expected drop in sales to IKEA versus prior year related to previous quarter's sales event interruptions. As our sales growth accelerates, we expect margins to improve.

Now, I would like to give an update on each of our major markets for the first quarter. First quarter sales in the United States grew by 2.7% to $49.3 million. Similar to the past few quarters, growth was adversely impacted by significantly lower sales to IKEA. As we mentioned before, IKEA resumed its promotional events in March and we expect this to have positive impact starting in the second quarter. We have continued to refine our growth strategy in the United States along three key lines, brand, execution and innovation. The Caesarstone brands and products have tremendous value, which we leverage mainly through creating a more compelling consumer purchasing experience in different channels at the points of sale and other platforms.

With respect to execution, we've also identified specific opportunities to enhance accessibility of our product samples and marketing tools throughout our value chain. And as to innovation, we believe we are on the cutting-edge in terms of the breadth of new products we will introduce this year. Longer term, we believe that our innovation capability is a strong and solid competitive differentiator. Alongside our excellent quality and service, this position us as an industry leader.

Australia sales in the first quarter were $25.7 million, up 10.1%. On a constant currency basis, Australia was up 19.6% in the first quarter. Housing conditions in Australia are slightly better than originally forecasted for 2016, and our business in Australia is proceeding very well. Canada sales in the first quarter grew 26.7% to $17.6 million. Canada's first quarter growth was 41.2% on a constant currency basis. Our business is strong and also our sales to IKEA continue to ramp up. Sales in Israel for the quarter were $10.3 million, up 4.4% compared to last year. On a constant currency basis, sales were up 3.6%. Europe sales in the first quarter increased 41% to $6.6 million and were up 43.3% on a constant currency basis. We believe that in the first quarter, we benefited from timing of orders and are not expecting this level of growth to continue in Europe. Revenue in the rest of the world during the quarter was down 7.7% to $7.3 million. On a constant currency basis, revenue was down 6%. In general, during the first quarter, we achieved our plan and we believe we are on track to achieve our yearly target.

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

Thank you, Yos, and good morning to everyone. I will start with our income statement for the first quarter. Sales in the first quarter increased by 8.4% to $116.9 million compared to $107.8 million in the first quarter of last year. On a constant currency basis, sales increased by 12.3% versus last year. Gross margin in the quarter was 36.5% compared to 42% last year. This margin decrease is attributed to inefficiencies related to our Richmond Hill manufacturing facility. Favorable product mix and lower raw material costs, specifically polyester, were offset by negative exchange rate fluctuations. Our manufacturing costs in Richmond Hill were higher than expected. As a result, we have taken actions to improve our performance including operational process improvements. We have also made managerial changes in the plant.

Operating expenses in the first quarter were $28.4 million, or 24.3% of sales versus $24.6 million last year, which was 22.8% of sales. Excluding an increase of $1 million in share-based compensation expenses derived from recent grants, and legal settlement and loss contingencies expenses of $0.7 million that were not incurred in the same period last year, operating expenses as a percentage of sales would have been the same as last year. Operating income was $14.2 million compared to $20.7 million in the first quarter of last year. Our operating margin decreased to 12.2% from 19.2% last year.

Adjusted EBITDA in the first quarter, which eliminate share-based compensation and legal settlement and loss contingencies expenses, was $23 million. This was a margin of 19.7% versus 23.7% last year. This lower EBITDA margin is a result of lower gross margins associated with the US plant operations. Finance income in the first quarter was $0.2 million compared to finance expenses of $1.9 million in the prior year. The change was primarily due to $1 million net gains related to currency exchange rate fluctuation in the first quarter of 2016 compared with net losses of $1.1 million in the first quarter of 2015.

Our taxes in the first quarter were $2.4 million, 16.4% of income before taxes compared to 13.1% tax rate last year, reflecting higher production portion from our US plant and certain non-deductible expenses occurred in this quarter. Adjusted net income attributable to controlling interest in the first quarter decreased to $13.3 million from $16.4 million last year. Adjusted diluted earnings per share in the quarter were $0.38 on 35.4 million shares. Adjusted diluted earnings per share last year were $0.46 on 35.5 million shares.

Turning to our March 31 balance sheet, we had cash, cash equivalents and short-term bank deposits of $59.9 million. Our net cash position went down by $7.1 million due to share repurchase of approximately 334,000 shares for a total of $11.8 million. Our cash flow from operations improved to $9.1 million in Q1 2016 compared to $2.7 million in the same period last year.

With respect to 2016 guidance, our business is proceeding well and we are pleased to see some positive exchange rate changes. At the same time, we are monitoring exchange rate trends and the development of our US sales, including IKEA. And therefore, we believe that in this early point of the year, it is prudent to maintain guidance. Accordingly, our revenue guidance for the year remains $550 million to $565 million, and our adjusted EBITDA guidance for the year remains $138 million to $145 million.

