Aug 6, 2014
Executives
Yosef Shiran - Chief Executive Officer Yair Averbuch - Chief Financial Officer Allison Townsend - ICR
Analysts
John Coyle - Barclays Alex Wong - Bank of America Merrill Lynch Michael Rehaut - JP Morgan John Baugh - Stifel Michael Dahl - Credit Suisse Lars Dollman - Adelphi
Operator
Good day and welcome to the Caesarstone, Second Quarter 2014 Earnings Conference Call. Today’s conference is being recorded.
At this time I would like to turn the conference over to Allison Townsend of ICR. Please go ahead Ma'am.
Allison Townsend
Thank you, operator and good morning to everyone. Certain statements in today's conference call and responses to various questions may constitute forward-looking statements.
We wish to caution you that such statements reflect only the company's current expectations and that the actual events or results may differ materially. For more information, please refer to the Risk Factors contained in the company's most recent Form 20-F and the subsequent filings with the Securities and Exchange Commission.
In addition, the company will make reference to certain non-GAAP financial measures, including adjusted net income, adjusted net income per share and adjusted EBITDA. The reconciliation of these non-GAAP measures to the most directly comparable GAAP measures can be found in the company's second quarter 2014 earnings release, which is posted on the company's Investor Relations website.
With that, I’d now like to turn the call over to Yosef Shiran, Caesarstone’s Chief Executive Officer. Yosef.
Yosef Shiran
Thank you. Good day and thank you for joining us to review our second quarter performance.
I would like to start with some highlights for the quarter. Sales increased by 30% to $116 million, a record for any quarter.
Second quarter adjusted EBITDA was $30.4 million, up 23% compared to last year. Adjusted net income for the second quarter was $20.7 million, up 11% compared to last year, with adjusted net income per share of $0.58 in the quarter versus $0.53 in the second quarter last year.
Overall this was a very good quarter with significant growth. Our performance was driven by the success of our products in the global market, combined with the strengths of the Caesarstone brand.
We are operating well, controlling our costs and growing our capacity to meet the strong demand for our products. I would like to provide an update on each of our major markets for the quarter.
Second quarter sales in the United States, our largest markets were $47.9 million, a growth rate of 55% compared to last year. This growth is coming from a wide range of channels, included the increasing contribution from IKEA.
We expect the US to remain a significant growth engine. Australia sales in the second quarter were $27.4 million, up 16.2% compared to last year.
On a constant currency basis, Australia was up 23.6%. The strengths we saw same as to the market in the first quarter has continued and our products are performing well, particularly Supernatural with our new Calacatta and granite inspired designs.
Sales in Canada in the second quarter grew 17.2% to $15.4 million and were up 24.8% on a constant currency basis. Canada continues to be a good growth market for us, even with a soft housing trend.
Israel was down about 0.5 percentage points compared to last year and contributed $9.9 million in the quarter. On a constant currency basis Israel was down 5.2%, reflecting slower housing activity.
Europe sales in the quarter were $7.3 million, up 61.9% compared to last year. On a constant currency basis sales were up 55.2%.
You may remember that Europe was temporarily soft last quarter due to the timing of shipment to certain distributors. The strong second quarter is a reversal of that situation.
In the first half of 2014 Europe grew 10.6% on a constant currency basis compared to the same period last year. Revenue in the rest of the world during the quarter was up 18.5% to $8.1 million.
On a constant currency basis growth was 14.3%. This group continues to be health.
Our Bar Lev capacity expansion increased in contribution to volume this quarter. Accordingly we were able to increase sales and at the same time build our inventory above the level of the previous quarter to service future demand.
Our new facility in Richmond Hill, Georgia continues to be on track towards the first line operational in the second quarter of 2015 and the second line in the fourth quarter of 2015. I would also like to mention that we intend to start initial steps towards establishing our second billing in Richmond Hill, to accommodate additional manufacturing capacity in the future as needed to satisfy potential demand.
To sum up, the second quarter was the strongest quarter in our history for revenue and adjusted EBITDA. Our increased capacity in Bar Lev was a part of this performance.
We are very excited for the next steps of our capacity expansion with our U.S. facility.
