Caesarstone Ltd (CSTE) 2016 Q2 法說會逐字稿

Good day and welcome to the Caesarstone second-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. You may begin.

Thank you, operator. And good morning to everyone. Certain statements in today's conference call in responses to various questions may constitute forward-looking statements. We 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 most recent annual report on 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 earnings release, which is posted on the Company's website.

With that, I would like to 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 second quarter.

Our second quarter was strong and our business is generally performing well. I would like to start with some highlights for the quarter. We grew sales by 11.6% to a new record of $142.3 million. Without currency impact, growth would have been 13.4%. We extended our adjusted EBITDA to a new record of $39.8 million, margin of 27.9%, up over 1.5 points compared to 26.3% in the second quarter last year.

Adjusted net income was $25.4 million and our adjusted diluted EPS was $0.73 compared to $0.65 last year.

Now, I would like to give an update on each of our major markets for the second quarter. Second-quarter sales in the United States were $59.9 million, representing 5% growth with core and IKEA business lower than expected. Core business growth was offset by year-over-year declines in IKEA.

We believe our IKEA business will accelerate through the second half of the year and will support a higher growth rate in this region in comparison to the first half.

I am happy to notify that we have extended the agreement with IKEA for the US markets until the end of 2017, which will allow us to further develop the business for the benefit of both us and IKEA. We see this as a demonstration of the successful cooperation with IKEA. We expect the agreements with IKEA Canada to be soon extended as well.

Our US team has been reinforced over the past quarter with new executives now on board. We continue to add talent and expand capabilities to better execute our go to market strategy. We have a devoted team that works hard, and we believe that will bear fruit going forward.

We grew our sales in Australia to $33.5 million, up 24.9% compared to last year. On a constant currency basis, Australia was up 29.5% in the second quarter. Housing conditions in Australia have been better than originally forecasted for 2016. Our Australian team is doing a great job and our business remains strong.

We grew sales in Canada $24.3 million in the second quarter, a growth of 26.8% or 33.1% on a constant currency basis. This was achieved despite weakening housing conditions. Our business in Canada is strong and our sales IKEA continue to ramp up.

Sales in Israel for the quarter were $11.[4] million, up 16.3% compared to the second quarter last year. On a constant currency basis, sales were up 14.2%. While it is a smaller market and generally mature, we are very pleased to see accelerated growth following strong execution.

Europe sales were up 1.6% to $6.9 million and 0.1% down on a constant currency basis. As we noted, following a 41% increase in the sales in the first quarter, this business is volatile due to timing of orders. Revenue in the rest of the world was $6.7 million in the quarter, down 16.6% on last year and down 17.7% on a constant currency basis. Like Europe, these tend to be smaller and more volatile individual markets.

Overall, our second-quarter results were strong and we are confident with our business. 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 second quarter.

Sales in the second quarter increased by 11.6 % to $142.3 million compared to $127.5 million in the second quarter of last year. On a constant currency basis, sales increased by 13.4%. We [drove] gross margin improvement in the quarter to 42.1% compared to 41.3% last year. This margin improvement was driven mainly by favorable product mix and economies of scale and, to a lesser extent, lower raw material costs and lower manufacturing costs in Israel. Those were partially offset by inefficiencies related to the US manufacturing facility and negative exchange rate fluctuations.

Operating expenses in the second quarter were $28.7 million or 20.2% of sales versus $24.3 million last year, which was 19.1% of sales. This increase in expenses was primarily due to increase in marketing and sales efforts, mainly in the United States, as well as legal settlement and loss contingency expenses that were not incurred in the prior quarter or second quarter -- in the prior year's second quarter.

Operating income was $31.3 million compared to $28.3 million in the second quarter of last year. Our operating margin was 22% compared to 22.2% last year.

