Nov 9, 2014
Executives
Allison Townsend - ICR Yosef Shiran - CEO Yair Averbuch - CFO
Analysts
Stephen Kim - Barclays Will Wong - JPMorgan David Goldberg - UBS Financial George Staphos - Bank of America John Baugh - Stifel Patrick Murray - Credit Suisse Bruce Schoenfeld - BlueStar Global Investors
Operator
Operator Good day and welcome to the Caesarstone Third Quarter 2014 Earnings Conference Call. Today's conference is being recorded.
At this time, I would like to turn the conference over to Allison Townsend of ICR. You may begin.
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 Forms 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 third quarter earnings release, which is posted on the Company's Investor Relations website.
With that, I’d now like to turn the call over to Yos Shiran, Caesarstone’s Chief Executive Officer. Yosef?
Yos Shiran
Thank you, Allison. Good day and thank you everyone for joining us to discuss our third quarter, another strong quarter with record results.
I would like to start with some highlights for the quarter. Revenue in the third quarter increased 31% to a record of $123.3 million, continuing very positive trend of growth.
Third quarter adjusted EBITDA was also a record at $35.9 million, up 42% compared to the same period last year. Adjusted net income for the third quarter was $27 million, up 63% versus last year and our adjusted diluted earnings per share of $0.76 is up versus $0.47 in the same quarter last year.
Our growth was broad-based in the United States, Australia and Canada showing the strongest increases. The Caesarstone brand continues to be a market leader around the world, recognized for high quality and innovative design.
We continue to expand our unique and differentiated product offering and recently we launched our Calacatta Nuvo product, which is rapidly becoming a success in Australia, Canada and the U.S. contributing to the strength of our brand in our financial results.
We believe we are well positioned to capture additional growth. I would like now to give an update on each of our major markets.
I will start with United States, where sales grew by 47.8% to $50.5 million. This is our largest and fastest growing market.
Our strong brand, the success of our new products and the contribution from IKEA were the drivers of these growth. Australia sales were $30.8 million, up 36% compared to last year.
On a constant currency basis, Australia was up 34.9%, we are pleased to see this market rebounding and with a stronger trend in the business. Canada was our third largest market this quarter.
Canada grew by 27.2% to $16.9 million. On a constant currency basis growth was even stronger with 33.2%.
We have recently entered into an exclusive collaboration with IKEA in Canada similar to the U.S. As much as we see this as a testament to the strength of our products and brand in Canada, currently we don’t expect this project to generate significant revenue.
Israel grew 2.6% in the quarter to $11.2 million held by stronger shekel. On a constant currency basis, we saw sales down 1.5% reflecting a weak housing market.
Europe grew by 3.2% to $6.3 million and was up 4.3% on a constant currency basis. Revenue in the rest of the world was up 4.7% to $7.7 million in the third quarter and was up 4.9% on a constant currency basis.
In general during the third quarter, we responded to growing demand executed well in increased capacity. We are progressing on schedule to our Richmond Hill, Georgia manufacturing plant in United States.
We continue to expand first line of this plant -- we continue to expect the first line of this plant to become operational in the second quarter of 2015 and the second line is expected to become operational in the fourth quarter 2015. We believe that this facility and this capacity will support our growth and improve our competitive position.
As we announced today, we have decided to distribute a dividend of $0.57 per share enabled by our strong cash balance and positive cash flow from operations, as well as our outlook for the future. This is a return of excess cash that we believe is beyond what is required to fund our growth, capital expenditures or working capital needs.
To summarize, we’re excited about the next steps of our capacity expansion in the U.S. and the strong demand we are experiencing all over the world, particularly in our key markets.
We are confident in our ability to grow and further develop the business. Thank you and I will now turn the call over to Yair.
Yair Averbuch
Thank you, Yos, and good morning to everyone. I will start with our income statement for the third quarter.
Revenue in the third quarter increased by 30.7% to $123.3 million, compared to $94.3 million in the third quarter of last year. This is another new record for any quarter.
