Caesarstone Ltd (CSTE) 2016 Q3 法說會逐字稿

Good day and welcome to the Caesarstone's Third Quarter 2016 Earnings Conference Call. Today's call is being recorded.

At this time, I'd like to turn the conference over to Allison Cain of ICR. Please, begin.

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 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.

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 third quarter earnings press release, which is posted on the Company's website.

With that, I'd like to now turn over the call to Yonathan Melamed, Chairman of the Board of Caesarstone. Yonathan, please go ahead.

Thank you, Allison, good day and thank you everyone for joining us. I will start by providing some highlights of the third quarter. In the third quarter, we grew sales by 5.5% to a new record of $144.3 million. Our adjusted EBITDA was $37.5 million, a margin of 26%. Adjusted net income was $24.3 million. And our adjusted diluted EPS was $0.70.

The Company achieved record performance and many of our regions continued to demonstrate the potential strength. At the same time, we are (inaudible) focused on reaccelerating growth in the United States. We are investing in expanding our marketing and sales capability in this region and are making other strategic and operational changes that we believe will improve the business and generate growth.

With respect to our Richmond-Hill manufacturing facility, we continue to face challenges (inaudible) and we have not been able to achieve optimal throughput and manufacturing efficiencies to-date. We have identified the major issue and we are focused on optimizing our manufacturing processes, and on improving efficiency, throughput and cost. We expect the plant performance to improve significantly in 2017.

Yesterday, we filed our proxy material for the Annual General Meeting of shareholders to be held on December 6, 2016. In line with our corporate objective to enhance the Company's global growth and market positioning, we are pleased to announce some significant changes to our Board of Directors. Dr. Ariel Halperin will be the Company's new Chairman of the Board. Ariel is the Managing Partner at Tene Investment Funds and has a long history of guiding Caesarstone to success.

Additionally, we have nominated two prestigious and very experienced individuals as new directors. Mr. Roger Abravanel and Mr. Eric Herschmann. Roger spent over three decades building McKinsey & Co. until his retirement in 2006 and has (inaudible) top management over 100 public and private companies. Roger also serves as director for several leading global companies and has been instrumental to their growth.

Eric previously served as Vice Chairman and CEO of Southern Union Company, a former Fortune 500 energy company where he also tremendous growth over 11 years' career there. We are excited for Roger and Eric to join us and believe that once elected, they will provide significant value for our Company and its growth objective.

While I will remain interim CEO until Raanan Zilberman's arrival during the first quarter of the next year. I will be stepping down as Chairman of the Board up on conclusion of the Annual General Shareholder Meeting. It has been (inaudible) of serving as the Chairman and I wish the Board, including the existing and new directors and the Company's management and employees best of luck.

Thank you. And I would like to now turn the call over to Yair.

Thank you, Yonathan, and good morning to everyone. I will start with our regional performance for the third quarter. Third quarter sales in the United States were $58.4 million, down 5.4% compared to last year's third quarter. Core business slightly declined, and IKEA business sequentially improved, but still generated lower revenue than the same period last year.

As Yonathan mentioned, we have made important investments to help extend our capabilities in the United States. Over the past several months, we have appointed new executive management, added people and [improved] processes for our sales team, increased our marketing activities, and we are implementing a revised and more focused go-to-market strategy. While there is some time required before these actions impact revenue, we believe we are taking the right steps to enhance growth. Although we are not yet providing guidance for next year, it is our expectation that we will resume revenue growth.

Turning to Australia, we grew third quarter sales to $35.6 million, up 21.8% compared to last year. On a constant currency basis, Australia was up 16.6% in the third quarter. Our execution in Australia has been consistently strong as demonstrated by fast growth rate, despite declining housing conditions.

We grew sales in Canada to $22.4 million in the third quarter, growth of [13%] or 12.3% on a constant currency basis. Our business in Canada remains strong, especially given challenging housing conditions, and the first full quarter anniversary of our sales to IKEA.

Sales in Israel for the quarter were $11.3 million, up 6.4% compared to the third quarter of last year. On a constant currency basis, sales were up by 5.8%.

Europe sales were down by 1.2% to $7 million, and was down 1.4% on a constant currency basis. The revenue in the rest of the world after two consecutive quarters of decline was up 14.8% to $9.6 million in the quarter, growth of 14.4% on a constant currency basis. These regions tend to be smaller and includes more volatile individual markets.

Altogether, global sales for the third quarter increased by 5.5% to a new record of $144.3 million compared to $136.8 million in the third quarter of last year. On a constant currency basis, total sales increased by 3.8%. Gross margin in the quarter was 40.5% compared to 39.5% last year. This full point of stronger margin was driven primarily by lower raw material cost.

Operating expenses in the third quarter was $30.3 million or 21% of sales versus $29.4 million last year, which was 21.5% of sales. Excluding legal settlements and loss contingencies related to Silicosis, operating expenses in the third quarter were $29.3 million, 20.3% of sales compared to $24.7 million or 18% of sales last year. This increase was primarily due to increased strategic investment, specifically in marketing and selling in the United States. I note, the legal settlements and loss contingency expenses were $1 million in the third quarter this year compared to $4.7 million in the same quarter last year when we initially recorded a liability related to Silicosis.