We feel confident with the growth and development of the business. Thank you, and I will turn the call over to Yair.
Yair Averbuch
Thank you Yosef, and good morning to everyone. I will now review our income statement for the second quarter.
Sales in the second quarter increased by 30.4% to $116.1 million, compared to $89 million in the same quarter of last year. This is a record for any quarter.
On a constant currency basis, sales increased by 32.3% versus last year. Gross margin in the quarter was 41% compared to 49.8% last year.
Excluding the two factors that are affecting this comparison, our gross margin would have been 41.7% this quarter compared to 45.9% last year. In the second quarter of this year we recognized a $0.8 million provision adjustment related to taxable employee fund benefit, as a result of settlement with the tax authorities in the National Insurance Institute in Israel.
Also, I remind you that in the second quarter last year, following our ERP system implementation we accounted for $3.5 million beneficial change in the value of our inventory. Once you exclude this factor, the decrease in gross margin would have been 4.2 percentage points.
This was driven primarily by currency impact, a significant increase in business with IKEA related to publication and installation activities, which comes a bit below the gross margin and to a lesser extent by an increase in raw material prices. Operating expenses in the second quarter was $24.1 million or 20.7% of sales versus last year's $22.1 million, which was 24.8% of sales.
This reflects a scale related benefit of our increased volume and mostly offset the lower gross margin. GAAP operating income grew 5.9% to $23.6 million compared to $22.2 million in the second quarter of last year.
Excluding the items I just mentioned and the secondary operating cost in both periods, operating margin would have been 21.7% compared to 22.8% last year. Adjusted EBITDA in the quarter, which eliminate the items I described before, share-based compensation and the excess cost of acquired inventory and other non-recurring items increased by 23.3% over the prior year to $30.4 million, a margin of 26.2% versus last year margin of 27.7%.
Foreign exchange fluctuation drove a significant swing in finance expenses, which was $1.4 million of expense in the second quarter this year, compared to $0.4 million of income in the same period last year. Out taxes in the second quarter was $3.4 million, 15.2% of income before taxes, compared to last years rate of 11%.
Excluding a $0.34 million tax adjustment related to prior years income tax settlement with the tax authorities, the tax rate would have been 13.6%. Adjusted net income attributable to controlling the interest in the second quarter increased by 11.2% to $20.7 million; 17.10% of revenue compared to $18.6 million last year, a 20.9% margin.
Adjusted net income per diluted share in the quarter was $0.58 compared with $0.53 last year. Our June 30 balance sheet was strong with cash and short-term bank deposits of $80.3 million.
This is a $10.5 million below our Q1 cash balance, reflecting our capital spending for capacity expansion and increased growth in capital. Our inventories went up by approximately $15 million compared to year-end, enabling us to better serve the growing demand for our product, which was achievable due to our continued strong manufacturing and our additional capacity.
I will note that as we mentioned in our press release, we have decided to increase our investment in the U.S manufacturing facility to approximately $150 million versus our previous estimate of $100 million. This is mainly to accommodate improvement in operation, including the upgraded machinery for higher manufacturing capacity.
With respect to our 2014 guidance, following our second quarter revenue and the increase in manufacturing capacity and in our inventory, we are increasing our full year revenue guidance from a range of $420 million to $430 million, to a new range of $435 million to $445 million. We are also increasing our 2014 adjusted EBITDA guidance to a new range of $112 million to $117 million from our prior range of $108 million to $113 million.
Thank you. And we are now ready to open the call for questions.
Operator
Thank you. (Operator Instructions).
We’ll go first to Stephen Kim of Barclays.
John Coyle – Barclays
Hi guys, this is John filling in for Steve today. Just wanted to start on the gross margins.
You indicated three factors: FX, raw materials and the impact from IKEA is pressurizing your gross margins this year. Can you maybe size up those three factors, how much each contributed to the 420 basis points compression?
Yair Averbuch
The biggest factor was FX. It was slightly over a 2% impact.
IKEA was significantly less than that and the raw materials price was even less than that, even less than IKEA.
John Coyle – Barclays
Got it. And you had impressive leverage on the operating costs.