On a constant currency basis revenue increased by 31.1% versus last year. Gross margin in the quarter was 43.7%, compared to 44.5% last year.
We benefited from favorable product mix related to the success of Supernatural and other unique and differentiated products as well as volume leverage. This however was offset primarily by significant increase in business with IKEA related to fabrication and installation activity, which comes with lower gross margin.
We also saw some pressure from currency and to a lesser extent by an increase in raw material prices. Operating expenses in the third quarter were $22.7 million, or 18.4% of revenue versus $21.1 million last year, which was 22.4% of revenue.
The benefits of scale more than offset the lower gross margin. Operating income grew by 49.3% to $31.2 million, as compared to $20.9 million in the third quarter of last year.
Our operating margin increased to 25.3% from 22.2% last year. Adjusted EBITDA in the third quarter which eliminates share-based compensation expense, the excess cost of acquired inventory and other non-recurring items increased by 42.4% over the prior year to a new record of $35.9 million.
This represents a margin of 29.1% versus 26.8% last year. Finance income in the third quarter was $1 million, compared to finance expenses of $1.1 million in the prior year.
This cost of income reflects currency exchange fluctuations during the quarter related to the strengthening of the U.S. dollar against all other currencies, which impacted primarily the Australian dollar hedging instrument and the net liabilities denominated in Israeli shekel.
Our taxes in the third quarter were $4.8 million, 15% of income before taxes, compared to $3.3 million last year, a 16.9% rate. Adjusted net income attributable to controlling interest in the third quarter increased by 63.1% to $27 million, from $16.5 million last year.
Adjusted diluted earnings per share in the quarter was $0.76 compared to $0.47 last year. Our cash flow from operations was healthy generating $21.3 million during the quarter, over 80% more than what we have generated in the first half of 2014.
Our cash and bank deposit balance was reduced by $2.5 million from previous quarter to $77.7 million due to capital expenditure of $18.6 million, mostly related to the Richmond Hill manufacturing site. Net cash position however increased by $1.7 million as we reduced our credit lines in Canada.
We believe that this level of cash combined with our expected cash flow and the outlook for the business allow us to provide additional value to shareholders through the dividend we announced today without effecting our ability to fund future growth. I will note that the dividend record date is November 26, 2014 and is payable on December 23, 2014; subject to applicable revolving tax.
Receivables at the end of the quarter were $67.4 million. DSO were 50 days this quarter, in line with previous levels.
Inventory at the end of the quarter was $75.7 million, up by $2.8 million from the level at the end of the second quarter. With respect to our 2014 guidance, following a strong third quarter we’re increasing revenue guidance for the full year of 2014 to a new range of $445 million to $450 million as compared to our prior range of $435 million to $445 million.
We are also raising our expected adjusted EBITDA guidance for the full year to be at the new range of $115 million to $118 million, compared to our previous expected range of $112 million to $117 million. Thank you.
And we are now ready to open the call for questions.
Allison Townsend
Operator?
Operator
Thank you. (Operator Instructions) And we'll go ahead and take our first question from Stephen Kim from Barclays.
Stephen Kim - Barclays
I wanted to ask about your increasing top-line and EBITDA guidance. I think this is the -- I think for the second time you've sort of done that for us.
And I guess my question particularly relates to how you originally thought about the drivers behind those -- earlier this year and in your view, how have things changed as the year progressed? In answering that, if you could also specifically talk about the increase in throughput and what kind of changes you think you made to continually increase your throughput?
Thanks.
Yos Shiran
I think when we tried to forecast in the beginning of the year, usually its tough mission and I think we spoke about it in the past. We do a thorough analysis bottom up.
Then I think the main reasons for the growth in sales were the reception of our new products, mainly the Supernatural, also our deployment in the U.S. and also in Australia and Canada and in general the people's openness around the world to accept quartz as the preferred product for their homes.
So these were the main drivers for the growth and please remember that it always a projection. We don't know what it will be in the future and sometimes it deviates a bit from what we expected before and we are happy to see it going upwards from what we thought before.