Adjusted EBITDA in the second quarter, which eliminates share-based compensation and legal settlement and loss contingencies expenses, reached a new record of $39.5 million. This was a margin of 27.9% versus 26.3% last year. This year-over-year margin improvement reflects the improved gross margin I just mentioned.

Finance expenses in the second quarter was $1.4 million compared to $0.4 million in the prior year. The increase was primarily due to $0.5 million net losses related to currency exchange fluctuations in the second quarter this year, compared with a net gain of $0.4 million in the second quarter of 2015.

Our taxes in the second quarter were $3.6 million or 11.9% of income before taxes, compared to a 16.6% tax rate last year. Excluding the one-time favorable tax adjustment of $1.2 million related to tax audit of the years 2012 through 2014, carried by the Israeli tax authorities, our effective tax rate would have been 15.8% this quarter.

Adjusted net income attributable to controlling interests, which eliminates share-based compensation, legal settlement and loss contingencies expenses as well as nonrecurring tax credits, increased in the second quarter by 9.9% to $25.4 million, up from $23.2 million last year.

Adjusted diluted earnings per share in the quarter were $0.73 on 34.9 million shares. Adjusted diluted earnings per share last year were $0.65 on 35.5 million shares. This year's increase mainly reflects the improved performance.

Since our share repurchase authorization was put in place, we have used $29.8 million to buy back approximately 829,000 shares through the end of the second quarter.

Turning to our June 30 balance sheet, we had cash, cash equivalents and short-term bank deposits of $55.7 million. Our net cash position from the end of 2015 went down by $9.9 million, entirely as a result of our use of cash to repurchase shares. Our free cash flow was $21.9 million in the first half of 2016.

With respect to 2016 guidance, we are reiterating our full-year guidance for both revenue and adjusted EBITDA. Revenue guidance for the year remains at $550 million to $565 million. And our adjusted EBITDA guidance for the year remains at $138 million to $145 million.

Before we take questions, on behalf of our entire organization, employees and the Board I would like to thank Yos. Yos has been a good friend and a great leader for all of us for the past 7 1/2 years and led the Company to great achievements. Under his management, Q2 annualized adjusted EBITDA is almost equal to the Company annual revenue when Yos joined. We will miss Yos and we wish him best of success in the future.

As we published on May 23 Yos's last day in office is August 21. The Board believes that the new CEO will be appointed by the end of September. Our Chairman, Yonathan Melamed, will act as an interim CEO for any periods in between. Thank you and we are now ready to open the call for questions.

(Operator Instructions) Michael Rehaut, JPMorgan.

Best of luck, Yos. The first question I had was on sales growth and, in particular, the US. You mentioned in your prepared remarks that the IKEA business was down year-over-year. And I think that's contrary to your expectations.

I was hoping to get a little more detail in terms of why you have confidence that that business will increase. Obviously, it has been a little bit of a wild card over the last several quarters, and we were expecting a turn in that business this quarter. And then just more broadly, if that business had turned, maybe just a comment on the broader strike of the core business as you referred to.

Yes. I would like to -- I will answer it in a few words and maybe trying to better explain the situation there. So first of all, our revenue from IKEA was below the projection and we believe it was mostly due to gradual implementation of the promotional events. We expect the IKEA business to grow sequentially and we see the order spike increasing. Overall, we believe that the outlook for IKEA is very positive.

And as I said, we have just signed an extension to the contract with IKEA US and soon -- and we expect to sign the same seven with IKEA Canada, an extension of one year through 2017.

And as to the -- services as for IKEA. So overall [EI] it did -- it was lower than we expected for Q2, but we think just we needed to be a little bit patient and it will start to grow again compared to last year, of course, and then further. And -- as to the core. And our sales organization in the US should be larger and better managed to accommodate our current scale of operation and our additional growth opportunities. And we believe that the step we take in reorganizing our sales and operations in the US will lead to more robust and focused performance and to better achievements gradually in our core business.

So this is the situation between IKEA and the core. I hope it explains it.