Operating income was $28.2 million compared to $24.7 million in the third quarter of last year. Our operating margin was 19.5% this quarter compared to 18.1% same quarter last year. Adjusted EBITDA in the third quarter, which eliminates share-based compensation, legal settlements and loss contingencies expenses, as well as other non-recurring items was $37.5 million, a margin of 26%. This compares with last year's adjusted EBITDA of $36.2 million and margin of 26.5%. This slightly lower margin mainly reflects our increased spending to support longer growth in the United States.

Finance expenses in the third quarter was $1.1 million compared to finance expense of $0.1 million in the prior year. This increase was primarily due to $0.2 million losses related to currency exchange rate fluctuation in the third quarter of 2016 compared with net gains of $0.7 million in the same quarter of last year.

Tax during the third quarter was $4.3 million or 15.8% of income before taxes compared to a tax rate of 17% last year, the lowest tax rate this quarter related to elimination of certain deferred tax liabilities.

Adjusted net income attributable to controlling interest, which eliminates the (inaudible) mentioned above was $24.3 million in the third quarter as compared to $24.4 million same period last year. Adjusted diluted earnings per share in the quarter were $0.70 on 34.5 million shares. Adjusted diluted earnings per share last year was $0.69 on 35.5 million shares. We completed our full share repurchase authorization during the quarter. In total, since the plan was put in place, we used $39.4 million to buyback a total of 1.1 million shares.

Turning to our September 30 balance sheet. We have cash, cash equivalents and short-term bank deposits of $74.5 million, up $11.9 million from the end of the second quarter, despite the share repurchase activity of $9.7 million during the third quarter. Our net cash position from the end of 2015 went up by $6.4 million even after we consumed $39.4 million for share repurchase. For the first nine months of this year, we generated $48.7 million of free cash flow.

With respect to our 2016 guidance, we have updated our view of the full-year to include softer-than-expected performance in the United States. We now expect full-year revenue in the range of $524 million to $534 million and full-year adjusted EBITDA in the range of $125 million to $130 million.

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

Thank you. (Operator Instructions) Michael Rehaut, JPMorgan.

The first question I had was on the United States. I was just curious, obviously, you guys are in the middle of making adjustments, investing and revising your go-to-market strategy. I'm curious, from a competitive standpoint, if you can give us a sense of an update of number one, where the market is today if you've seen continued growth in the broader quartz, engineered quartz market? And number two, if there's been any change from a pricing standpoint, more broadly?

Yes. Thank you, Mike. So we believe that current (inaudible) markets in the overseas is doing well in specifically quartz. The housing condition are also reasonable. With regards to competition, although we don't have current data, we believe that the quartz market continues to grow; and as the quartz opportunity grows, the competition grows as well.

And we also see Chinese manufacturers entering the market more intensely. It seems that the low segment of the market has had more growth in general and is led by Chinese manufacturers. We are currently competing in the mid-to-high end of the market. Our product quality, service, innovation, design and service matters. A lot of manufacturing compete with us as well, but we believe that our differentiation and multi-channel strategy will prevail.

But in particular in terms of the Chinese competition, that's not obviously a new trend and would you say that trend has changed dramatically or accelerated negatively in the most recent quarter or are you referring to more just a general trend over the last couple of years?

No, I think it's a general trend that continues, there isn't a big change here.

Just second question on the manufacturing. I think in your prepared remarks, Yonathan referred to challenges in the new plant, but at the same time, if I heard it right, you've identified some reason -- some of the issues and our hope for that you'll see more improvement in 2017. So I was curious if you can give me a little more detail -- give us a little more detail on what was identified, why you believe you've been able to correct, if I have that right, and what perhaps that was in terms of a drag on gross margins in the quarter?

Yes, okay, Mike. So the bottom line performance of the plant in Q3 was disappointing for us in both throughput and yield, right? However, we have established few very important input processes now in order to shorten idle time and maintenance interruptions and to reduce the number of substandard slabs and improve the overall efficiencies.

We also continue to recruit experienced people, as we go (inaudible) training. So while the bottom line of Q3 was not good, I believe that there is now some momentum for improvement. It will take time, but with positive momentum. Now, if I'm going on a year-over-year housing sector margin, basically Richmond-Hill kind of dragged us around 150 basis points. On the other side, our Israeli plants performed very, very well and basically offset all of these drags.

Susan McClary, UBS.

You mentioned in your remarks that as part of your US strategy, you're revising your go-to-market, and how you're approaching that. Can you just give us a bit more detail there on the changes that are coming through and how we should expect those to come together for next year?

Yes. So Susan, as you know, we are in the process of improving our performance in the US to accommodate the growing business scope and our challenges. We have been implementing several steps, including new local management, organizational changes, expansion of our marketing and sales team, adding talent, updating certain sales processes, and enhancing visibility for the brand and other strategic and operational steps.

However, this improvement process is proving to take more time to implement than we anticipated. And it is also also evident that some more time will be required before we can see the benefit of it.