Stephen Kim - Barclays
Certainly. I guess, with respect to the strong sales and acceptance of Supernatural, I guess one of the things I was trying to figure out was, how much of the increased throughput would you attribute to mix and a greater mix of let's say higher price point products like Supernatural versus the actual slabs?
I think I asked you that question in the past. Now I'd just like to ask it again, because it seems you're getting a little bit of both.
I just wanted to get a sense from you.
Yos Shiran
It is coming from both and as much as we would like to share relevant information, we're trying not to provide specific numbers on specific products as it seems very sensitive competitive wise.
Yair Averbuch
Stephen, I would also like to add, as you may remember we talked about three factors in increasing the revenue per line. One was the mix of product, one was the productivity of our rich line and the third one was IKEA, a partnership in the sense that now we have some installation and fabrication that is not a slab, it's not slab per se but it's attached to every slab and kind of increased the overall blended rate.
So that's another thing.
Stephen Kim - Barclays
My last question just relates to the ramping up of the workforce at the Richmond Hill plant. It started there when you guys did a job fair I guess there recently and was curious if you could just sort of talk about what your intentions are around the hiring and training of the personnel at the plant.
In particular, are you going to be bringing folks over to Israel, or how much of the personnel though of the plant do you expect to train in Israel versus bringing folks from Israel over into the U.S.?
Yos Shiran
So currently we relocate about a 12 people from Israel and we are bringing over key employees to a period of time to Israel, everybody according to his or her specific role. I don't remember how many people exactly we are going to bring to Israel, but the backbone of the factory will have some training in Israel.
Operator
Our next question comes from Michael Rehaut with JPMorgan
Will Wong - JPMorgan
It's actually Will Wong on for Mike. With regards to the gross margins, obviously very strong there.
And Yair, thank you for the color regarding the drivers. It's a mix, offset somewhat by IKEA FX and raw material prices.
Just wondering if you could just give us a little bit more color in terms of the magnitude of the improvement on the gross margin in terms of those four factors?
Yair Averbuch
Without getting into too many details, the impact of IKEA is by far larger, probably around 200 basis points. FX is around half of it and material price increase is half of the half.
Will Wong - JPMorgan
And then with regards to the [indiscernible], the U.S. plant becoming operational in the second quarter of '15, if we were to think about the [indiscernible] and I think it became operational towards the end of the third quarter of last year, and it didn't really become fully operational until I think the second quarter of this year.
Should we be thinking about the rollout of the U.S. facilities in terms of timeframe, in a similar regard in terms of maybe a couple of quarters before it becomes fully operational or do you think because this is in a different -- in the U.S., it will take maybe a little bit longer to become fully operational?
Yos Shiran
Basically, you should consider let's say at least six months until it gets to full capacity. Again, this is again what we expect and we will know only when we operate it -- we actually operate it.
But we believe you will see the ramp up in the states from start to full capacity in about a six to nine months.
Will Wong - JPMorgan
Okay, great. And then just last question on the -- just going back to gross margins and just looking forward, you guys have had gross margins kind of in that 3% [ph] range, 41%, or 42% -- 44.5% last year and kind of around 41%, 42% this year.
Just with regards to trends going forward, as IKEA grows and as well as like Supernatural becoming a bigger part of your overall operations, what do you think in terms of just directionally gross margins can do over the next couple of quarters and just next four to eight quarters? Do you guys expect it to kind of continue to trend down a little bit due to IKEA or do you kind of expect it to be flat as sort of mix -- Supernatural mix offsets some of that?
Yair Averbuch
So without getting into too much guidance for 2015 year, IKEA, the way we see IKEA is just a split up margin and OpEx and in terms of operating income margins, it's a very healthy business for us. So that's the way we look at it.
I think that we will have some pressure next year from ramping up the U.S. factory.
That will put some pressure on margin but we are -- we still need to finalize our annual plan getting to all the numbers to figure it out and probably at the next quarter earning, we will be much clever and much ready to quantify that for you.
Operator
And we'll take our next question from David Goldberg with UBS Financial.