Just so I heard correctly, you said from IKEA, you use the words a more gradual implementation of the promotional events. Is that right?

No. The promotional events are back, but the growth rate -- so, IKEA in Q2 was -- it grew, but it was still below the absolute number of IKEA last year. So there was a decline in IKEA between Q2, as distinct to Q2 2015. So, we expect that going forward that IKEA will get stronger with the events. So of course, in absolute numbers, it will change.

And also we expect to see, of course, a positive growth rate for IKEA.

Okay. And then, are you able to describe a little bit more in terms of some of the changes in the US team? You mentioned new executives and new people in place. Just to get a better sense of what you are doing, either through new people or new strategy, you said to better capitalize and organize the efforts?

So again, from a wide angle, of course, first of all, I think maybe to emphasize that we view the current growth rates in the States as temporary and we believe that the US market represents a strong growth potential for us.

As to what we do there, so we believe that we can leverage sales by improving our performance and adjusting it to the current scale of the business. And maybe to illustrate, within our activities, we recruited a new executive team. We increased our sales force and we are launching new products which we believe will be appreciated by the American consumer. And in general, we are trying to make sure that the way we manage the sale organization is adequate to the size and opportunity.

And I think it takes a little bit longer than we expected, but we are confident that we are taking the right steps and we will see the fruits going forward, as I said.

George Staphos, Bank of America Merrill Lynch.

First question I had, piggybacking on Mike -- so in the third quarter should we expect IKEA in the US to be up year on year? You said it would grow sequentially but you would be having positive comparisons year on year.

So we would like to get into, first of all, regional guidance and, of course, not to start to break it down to core and IKEA.

But overall, we expect the second half in the States to be stronger than the first half. And we believe that our IKEA business will accelerate gradually through the year, the second half of the year, and will support the high growth rate in this region in comparison, as I said, to the first half.

So again, I cannot get into specific quarters. But IKEA is -- what I can say is that we see a healthy pipeline is getting stronger, and we see IKEA coming back. And now, with the extension for additional year, we see this as a positive trend and we believe it will be a good business for both IKEA and Caesarstone.

Okay. Just on the US and maybe one other question on IKEA, in the past, maybe taking the last one first, have you discussed how far out you wanted to re-extend with IKEA? Or was it always a one-year extension that you had in mind? And then in the US, the slowdown in growth -- would you attribute any of it at all to increased competition or you really don't see any change in the run rate there?

So the IKEA, the IKEA conference was for two years. Now we extended for additional (inaudible) and now we extended it for a further one year. It, of course, also matters and decision of IKEA, and we try to accommodate and meet the ideas of both sides, IKEA and us.

So as of now, it is extended through 2017.

Now, as to the rest of the business, we still have a lot of work to do. And we believe, as I said, that we can grow -- the growth opportunity in the States is much bigger, and we believe that it will come.

But it will take some time.

Okay. My last question, and I will turn it over -- two-part: one, the investment in marketing and sales and SG&A, is that reflective of the changes that you've already made an organization or reflective of growth-related spending that you are doing looking out to the future?

And then, have you seen any effect at all from Brexit in terms of consumers, purchasing patterns, any kind of trend in volume early in the order? Thank you.

So, I think your first question, the answer is both. I think to -- as to Brexit, we don't feel it. We don't see any impact currently in our business.

Okay, thank you.

Mike [Dove], Credit Suisse.

Just to follow on to the last couple of lines of questioning around the US, I guess one other question I have is you are in a lot of markets that are much further developed as far as adoption rates for courts, and yet, you are still seeing substantial growth in some of these markets.

So is there anything you see structurally about the US or anything else you can help us understand outside of some of the Company-specific issues you have discussed that are making this growth ramp more gradual than you initially thought? And then, also, how much of it is potentially just also product launches that haven't yet hit the US versus some of these other regions? If there's any more color you can give us on those things, that might be helpful.