Is the current run-rate of $24 million of SG&A a level you’re comfortable with for the second half or should we see a sequential increase in SG&A dollars spent, just associated with the planning of the Richmond Hill Facility.
Yair Averbuch
I don’t think that the Richmond Hill Facility will affect SG&A dramatically in the second half of 2014. I think that there is two things regarding SG&A.
From this quarter you have to take out the follow-on operating expense; that will not repeat itself, and on the other end we expect some increased M&A in the U.S for the second half.
John Coyle – Barclays
Got it. All right, thanks guys.
Operator
Thank you. We’ll take our next question from George Staphos of Bank of America/Merrill Lynch.
Alex Wong - Bank of America Merrill Lynch
Hi. It’s actually Alex Wong sitting in for George.
Thanks for taking the question and congratulations on a solid quarter. First, question regarding growth in the U.S., obviously a very solid growth there.
Can you just provide a little more color on the relationship with IKEA and also what are you seeing from an end market growth standpoint right now?
Yosef Shiran
I think in general what you see is like we said in the past, the results of implementation of our strategy. We see the quartz story unfolding in the U.S.
IKEA of course has reflected also and our PR is going very well and continues to grow. Overall we feel that our strategy works.
Our new products are succeeding very well in the market and we feel confident that we are in the right direction.
Alex Wong - Bank of America Merrill Lynch
Thanks for that color. Maybe just wondering if you could provide some granularity around the opportunities that you’ve learned over the last few months around the incremental $15 million spend on the Richmond Hill Facility, and then also on the plans around the second building.
Any anticipated impact in ‘14 guidance that we should be thinking about?
Yair Averbuch
So as to this, if I understand, I will start with the first part. So as to the $15 million, most of this recent increase has to do with maximizing our throughputs and operational efficiency in the facility, so this is to that end.
And the rest of your question, are you referring to the capacity that we are building or just I would like to be sure that I understand your question.
Alex Wong - Bank of America Merrill Lynch
Yes, so just around the second building, if you could talk about what the setup is right now at Richmond Hill and what the timing of that we should expect relative to the 2014 guidance. Any impact on that?
Yair Averbuch
Yes, so just to again to reiterate. In 2014 the only addition to capacity is line number five in Bar Lev and then we expect that still to have additional two more lines; one in the first half of the year and the other one in the second half.
So this would line six and seven and will be the first two lines in the state. According to what we see now, we started to plan and take steps towards the additional expansion and we have room in the same area in Richmond Hill to build another two lines, lines eight and nine.
But this is still relatively far from today. However, we need to start to take care of it.
This is of course involved our estimation of future demand and may vary, but according to the current demands we need to start work on it.
Alex Wong - Bank of America Merrill Lynch
Great, and just a last question. How is the supply chain functioning in your quartz procurement from Turkey?
Are there any issues that haven’t risen given the outbreak of geo political tensions in the region? Thanks very much.
Yosef Shiran
No, we have a long relationship with the Turnkey suppliers. It has never been affected by political issues and there are no issues.
Operator
Thank you. (Operator instructions).
We will go next to Michael Rehaut of JP Morgan.
Michael Rehaut - JP Morgan
Thanks. Good morning everyone and congrats on the quarter.
Yosef Shiran
Good morning.
Michael Rehaut - JP Morgan
The first question I had was, just looking at the U.S growth and opportunity, which continues to be fantastic and obviously driving your results here. I was hopping if you could just take a step back if possible and just give us a sense at this point, perhaps as you look at the first half of 2014, if you could give us a rough sense of how your sales in currently breaking down across the different end markets; residential, commercial, new repair and model, and where you think the biggest opportunity is in terms of the different end markets over the next couple of years.
Yair Averbuch
Hi Mike. So according to our last estimation and I would like to emphasize that we don’t have the solid data, so its only our analysis.
We believe that home starts accounts for about 30% of our sales, innovation about 55% and commercial 15%. This is the situation in the states.
It’s a little bit different in Canada, Australia and Israel and where in Canada and Australia the home starts play a bigger role, around 40% give or take, and commercially smaller about 5%. So this is, just to mention I would like also to mention that we saw this quarter also with positive trend in Australia and Canada in addition to the States.