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

(Operator Instructions) Michael Rehaut, JPMorgan.

Thanks, good morning everyone. First question I had was on the gross margins and more specifically the costs with the plant inefficiencies, and I guess, you mentioned that the costs were higher than expected; and as a result, you made some changes both operationally and from a management standpoint. At the same time, you reiterated your full year EBITDA guidance. So, there's two parts to the question here. Number one, if you could go into more detail in terms of the changes that you made both operationally and managerially, and do those changes -- when do you expect those changes to have an impact on the P&L? And are there offsetting positives that, from your perspective, allow you to retain the EBITDA guidance despite, at least at this point in the year, a greater than expected headwind in this area?

I think -- Mike, I will start with the plant and then Yair will answer about the guidance question. But in the plant, it's not a secret, it was also demonstrated in the fourth quarter that we had some deviations from our expectation. This quarter was better, but we think it should have been much better; and we took some more aggressive steps in order to correct it. It has to do with the way we operate with expenses and with processes. We're already seeing positive result there and this quarter, for sure, we'll suffer less than in the first quarter. In general, the plant is progressing. It's not that -- it's progressing, but it's not progressing as fast as we would like it to be. So I think now with the measurements that we took, it is going to be better. Now, we will see improvement gradually during the year and it should be better of course through the course of 2017. Yair? Regarding the EBITDA for the year.

Yes. So again, as Yos said, we took immediate action. Now, we believe that we will be starting all this impact in Q2 and more noticeably in the quarter thereafter. We expect volume to grow, our revenue and EBITDA margins to improve significantly from Q1.

Just to be a little more specific as possible. Number one, when during the quarter were these changes made either operationally or in terms of management? And number two, again going back to the gross margin question, if 1Q was a little worse than expected, how are you able to maintain full year EBITDA guidance? Were there other positives that came through like less than expected FX headwind now or is it just that you expect this to really turn around and fix itself?

So, with regards to FX, as we said, there is some positive FX trend. However, we prefer to remain cautious in those and to see this trend stabilize [in order to] going backwards. We have some -- Australia again and Canada doing very well. US, we believe, will improve. So, our visibility as of now is that we remain confident with our guidance.

Mike Dahl, Credit Suisse.

Hi, this is actually Matthew Belay on for Mike. Thank you for taking my questions. So, first on the annual sales guidance, I just wanted to tie all that together. So you mentioned you're continuing to monitor the US and IKEA sales and the same time foreign exchange has improved since the last guide and you're seeing Australia come in a little bit better than initially expected. So, really just the question is, has anything really changed in your kind of organic assumptions given some of those trends?

No. I think the organic assumption in general are the same. And all-in-all, we feel that we stay with the same expected sales.

Okay. Thank you. And then just more broadly, now that we're few months into the leadership change that you made in the US and you mentioned redefining the growth strategy in the US. I just wanted to get your updated thoughts on new channels and specifically what if any opportunities you might pursue in terms of the home centers.

So, again just to reiterate partially what I said, we have continued to refine the growth strategy there along the three lines that I mentioned, the brand, execution, innovation. And so first of all, we intend to leverage the brand mainly through the points of sales and other platforms, and execution. Execution of sales and marketing within the channel is very important and we intend to imply more consistent processes to distribute samples of our newer products as well as marketing tools throughout the value chain, [so for these] designers, architects, and of course at the point of sales, and we believe this was part of the weakness. And we believe that we have a successful new product offering to introduce down the road this year. So, all of that, I think, provides us the confidence that the sales in the States will improve during the year, and we see the strength in the other markets in Australia and Canada, which are very strong. So this is it.

Stephen Kim, Barclays Capital.

Yes. Thanks very much guys for taking my questions. I guess the first thing I wanted to understand is the IKEA effect. You had indicated that the promotions restarted in March and helped IKEA. I just want to make sure, first of all, that they're going to benefit the entire quarter or if there's going to be a lag that would make IKEA most of the quarter, but not all of it. And then the second thing part of that would be -- the second part of the IKEA question is, can you just generally tell us what kind of seasonality the IKEA business typically sees overall, excluding this promotion effect. 1Q, I would guess, would probably be the smallest quarter, but I just want to make sure that is correct and seasonality is lower in 1Q.

So we believe that the IKEA business also will improve gradually as -- because of the interruptions that we saw for the year ago. So, we should definitely benefit in Q2, but it should be more beneficial in Q3 and Q4. In terms of seasonality, I don't think that we can identify any specific seasonality in the IKEA sales.

Okay. And then the second question relates to the small charge that was taken in the quarter regarding silicosis. Was that -- what region of the world was that related to and how much of that was -- how much was covered by insurance?