It's clear that the US revenue was below our expectation this quarter and we are unable to meet our plans for the -- as for the US. Having said that, we are optimistic that there is a significant growth potential in the US, and that we are taking the right steps to leverage it. We are rolling out a new product launch in the US as we speak, and are planning to expand the market scope we are covering with our product offering.

We believe that the step we take in reorganizing our sales operation in the US will lead to more robust and focused performance and to gradual better achievement in our core business. There has been and will be other changes to improve our presence in all the market segment, but couple of those changes are competitively sensitive, and I cannot specify them right now.

So I think we are looking at 2017, yet we are not providing guidance for 2017, but we expect US business to return to (inaudible) next year.

And Yair, is the new local management here, is that in addition to the changes that you made earlier this year, are those like people that you are re-swapping out or are they just further addition to those?

So at the beginning of the year, we just did the change and brought Dan from Canada into the US. Dan had to identify all the organizational gaps, the (inaudible) in his current organization and very recently in the last three months, he brought a lot of executive talent in and we brought a lot of strength into our sales force. We grow our marketing and sales headcount by 20% so far for the year in the US and expecting to complete 25% growth by the end of the year. So there is, I mean, bringing Dan in was not a final solution, he needs to make changes; and it takes some time.

Okay. And then can you just also kind of give us an update on those new product introductions, I know that those launched a little earlier this year in the US. How has the traction been with that and how does that compare to where you expected it to be?

So to be quite honest, there was a launch earlier this year, but there was some operational issues that we (inaudible) and we did a complete relaunch with some brand-new product, but also relaunch of few product that we launch early in the year, not in a very successful manner. This time we did the major milestones through all the regions in September and October. We see some very good initial response on those and are looking forward to leverage our sales as a result.

John Baugh, Stifel.

May be address your -- and I guess two things on the US, where IKEA goes in the fourth quarter year-over-year, I recall that it was very weak in the prior year fourth quarter. And I assume the guidance for revenues assumes US declines in the fourth quarter, so that implies core US is down year-over-year. Do I have that right? And then what would be your assessment as to why your core US sales are down (inaudible) lost market share?

So in terms of IKEA, we start with IKEA, John. We see a sequential growth of the IKEA business from the bottom that we experienced in the fourth quarter of 2015 and in the first quarter of 2016, so the recovery has been slower than we expected. So overall, our outlook for IKEA is positive. Yes, we are expecting our US revenue to be down year-over-year in the fourth quarter, and you're right that we expect a better year-over-year IKEA growth in Q4. And therefore, the conclusion is that the core will be weaker on a year-over-year comparison. As I already said before, the implementation of the transition plan is taking longer than expected. However, we are optimistic that we will return to notable growth next year.

Yes. Is it possible to be specific on where you've lost business in terms of distribution channels or price points or anything more granular in terms of why or where the erosion is occurring?

Yes. The overall performance now is just not good enough, we are taking steps and measures and revising our strategy and organization. And we believe that we will return back to growth, this is not specific segments now that are worth discussing.

And then on the plan, is it your expectation that as we move into 2017 or maybe inclusive of the fourth quarter that the throughput and yield results you've seen, you mentioned some momentum are going to narrow that gross margin drag?

So first of all, I want to just remind that we brought a new executive to the plant actually at the very beginning of Q3. And I think there is a lot of steps being taken now, significant steps to improve all processes. So we anticipated many of the issues will be resolved in 2017 and expect to be in a reasonable utilization rate by the end of 2017. It will be a gradual improvement, and with the growing global demand, we expect the utilization rates and associated cost to be much better next year. Again, it's not only a matter of gross margin leverage or not, it's a matter that we need to intend to grow our top line and we need the throughput from this plant.

Okay. And then any update on the Silicosis law suits, any numbers around additional claims or any color there? Thank you.

No, there was a few new claims coming in and few settlement to close on, so the overall $1 million was the results of all this blended events. We'll give more specific number, the number of litigation at the 20-F. But in general, the picture is basically the same.

Lena Rogovin, Chardan Capital Markets.

I actually have two questions. The first is very similar to the previous one. So during the last conference call, you mentioned that you expect some -- you actually had a new recovery during the second half of the year. And you also mentioned some positive signs you see there. So what exactly happened and why the core business was so slow even quarter-on-quarter?

And the second question is that, if US production facilities can be used for production for other regions, not just for the US, in order to improve facilitation rates, if that is not enough potential demand in the US itself? Thank you.

Okay. So with regard to the first question, as we said before, we are implementing a lot of things, and we are now in a transition plan execution and it just take longer than we thought. So on the plant, basically the plant for the most part, it sells the North America market. We can send products from there to other regions, but it's basically (inaudible) we divide the supply that we have. So the US utilization now in Q3 was not a demand dictated result, it was our own performance that we want to improve.

Thank you. We have reached the end of question-and-answer session. I'd like to turn the floor back over to management for any further closing comments.

Thank you, everyone. We are pleased to see that the strength of our brand and success of our product translating into good performance in most of our regions. We believe that we are taking the right steps to reenergize our business in the United States. Thank you for your attention today.

Thank you. That does conclude today's teleconference. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.