David Goldberg - UBS Financial
I wanted to just start by talking about IKEA and the decision to kind of roll out the relationship with IKEA in Canada and maybe think about where you guys are with IKEA globally. It would seem like the opportunity outside the U.S.
and outside Canada would be much bigger than what it is within the U.S. and Canada, just given the much larger footprint in terms of stores.
So is that something you guys are considering now and should we see the decision to move forward in Canada be, maybe an opportunity for you in '15 and '16 to roll this out in more countries with IKEA?
Yos Shiran
So, first of all we are very happy with the business and the collaboration with IKEA and we are happy to expand this into Canada. For the time being, we are concentrating on United States and Canada and no plans to expand it elsewhere.
So we will try to make the utmost of this business collaboration in the North American market.
David Goldberg - UBS Financial
And then on Australia, I know you mentioned the market there rebounding and that contributing to the growth. But the growth you guys posted was a really phenomenal rate and I was wondering if there is anything you are doing in Australia now that’s helping you gain share other than new product introductions, just the product has been well received or is there any kind of strategic things you are doing that are gaining -- because the 40% growth rate was so significant?
Yos Shiran
So I think in Australia, first of all of course we enjoy higher penetration of quartz, which is a according to the last recording [ph] our report from two years ago, it was 35%. But there is a still room for growing quartz penetration as a whole in Australia.
Adding to that is our robust operation in Australia and our new products were very, very well received in Australia. So this also supports our growths there.
Yair Averbuch
I would to add to that that in terms of the macro economy in Australia, it's very positive here. So if undoubtedly going for us.
It’s the first time after full year the both home start and renovation activities are increasing. So that is another factor in our growth accelerating in Australia this year.
David Goldberg - UBS Financial
If you had to think what kind of price versus unit growth in Australia, if you could give us an idea kind of how that broke out.
Yos Shiran
It has a significant portion of price as well. Let’s put it this way.
Operator
And we’ll take our next question from George Staphos with Bank of America.
George Staphos - Bank of America
I guess my first question, and maybe it’s a little preliminary, but do you have in mind and are you in a position to share when perhaps the next line might start to be needed, considering that six and seven are coming up next year. And if you can provide details on that relative to where you were, say, six months ago, is that line, even though you can’t call the timing, more accelerated or on the same timeframe?
Yos Shiran
You are asking about line number eight.
George Staphos - Bank of America
Yes.
Yos Shiran
So first of all I would like again to remind that when somebody tries to rely on Company future prospects, we think the best thing to do is to rely upon guidance and the capacity expansion of course reflects our view of the future. But it’s not precise enough.
So in general when we plan, we plan for longer term and we did say that we are starting to plan now also lines eight and nine. But we cannot report on any changes as to the timelines of line number eight and nine.
Of course there may be some adjustments. There is not something major relating to that.
George Staphos - Bank of America
Okay, that’s clear. I want to come back to Steve Kim’s question and try a different line of approach.
Relative to your increase in guidance, and obviously that’s a good thing, what was the single biggest driver in your expectations in terms of that raise in guidance relative to your expectations three months ago?
Yair Averbuch
I think that Q3 was very strong for us and that was the primary reason for increasing the guidance for the full year. On that when do from a some more of thing would have exchange rate that continue to deteriorate enough, which otherwise it would have been even higher.
George Staphos - Bank of America
Yair, in the operational component, if you will of third quarter performance; was it more driven by the acceptance of your new products that drove the variance relative to your expectations and therefore the guidance or was it the operational side of the house, so to speak, that was a little bit more significant in terms of the guidance raise and the performance in third quarter?
Yair Averbuch
It was mainly related to volume, to bigger volume then we thought which kind of tied big to our utilizations of the line and also to the mix of product. That was even better than we assumed.
George Staphos - Bank of America
Okay.
Yos Shiran
I think if I understand the question, so it was more connected to the sale.
Yair Averbuch
Yes, more connected to the sales than to operation and cost.
George Staphos - Bank of America
Clearly they are joined at the hip, but the first thing was the volume which drove the operating efficiency and the mix for that matter. My last question and I'll turn it over.