So, basically it was all in Israel and related to a few additional claims. And today if you remember, the first $5 million not insured, so anyway we're exposing the first layer of $5 million.

Maybe one comment to that. So to the claims in Israel, so we got one new claim in early proceedings in Australia by the end of the quarter. So we don't know how to evaluate yet, but just to worth notice.

Is that the first claim that you've had in Australia?

The first claim is against us and others. And other manufacturers, yes, it's a first claim there. We had, at the time, one claim in the States, but we were deleted from the claim afterwards. This was, I think, about two years ago or so, three years ago. And this is the first claim apart of that of the States that we are aware of outside of Israel for us.

And I know you're probably going to be limited in what you can say regarding these. But in general, would you say that the nature of the claim or the complaint is very similar to that we've seen thus far in Israel or is there anything substantively different about the claim that they are making?

No, the nature is the same, but it's too early for us to assess and to understand exactly what is the situation, but the nature is the same nature.

George Staphos, Bank of America.

Hi, it's actually Alex Wong on for George. Thanks for taking the question. First question, I appreciate you identifying the IKEA impact for us last quarter, but was the growth in the US this quarter in line with your expectations? And then on the outlook, can you maybe talk about what gives you confidence in the pick-up. I know you talked a little bit about the change in the strategy and marketing tools, but are you seeing any change in the underlying demand, especially given a pretty strong start to the new home construction this year?

So, I think regarding the IKEA, I'm not sure if I fully understand your question, but IKEA restarted the events and this is why I said that we expect it to grow gradually as of Q2. As to the business in the States in general, so many parts of the business are very good. I think we have opportunities to be more consistent in the China in sales and marketing, and this is what we are doing. The business has grown and we thought that it needed a different treatment and this is why we did the change, and we believe that it will bear fruits.

Understood. So would you characterize the confidence and the outlook more related to these internal initiatives that you're implementing or is the underlying market also giving you a pretty high sense of confidence in the acceleration?

In general, when -- we try to do our best project and it's a process that we do bottom-up and it's a [slower] process, and this is from the lower level. From the base view, we see the markets, we see the trends, and we believe that we are confident with the projection that we provided.

Appreciate that. And then just as a follow-up, mix has been a tailwind for margins in recent quarters, can you comment to what's driving the favorable mix shift and how sustainable do you think this trend is, and if you could talk about any new products by market or what the pipeline looks like?

So, we continue to work on differentiating sales from the competition. We believe we have a very strong R&D and very strong operation organization to execute upon the R&D inventions. It's a game, it's a race. So, we launch products and we launch series of products and then the limitations and all the time, you have to invent your collections and also to understand the trends to be ahead of the competition and better from the competition -- of the competition. And we have succeeded to do it so far, and we believe that we will continue to succeed to do it in the future.

Susan Maklari, UBS.

Good morning. First off, I wanted to get a little bit more details on the raw material cost. I know that you said that, that was a little bit better during the quarter. How are you thinking about that as we move through the year?

It's basically related to polyester prices. And we -- this tends to be volatile, we don't know how it will develop, but we are basically locked for the first half.

Okay. So where -- you will maintain these prices through the second quarter then?

Yes.

Yes. Okay. And then in terms of the share repurchases, you spent about $12 million or so of the $40 million that you've been authorized. Can you just give us some sense of timing, how you're thinking about using the remaining $28 million or so?

Yes. So, the execution of this authorization continues under a predetermined plan, and we will report our progress each quarter under earnings.

John Baugh, Stifel.

Thank you, and good afternoon. I guess I wanted to ask a couple things on the US gross margin again. Was there any unusual discounting or promoting going on, or was it really largely, if not solely, the US plant utilization weighing on the gross margin percentage?

So, basically, there was swing in gross margin relative to last year was due to the US plant. Again, as the Yos mentioned, part of it was expected because we are not in an efficient utilization yet, but part of it was more than we expected. And basically all the rest was offset -- impact offsetting each other. So, there was a negative FX impact that was offset with the lower material cost and the volume impact.

Great. And I think I heard one of you comment about sort of sales growth ex-IKEA with Canada maybe leading Australia, anyway, I couldn't remember the order. Could you restate that?

Yes. So, on a constant currency basis, again Europe and Canada were the fastest growing regions this quarter, each above 40%. Australia was 19.6% overall constant currency growth. Now with regards to US revenue in the first quarter, again, we are not breaking out revenue without IKEA, but just want to remind everybody that IKEA revenue dropped significantly from the first quarter of last year. So, that's what I can say about this. Regarding Canada, I can say that Canada even ex-IKEA has a very healthy growth.