So basically, Mike, just for me to understand that I'm answering your question precisely, you are asking in essence how do we compare the execution in Canada and Australia, for instance, compared to the States. Is this what you are asking or --

Right, yes. Effectively, part is how you compare the execution of Caesarstone in the US versus those markets, but part is also a market question in that, is there something different about the structure, whether it's distribution or something else, in the US that is making this growth ramp more difficult to sustain and in some of those other markets?

So I think basically the United States is much bigger than Australia and Canada, and is a tougher challenge to control, on the one hand. On the other hand, the market is very healthy. We don't have numbers. We don't have an exact quantification of the quote growth rate, but we feel that the quotes continue -- the [quotes growth] continues to grow. And it's really a matter of our execution. Of course, with the market growth, the competition is growing as well.

But it's not new to us and we are also competing in Canada and Australia and Israel, as we were. So we are used to competition.

So I think it's more get adapted to the size of the States. We grew very fast there, almost four times in the last few years. And we need to adjust the organization to the new scale and to make it ready for future growth. So it's a bit more complicated than Canada and Australia.

In addition to that, in Canada and Australia we are number one in terms of brand and size. And it's not the case in the States. Of course, we are striving to get there. But we still need to work hard for that. So I think this -- I hope this helps.

[Susan McClary], UBS.

Can you talk a little bit about the US plants here and how that has progressed and maybe how you are thinking about it coming further online through the back half of 2016?

Are you asking about the progress in the plant enrichment [build]?

Yes.

So again, as you know, this factory is very important strategically. So far, we see just the burden financial wise, but of course we expect that in the future it will help us to deliver better results. It was definitely significant, negatively significant in Q4, last year in Q1, and I'm happy to say that in Q2 we managed to control it better.

And we expect it to get better gradually with time and with the people gaining more experience and more control over the processes there.

There is a huge potential. As I said, so far we just see the negative impacts. But I'm confident that the positive impact will also arrive in the future.

Okay. So do you expect it to basically be much further along by the end of this year? Will it be shipping products, do you know?

No; we ship products from the States. Of course, we optimize our production locations between the States and Israel. And as I said, gradually we see the plant in the States getting more and more efficient.

Okay. And then, Yos, congrats on doing such a great job there. But can you just give us a little bit more detail on the CEO search and perhaps where that stands?

I know that you mentioned you expect someone there by the end of September. But any further information on that?

I think so. The Board appointed a committee that deals with this, to my opinion, very professional. And I'm sure they will or expect that they will find an adequate new CEO soon, hopefully sooner than later. And you know that they are looking for somebody that can manage a global company with a high growth. So, hopefully, they will be able to present somebody soon.

Okay, thank you.

[John Pfall], Stifel.

Yos, lots of luck in your future. I was wondering if you could give us the FX headwinds to the EBITDA in the second quarter and what it is now year-to-date and what the outlook for that is for 2016?

Yes. So FX was around [just] basis points direct for the second quarter relative to 2015. And you know we looked at the current exchange rates and took them in consideration when we reiterated our guidance.

Thank you for that. And maybe back to the plant and the drag, it sounds like you are making progress. I'm curious if that progress increased production and absorption of cost, or are you also seeing less scrap and better unit reduction costs, or any more granularity there? Thank you.

So the plants performance is progressing. We have succeeded to establish control of our spending and cost [within] the plant. And we are slowly ramping it up as demand dictates, and focus on further improvement of quality. Right?

And sorry, I don't want to get specifically into whether we produce more. But we certainly improved the processes and the performance there.

And then I was curious on the new product launches. Are those --? That I think you were saying were specific to the US. Any color on the timing and what types of products we are going to see?

Yes. Most of the launches this year happened around June-July. And in the States specifically, this will be a line of more traditional colors, more granite-inspired but also marble-inspired. So there will be extensions of, basically of traditional colors with a partial add of what is core conditional.