Could you comment to any greater depth in terms of how Calacatta Nuvo is doing in the market? I forget exactly your terminology, but you seem to be pleased with it from your comments, both in the release and the conference call.
Can you provide a bit more color there? Thank you.
Yos Shiran
Yes, so the Calacatta Nuvo is based upon the basic technology that we developed for the Supernatural and now we took it even further. And this technology is proprietary technology of Caesarstone.
Calacatta itself is a very high and prestigious marble and this -- the product that we do is inspired by Calacatta. So got the look of Calacatta but has all the advantages of Caesarstone product.
We operate in a very high price because of the cost associated with that but more than that because of the prestigious perception that it captures in customer's eyes. The launch started in Australia and in Canada and so far it is very successful and we already started to sell it in the states, but not with the full blown launch that will be done by beginning of next year; even though the sales are rather good also in this states.
So we are very excited about this product and we are excited about -- we are happy to see the consumers and our customers buying into it and willing to spend the money and appreciate the design and the quality of it.
Operator
Our next question comes from John Baugh with Stifel.
John Baugh - Stifel
My question is first I guess on the Q4 guidance, you mentioned the FX headwinds. Are there any other factors, I guess, both pluses and minuses that may influence the EBIT margin as we look at Q4 versus Q3?
Yair Averbuch
Yes, so Q3 in general is our strongest quarter on a seasonal basis. December is a relatively week month in Australia and North America given Christmas time.
So there is some volume and a significant FX impact.
John Baugh - Stifel
And then maybe for you, Yos, Canada's housing market is not exactly robust and your numbers remain strong there and at the higher-penetrated market. Could you speak to what you think is driving that?
Is it share gain? Is it just overall increased penetration of quartz, commercial customers, new construction, repair, remodel, what's driving it?
Yos Shiran
I think in general the penetration of quartz in Canada is higher than in the States and we -- the most fundamental thing for us is the material conversion story. So Canada is good demonstration of what could be done.
So if the market is stopped we could still increase our sales. I think it is also supported by the successful new Supernatural collection and the expansion of this collection.
And these are the two main factors.
John Baugh - Stifel
And my last question relates to IKEA. I assume we'll still have year-over-year influence from that business and its growth.
Should we think about that business, though -- is it a full run rate or a much slower growth rate sequentially or is IKEA still seeing huge increases via new products or training or something that would drive that number even further?
Yos Shiran
I think that IKEA numbers and IKEA sales will be influenced by the IKEA consumer and by this consumer getting to know the advantages of the Caesarstone products with time. We operate in all the IKEA stores in the States.
So I don’t think that there will be any surprises in terms of jumps or I think at least from what we see now but we see a steady growth in the business step by step.
Operator
Our next question comes from Michael Dahl with Credit Suisse.
Patrick Murray - Credit Suisse
This is Patrick Murray on for Mike. First, with respect to the special dividend, could you talk about how you're thinking about capital allocation going forward, and if this action you're taking is something that you revisit on a quarterly or annual basis going forward or any thoughts around there?
Yos Shiran
Are you referring to the dividend?
Patrick Murray - Credit Suisse
Yes, the dividend.
Yos Shiran
So I think we’re focused on growth and the dividend that we are distributing is based on our assumption that this is an excess cash that will not harm our flexibility to grow the businesses as we like to maintain the ongoing capital that we need. So this decision maybe revisit by the board from time-to-time.
For the time being what you see is what there is. So, we don’t know what will be in the future regarding to this kind of fair capital allocation.
We may distribute dividends in the future, we may not according to the situation and to the capital news at the Company.
Patrick Murray - Credit Suisse
Okay, fair enough. And then switching gears a bit; with Richmond Hill, as you think about that over the next year or two, is there any thoughts on margin differentials based on regions that you sell into and any expected shift you would see as that facility comes online, realize that there's quarter to quarter product mix, but just generally if there is any headwinds or tailwinds that you'd expect from geography specifically?