Great. That's helpful. And then the -- there were the stories around [the Cabots] and what they may or may not do. I realize you may not be able to comment on their intent, but ask the question anyway?

Yes, I think you realized right.

Okay. And then is there anything on the plant -- you talk about process, you mentioned progress, what -- maybe you could talk about two or three metrics you're looking at, is it scrap rates, is it utilization rates, is it labor per foot. What kind of metrics are you looking at? And any kind of feel for what you've seen sequentially January through April in any or all of those metrics you're willing to share? Thank you.

So, in high level, it's the regular industrial KPIs. So, processes should be controlled, deviation should be lower, and then you have usage of material, hours of work and general expenses that needs to be better controlled. In general, as I said, we see a progress but the progress is not fast enough and we are improving all the time, but we definitely took some more strong steps toward the end of Q1 and we already are seeing it's getting better.

(Operator Instructions) Lena Rogovin, Chardan Capital Markets.

I've got a couple of questions on your US business. First is, I realize that you don't disclose separately IKEA and organic growth, but just in terms of the trends, in terms of like-for-like revenue in this first quarter, how is it compared to growth rates in the previous quarters and do we see any like-for-like growth slow down ex-IKEA? And my second question is regarding your Richmond facilities, is it possible to quantify a utilization rate and the progress there that are in the year? And the last question is also on IKEA business, since it has structured lower gross margins for you and you're saying that (inaudible) IKEA is going to be stronger in the coming quarters. What they (inaudible) your overall gross margin in basis points? Thank you.

Okay. So regarding IKEA business, again, we do not break it out, but as I mentioned before, Q1 -- revenue in IKEA in Q1 in the US was a major drop compared to last year. So that's what I'm willing to say on that path. To your last question, when IKEA business grows, for us, it's little bit of gross margin, but there is significant OpEx leverage. So basically, it's a very good business for us in terms of operating margin, which is what count; and therefore this shouldn't be a problem for us and it shouldn't reduce our EBITDA margins at all. With regards to Richmond Hill, can you remind me again the question?

Yes, sure. I asked if it is possible to quantify utilization rates in the Richmond (multiple speakers).

No, we are not specifying utilization rate. But currently, they are not -- we expect the utilization rate to continue and improve during the year, and this will also benefit our margins.

Michael Rehaut, JPMorgan.

Thanks. Just wanted to circle back to a couple of quick items. Number one, in the US, with the expected improvement now in the second quarter from IKEA, I was wondering if we should be expecting a return to double-digit sales growth in the second quarter or that more be a two -- second half event?

I think, overall, we don't provide guidance according to quarters, but I think this will be the direction.

Are you seeing the direction for 2Q or for second half? I mean when you say this is the direction, I'm just not sure I understand what you --

Direction starting with Q2 and improving in Q3.

Okay. And then also just on the -- I just wanted to be clear on the managerial changes, I don't think I got an answer from my previous question, if you could just give us a sense of when during the quarter did you make the managerial changes at the Richmond Hill plant?

Our Richmond Hill managerial changes, part of it is part of the regular process and part of it starting just now and it's a natural development. We had relatively few people from Israel there for relocation and we are replacing them step-by-step by local people. And now we appointed a new General Manager that will start -- starting now basically.

(Operator Instructions) George Staphos, Bank of America.

Yes. Thanks for taking the follow-up. Just two quick questions. One on IKEA, can you maybe provide a little color in terms of what you're monitoring when you talk about the IKEA sales for the rest of the quarter, can you remind us what drives the promotional timing, how much visibility do you have on this? And then just as a second part to that, when do we anniversary the Canada IKEA sales, if you can remind us?

So, the IKEA promotions are usually about three or four year, and this was -- now by the end of -- it started on March, was the first event this year, and we will have probably two more events this year for promotions. And the timing in Canada is quite similar, I think, to the timing in the States.

And maybe to continue on your question, we do have a little bit of visibility on IKEA because all of those are normally fulfilled in a lag of time. So there is some visibility about how many (technical difficulty).

Thanks for that, Yair. And just last one for me. Can you talk about the sales growth in Australia? I think in your formal remarks, you mentioned maybe better than expected housing statistics, but I believe you've also introduced some new products over the last few quarters or maybe that's also driving the growth, but if you could provide some additional color. Thank you.

Yes. So the dominant factors behind our growth in Australia are increased growth penetration of course and then improved product offering combined with our strong execution there. And the housing environment is currently slightly better than we assumed in the beginning of the year. So, Australia performance is very good overall. Alex?

And at this time there are no further questions in the queue. I'd like to turn the conference back over to Mr. Shiran for any concluding remarks.

Thank you for your continued interest in Caesarstone, and we look forward to sharing more with you next quarter. Have a great day. Bye.

And that does conclude today's teleconference. We thank you all for your participation.