Now trying to look forward to the next few years, again I think one important point is that we build our plans according to the material conversion story and with having said that, I cannot say a lot more than what we said in our guidance in terms of the future growth.
Michael Rehaut - JP Morgan
I appreciate that, and certainly when you talk about starts, you are talking single family and multi-family apartments as well.
Yosef Shiran
Yes.
Yair Averbuch
Yes.
Michael Rehaut - JP Morgan
Okay. Now, a second question just on the SG&A leverage.
It continues to be very powerful for the company and as you continue to grow the business, I mean do you expect further leverage potential going forward. I mean we’ve certainly seen a lot over the last couple of years and its only something that we are expecting and I just wanted to get a sense for – it would seem to me that that’s an opportunity where you can continue to drive further leverage.
Obviously its going to be difficult for you to give us an idea in terms of how much, but directionally is it still fair to think that there’s more leverage opportunity on SG&A as you continue to grow the top line like you have.
Yair Averbuch
Yes I believe that’s the key. I believe that there is potentially additional leverage as we grow, and also in line with IKEA, a business that we talked about before, which is shifting a bit our model towards somewhat lower gross margin, but an increased OpEx leverage as well.
Michael Rehaut - JP Morgan
Okay, right. And just one last one if I could.
You’ve talked in the past about roughly $95 million per line in terms of capacity. Is that still the way to think about it and could that change at all as you continue to introduce some higher priced products.
Yair Averbuch
Yes, I believe that today we are more closer to north of $100 million, probably around $105 million and the increase that we saw is the mix of the fact that our differentiated product was becoming bigger in the sales mix; the ongoing throughput improvement that we are able to take out of our current lines, plus adding the IKEA in salaries and installation and publication companies, which is not generated by the line itself, but its taking account in the blended rate.
Michael Rehaut - JP Morgan
So, its the IKEA business mix just lends to a higher price per sale you mean; higher sale per unit.
Yosef Shiran
Yes.
Michael Rehaut - JP Morgan
Right, okay. But mix and throughput are the biggest drivers at this point of the increased line capacity?
Yosef Shiran
No, I think those three contributed, I didn’t measure exactly how much is each component.
Michael Rehaut - JP Morgan
Okay. Great, thanks very much.
Congrats again.
Yosef Shiran
Thank you.
Operator
Thank you. We’ll take our next question from John Baugh of Stifel.
John Baugh - Stifel
Good morning and congrats on a great quarter. I wondered if we could talk about a couple of your more mature markets; Australia and Canada, which have both had less robust economies.
You are still growing there. Could you give us a sense, are those market share gains?
Are those mix benefits? Are those penetration of quartz, all of the above?
What’s allowing those markets to continue to grow against some headwinds.
Yair Averbuch
Hi John. First of all, the discussion and color in Australia is a bit different.
In Canada we experienced a relatively soft housing market. In Australia the situation is getting better after two tough years.
So I think to start with Australia, it is driven again, first and foremost because of the quartz story; second, our products there; and third, the situation in the markets. We don’t know and we don’t have information about the percent, our market share compared to the others when we are very concentrated and have enough to concentrate on our business, which is growing and we have to take good care of.
In Canada, I think it’s the same as Australia without this situation over the market, which doesn’t help. On the other hand again, we see a lot of success coming out of our new products, our new designs, especially of course the Supernatural and now also the granite inspired designs and those two markets are performing very well.
In Israel we saw a little bit of weakness in this quarter. It’s a very much old market.
We don’t expect huge movements, neither up, nor down in Israel.
John Baugh - Stifel
Thanks for that color. And then as it relates to IKEA in the U.S., you were in I know a bit of a service deficit last year.
Are you caught up or are you fully where you want to be. I know its rolled out in their stores, but wondering what the incremental growth from the second quarter run rate of IKEA is moving forward.
Yosef Shiran
If you are relating to our inventory issues last year, so this is solved almost totally, almost totally solved. In general I think in IKEA, I believe also maybe the customers get used to the product more and more and the corporation is very good.
Probably also has to do with what IKEA is offering, a part of the counter talk and overall it looks very good.