Yair Averbuch
Yes, so the geographical distribution of our revenue will be determined by demand, not necessarily by world factories. So I don’t think that this is a factor there.
As we spoke however before, we believe that in the long run the U.S. factory and the factory in Israel, there was many puts and takes, very similar in the cost structure and shouldn’t have much difference between them.
However that means in the long run, in the short run when you bring lines into operation though, we expect to have some initial pressure or some learning curve as we spoke before and there is difference on an ongoing level is the FX implication because the U.S. tax bracket is much higher than in Israel and we have spoke about it.
Operator
We’ll take your next question from Bruce Schoenfeld with BlueStar Global Investors.
Bruce Schoenfeld - BlueStar Global Investors
I just wanted to get back to the issue of FX. Most of October, we saw a steep depreciation of the shekel against the dollar.
So you briefly touched about the impact going forward in Q4, but if indeed this is kind of a step change, what is the Company thinking about that in terms of perhaps hedging some of the currency risk? And in general, if you could quantify the sensitivity of the Company's operating income multiples to the shekel dollar and Australian dollar, U.S.
dollar exchange rate?
Yair Averbuch
Yes, so I would say that first of all the exchange rate fluctuate quite a bit in our environment and it’s definitely a challenge for us, part of our challenges. By the way if we look backwards on when we started the year and the guidance that we gave and where we are today, this is all done and we were raising guidance all time along despite a significant and favorable exchange rate.
So I’m not saying that every time that there will be exchange rate issue. We will be able [ph] to overcome it.
But it’s part of our challenges. We don’t know exactly where is growth?
In terms of the sensitivity, by far the biggest sensitive one is Australian Dollar versus U.S. Dollar and this is on an annual basis.
It’s all listed by the way in our 20-F. It’s around $6.5 million on an annual basis, impact on operating income.
Second, is Canadian Dollar and Israeli Shekel around $3 million each? Now on the Canadian Dollar we like to have a very strong Canadian dollar relative to the U.S.
dollar and the Israeli shekel the opposite $1.4 as per the shekel. The impact on the euro is the lowest of all of them, less than a million.
This is on the 10% -- on a 10% evaluation or devaluation. That's worth mentioning.
Operator
We will take our next question from Michael Rehaut with JPMorgan.
Will Wong - JPMorgan
Hey, guys it's Will again. Just had a quick follow-up.
Last quarter you guys had mentioned that each line in terms of revenue from the alliance is about $105 million. I just wanted to see if there was -- if that's still the case, and if not, is there any change to that?
Thank you.
Yos Shiran
Yes, we believe that this is still more or less the case. Just to say that line number five came into full operation in the beginning of the third quarter, but it is not in 100% utilization yet.
So it is growing a lot but it should do a little bit more. But to your question it's still around 105.
Operator
Our next question comes from George Staphos with Bank of America.
George Staphos - Bank of America
Two questions, first of all on the question of capital allocation, I think I know the answer to this question, but just wanted hear it from you. In terms of utilizing excess cash, why was special dividend viewed as more favorable to, say, something like buyback?
Would it just happen to be related to the liquidity or trading volume in the stock that drove that? And then can you update us at all on any challenges in the supply chain that may have been created or intensified in the last couple of months, riot events in the Middle East?
Thank you, guys, good luck in the quarter.
Yos Shiran
So there are couple of locations. There are many different ways to analyze the wise options we might use to drive value to shareholders.
And this seems to us to be the right method at this time. As to anything related to supply chain, so nothing has changed.
If you are referring to the hostilities in the Middle East, again we were not impacted by it. And as we said in the past, we don't expect that these type of things will prevent us from developing the business.
So this is where we are.
Allison Townsend
Operator?
Operator
So that concludes today's question-and-answer session. At this time, I'd like to turn the conference back over to Yosef Shiran for any additional or closing remarks.
Yos Shiran
So we appreciate your continued interest in Caesarstone. We are working hard to deliver consistent performance and growth and we are pleased with the results of the year so far and feel strong about our business.
Thank you and have a great day.
Operator
This concludes today's conference. Thank you for your participation.