So it's between modern and traditional colors. So it just starts. We don't have indication yet of the reception in the market. But according to the initial responses that we got, at least part of it seems promising. We will have to wait and we will be happy to report about it later.

And what are the price points? (technical difficulty) Supernatural, above, below? Where are we, price point and margin wise on those?

So most of the granite [took a] price in the classical range, in the regular range. But part of it, which are very unique, will be priced at the Supernatural area.

Okay. And then my last question -- any developments on silicosis? Any new cases, names, etc.?

Yes. So, as to silicosis and how we continue to deal with losses in Israel including the losses that were filed this year and in the quarter, as reported. Also we have one client in Australia in which there was no significant development. And in general, the big picture remains the same.

Thank you. Good luck.

(Operator Instructions) Michael Rehaut, JPMorgan.

I wanted to focus on what I feel is one of the real bright spots of the quarter. It hasn't been talked about as much yet.

The gross margin had very strong sequential improvement. And basically, after three quarters of very sizable year-over-year declines, you had a positive -- versus a year ago, you had a positive margin. So I just wanted to get a sense of -- I think you highlighted that FX currency was 100 basis points drag. But what's some of the other positive -- if you're able to quantify what some of the other positive drivers were from a basis point standpoint?

And also how to think about the back half of the year, if we should be expecting something about 40% as well or if there's anything that should drive it back below 40%?

Okay, Mike. So maybe you asked this from the point of previous quarters. So maybe I don't know if you want to answer sequentially or year over year. But let me maybe start sequentially.

We saw a major gross margin improvement related to improved mix of our product, regional mix, which also got better with Canada and Australia growing so much. And that, along with volume, was almost 600 basis points. Then, there was [450] basis points related to [Stoic].And then there was 150 basis points of improvement related to the Richmond deal. The Richmond deal was better in last quarter, relative to its drag on the margin.

And this was offset with a couple of other smaller factors. FX wasn't much of a big deal between those two quarters.

If you look at it year over year, then, deposit mix and volume contributed 350 basis points. For margin, material cost and lower manufacturing cost in Israel was each around 50 basis points. And those two factors were offsetted with Richmond being a drag -- it was approximately 200 basis points relative to last year, and FX was a drag of 100 basis points.

And you said year-over-year materials and lower --

Lower manufacturing costs in Israel.

50 basis points each?

Yes.

Okay. And so how do you think about the back half [(technical difficulty) you got here]? Again, substantial improvement sequentially. Do you think that 42% is a reasonable number? Or -- and obviously, over time, the inefficiencies from Richmond Hill should continue to update. So how should we think about the back half?

You know, we don't really provide guidance by line items. And everything, all our expectation of [beating] to our guidance -- the last thing I want to mention, though, is we took into consideration an expected increase in SG&A, mainly related to our investment in the [AUS] market. And this was one factor, of course of many others. But that's what I can say about the second half of the year.

All right, thank you.

Mike Dove, Credit Suisse.

I think you just addressed my question around gross margins with the answer to Mike's questions. I'm all set. Thank you.

At this time, we have no further questions in the queue.

Okay. Just some closing remarks on my end -- so I would like to thank everyone. It is been an honor to be part of the Caesarstone success story and to have had the opportunity to lead its transformation to become a strong, innovative, global company with a worldwide nonpremium brand, cutting edge technology and a winning strategy.

Our people have all worked together to create a solid, globally recognized leadership position and significant opportunities for the future.

I would like to express my thanks and appreciation to Caesarstone's current and past directors and employees worldwide. Without them, this great journey would not have been as successful and as meaningful.

It has also been my pleasure over the past years to engage with our investors and analysts. I am grateful that you have shared our vision and success and thankful for your support and confidence.

I wish all of Caesarstone's investors, management and employees a lot of success in the promising future ahead. Thanks again.

That does conclude our conference for today. We thank you for your participation.