John Baugh - Stifel
I know that you probably won’t comment, but I was just curious, is this program from IKEA’s perspective going so well that they may contemplate it internationally and once your in a better service position with capacity that that’s a big opportunity or that’s just too far out in the future.
Yosef Shiran
I think it’s half of North America market, which is one thing. I think globally there is no connection, at least with what we see now to the rest of the world and in many countries it’s a country-by-country thing, so I don’t see at the moment any impact or any relation of what is happening in the States or other markets.
John Baugh - Stifel
Thanks for that color. Good luck.
Yosef Shiran
Thanks.
Operator
Thank you. We’ll take our next question from Michael Dahl of Credit Suisse.
Michael Dahl - Credit Suisse
Hi, thanks and good quarter.
Yosef Shiran
Thank you; thank you.
Michael Dahl - Credit Suisse
I was wondering if you could give a little more color going back to the capacity. First, the increased investment on the first two lines in the U.S.
Should we also expect that that means your putting those lines in a position to produce some of the higher end product quicker than you may have previously expected to do so?
Yosef Shiran
I think that relating to these two lines, the increase is mainly to do with new machinery that we bought, that can produce better product or can help. You know its part of the line, so its not the line, its specific parts of the line that can produce better products, also a little bit faster.
It also has to do with additional piece of building that we decided to add. It has to do with the showroom that we decided to add and to do in more fancy ways and to a much smaller extent also additional money that we had to invest, for example, infrastructure.
Overall it may well be that it will allow us to improve the throughput, this is what we believe; however, I cannot quantify it at this moment. So the intention is of course to allow us to increase throughput, but we still need to wait and see.
Michael Dahl - Credit Suisse
And are some of the things that your doing at the U.S. plant, would you say that would put them on par with your existing plants or even more modern and if more modern, is this something you could look at doing as far as retrofitting, some of your other existing mines to also increase throughput on those.
Yosef Shiran
It’s more modern, but I don’t see -- the basic things that we can do, in Israel there are in its site there is the specific constraint. So we need again to take care of it site by site and we cannot for example change the site.
It means Sdot-Yam to be the same as the site in Richmond Hill. This would be our most advanced site and we expect for the medium term to operate in a higher throughput than the average of what we do in Israel.
Michael Dahl - Credit Suisse
Got it. And lastly, I guess as you think about bringing on all of this capacity, I guess your success in the U.S.
is probably getting tougher and tougher for our competitors to ignore. So are you seeing others start to also increase their capacity plans or how are you seeing the competitive response right now?
Yosef Shiran
There are also other competitors that increased capacity. According to what we know, there are very little of them and we may not be aware of everything.
We don’t see this in our States reaction to what we do. Again, we may not know, but there is nothing that specifically that we know that was done in order to cope with Caesarstone.
Michael Dahl - Credit Suisse
Okay, thank you.
Yosef Shiran
Thank you.
Operator
Thank you. We’ll take our next question from Lars Dollman of Adelphi.
Lars Dollman - Adelphi
(Foreign Language). Congratulations.
Yosef Shiran
Hi.
Lars Dollman - Adelphi
A couple of questions from my side. On the market share in the U.S., you have any guess how much market share you are gaining?
Yosef Shiran
No, as I said before, we don’t have an objective data about market share. It’s very difficult to assess and to quantify.
I also mentioned that what we see is we see a very strong business and we need to take care of. Market share is important, but its not very important in the short term, so we don’t have a good way to assess it in the absence of an objective data.
Lars Dollman - Adelphi
Okay. And then on IKEA again, and you touched it a couple of times already.
So at the end of the day we obviously we give up a bit of margin up and then we take a bit back, because your marketing expense is obviously lower. So you would say that it’s okay that if I take in the profitability of IKEA sales; it’s relatively close to the other profitability?
Yair Averbuch
Yes, I would say that IKEA as a whole, including the slab business and installations, fabrication altogether is within our operating income margins.
Lars Dollman - Adelphi
Okay. And then the next one is, yet obviously a bit of a tax impact again.
We saw that (inaudible) can out and obviously it decreased rates in Israel and specifically it stated the first time, a really big time, saying that they have to fight against the shekel appreciation. So, any view from your side in regard to the FX that it should roll off after having a couple of big quarter impacts.
Yosef Shiran
The shekel was very strong during the last nine months. It earned extremely well during the last month, during this war that we had, so I am not really optimistic that it will devaluate now against the dollar, but I think its everybody’s guess, so we’ll have to just wait and see.
Lars Dollman - Adelphi
And then one just kind of question going forward, as soon as obviously you have the capacity ready, but what is holding you actually back in total from selling more in Europe.
Yosef Shiran
Do you me what prevents us from selling more in Europe?
Lars Dollman - Adelphi
Yes, yes, going forward strategically.
Yosef Shiran
Well, strategically Europe is interesting as all the world is interesting and it’s just that we have to prioritize and we are not a huge company. We would like to be a huge company, but at the moment we are not a huge company, so our first priority is to focus on the States and then Australia and then Canada.
Europe is a big market, very fragmented and I assume that if we invest a lot of time and money, we can of course increase the business there. So, we maybe opportunistic about Europe.
If there is any special opportunity we may pursue it, but overall I don’t think that we will see a lot of growth there, at least in the short term.
Lars Dollman - Adelphi
No, because obviously priority at the moment as a US facilities, right. But then going forward probably over a couple of years time, there should be the same opportunities as you have in the U.S.
coming through in the longer term in Europe.
Yosef Shiran
So as I said, its more complicated, its more fragmented than the U.S. Europe is like making the business in many countries; its not one country, so we need to address it differently.
As such it is in a lower priority than other markets in the world for us.
Lars Dollman - Adelphi
Okay, good. Thank you.
Yosef Shiran
Thank you very much.
Operator
Thank you. We’ll take our next question from Michael Rehaut of JP Morgan.
Michael Rehaut - JP Morgan
Thanks. I just had a follow up.
Actually on the gross margins, last quarter I think you stated that you expected gross margins to improve from the first quarter level. I guess if you exclude the items, some of the one-times it improved slightly, at the same time FX continues to have a big drag.
So I just wanted to get a sense; number one, excluding the one time items, were gross margins kind of in line with your expectations or did IKEA, perhaps the better than expected success from IKEA impact those expectations for the quarter itself and just how to think about gross margins for the back half of the year?
Yair Averbuch
So regarding Q2 versus Q1, I think there was two things that worked in our favor and those were the continued increase mix of differentiated products that helped likely the gross margin in Q2 over Q1, and also FX was better than in Q1, so that was helping margin relative to Q1. However IKEA increased business was in margin, in gross margin a bit of a drag and this one time employee fringe benefit provision.
So, all in all those were the two positives and two negatives to the 0.5% difference. Going forward, I think you should conclude from our guidance that included a margin.
I prefer not to breakdown specific line items in the income statement.
Michael Rehaut - JP Morgan
So obviously you don’t want to get pegged down, I understand here, but it seems like given the trends and everything, it would seem reasonable that perhaps the second half should be similar to the first half. Is that unreasonable to think or…
Yair Averbuch
I believe that we will have higher volume in the second half compared to the first half and line five should bring better utilization going forward and higher differentiation for this mix also helps. So these exchange rates won’t dive down negatively all at once now I believe and that kind of within our guidance, I believe the second half will be better.
Michael Rehaut - JP Morgan
Okay, great. Thanks very much.
Yosef Shiran
I think Mike, if you analyze our guidance, it’s the outcome deserved a very simple and the very -- one conclusion that you can get is we expect better results in the second half.
Michael Rehaut - JP Morgan
Right. No, no, I haven’t worked through the model fully, but I appreciate it.
Obviously there’s gross margin and operating leverage as well, so I just wanted to make sure.
Yosef Shiran
Okay, thanks.
Operator
Thank you. At this time I’d like to turn the conference back over to Mr.
Yosef Shiran for any additional or closing remarks.
Yosef Shiran
Thanks. Thank you for joining us.
We feel very confident that we are on the right path to continue and grow our business and drive value to our shareholders. Our strategy is working well.
We are going around the world maintaining a strong brand and building for the future. We appreciate your attention and support and we look forward to speaking with you again soon.
Bye.
Yair Averbuch
Thank you. Bye.
Operator
That does conclude today’s conference. Thank you for your participation.