Aug 5, 2015
Executives
Allison Townsend - ICR Yos Shiran - Chief Executive Officer Yair Averbuch - Chief Financial Officer
Analysts
Stephen Kim - Barclays Capital Michael Rehaut - JPMorgan. George Staphos - Bank of America Susan McCrory - UBS Mike Dahl - Credit Suisse
Operator
Good day and welcome to the Caesarstone Second Quarter 2015 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, 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 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 investor relations website.
With that, I would like to now turn the call over to Yos Shiran, Caesarstone’s Chief Executive Officer.
Yos Shiran
Thank you, Allison. Good day and thank you everyone for joining us to discuss our second quarter.
I would like to start with some highlights. Sales in the second quarter increased 10% to a record of $127.5 million.
Second quarter adjusted EBITDA was $33.5 million, also up 10% compared to last year. Adjusted net income for the second quarter was $23.2 million, up 12% versus last year, and our adjusted diluted earnings per share of $0.65 are up by 12% versus $0.58 in the same quarter last year.
All of our markets grow on a constant currency basis, although our results show adverse impacts of changes of currency exchange rates, the United States, Australia and Canada our three most important markets were healthy and excluding the impact of currency exchange rate changes showed strong gains versus last year. We continued to believe that our performance in these markets and across our other regions speaks to the strength of our brands and the innovation of our product.
We are also executing well in our other smaller markets. Our sales in the United States grew by 19.2% over the same quarter last year to $57.1 million and the U.S remains our largest market.
We are confident that the market opportunity remains very strong and although this represents healthy growth we expect it to be a bit higher. We expect to see a second half growth rate that is stronger than what we saw in the second quarter.
Canada was our fastest growing markets up 24.4% to $19.1 million; this is despite significant currency pressure. On a constant currency basis, growth was 40.3% partially driven by our new partnership with IKEA Canada.
Australia sales were $27 million, down 1.7% compared to last year. On a constant currency basis Australia was up 17.8%.
We are pleased to see a continued strong trend in this region. Israel was down 3.5% in the quarter to $9.6 million but was up 7.6% on a constant currency basis.
Europe was down by 7.3% to $6.8 million, and up 14.5% on a constant currency basis. Revenue in the rest of the world was down 1.6% to $8 million in the second quarter, and was up 16.8% on a constant currency basis.
As you know our first U.S. production line in Richmond Hill, Georgia is now operational and we are on track with a start up and anticipate to start operating the second line in this facility, our seventh line overall in the fourth quarter of 2015.
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 second quarter.
Sales in the second quarter increased to a new record of $127.5 million, up 9.9% compared to $116.1 million in the second quarter of last year. On a constant currency basis, sales increased by 20.2% versus last year.
I would note that this growth comes on top of our highly favorable comparative period last year in the U.S. given the list from the ramp up with IKEA, Super-natural and our expansion of 14 locations.
Gross margin in the quarter was 41.3%, compared to 41% last year. This was driven primarily by favorable product mix, lower cost of polyester and benefits of scale.
These factors were partially offset by start-up costs related to the U.S. manufacturing facility and negative exchange rate fluctuations.
Operating expenses in the second quarter were $24.3 million or 19.1% of sales versus $24.1 million last year, which was 20.7% of sales. This improvement was due primarily to revenue growth as well as the non-recurrence of several expense items primarily costs associated with last year’s secondary offering.
The revenue growth and absence of those expense items drove a 20% increase in operating income to $28.3 million as compared to $23.6 million in the second quarter of last year. Our operating margin increased by 190 basis points to 22.2% from 20.3% last year.
Adjusted EBITDA in the second quarter, which eliminates the impact of share-based compensation, the excess cost of acquired inventory and other non-recurring items, increased by 10.4% over the prior year to $33.5 million. This was the margin of 26.3% versus 26.2% last year.
Finance expenses in the second quarter were $0.4 million compared to finance expenses of $1.4 million in the prior year. This decrease was primarily due net gains related to our currency hedging instruments in the second quarter of this year offsetting some of the unfavorable exchange rate fluctuations.
In the second quarter of 2014, we recognized net losses on those instruments. Our taxes in the second quarter were $4.6 million, 16.6% of income before taxes compared to a 15.2% rate last year.
The increase in tax rates is partially due to higher tax rates associated with our new U.S. manufacturing operations.
Adjusted net income attributable to controlling interest in the second quarter increased by 11.8% to $23.2 million from $20.7 million last year. Adjusted diluted earnings per share in the quarter were $0.65 on 35.5 million shares.
Adjusted diluted earnings per share last year were $0.58 on 35.4 million shares. Turning to our June 30 balance sheet.
We had cash, cash equivalents and short-term bank deposits of $37.7 million, down $3.4 million from our Q1 cash balance. Our cash flow from operations grew to $20.2 million in the second quarter of 2015 compared to $2.7 million in the previous quarter, yet we continued to consume cash given major CapEx payment of $26.7 million associated mostly with the new U.S.
manufacturing facility. With respect to 2016 guidance, we continued to expect adjusted EBITDA in the range of $123 million to $129 million.
Our profitability has been strong through the first half and higher margins are offsetting the impact of more robust expectations for revenue growth, due to slightly lower than expected growth rate in the U.S. this year as well as the ongoing impact of foreign exchange rates.
Our current view is that we will achieve our profit target on revenue of $495 million to $505 million. Thank you.
And we are now ready to open the call for questions.
Operator
Operator Instructions] And we will take our first question from Michael Rehaut with JPMorgan.
Michael Rehaut
Thanks. Good morning everyone.
The first question I had was on the U.S. growth and after that I had a follow up.
But on the U.S. you mention that you are now expecting a slightly less, lower growth rate for the year and that was part of the reduction sales guidance.
I was wondering if you could give us a sense of what that difference is and what type of growth do you expect now? And what do you attribute the lower than expected 2Q results that by contrast you think the second half should be have stronger growth?
Yos Shiran
Hi, Mike. So first of the deviation you know the change is coming from two aspects.
One is the currency aspect and the other one is the U.S. performance.
The deviation is relatively small from what we have thought initially but its beginning up to impact it because the United States is growing. So first of all we are still growing very healthy in the United States and maybe some of the external factors like the strong growth in multifamily you know in light of doubt it may appeal that the growth is not as high as it could be as but we are a lesser of a player in these segments and this segment is more price oriented.
Overall, last year we had some factors that push the growth strongly like IKEA, like new stocking [ph] locations like strong ramp up of the Super-Natural. So, this year it is coming to affect of course much less, and this is what is happening.
So according to what we see now and what we expect the growth would be stronger than the second quarter but lower than we have initially anticipated.
Yair Averbuch
I may want to add Mike to quantify of the 20 million approximately 30 million is the exchange rate, deteriorating exchange rate and the remainder is slightly lower than expected the U.S. growth.
Michael Rehaut
Thanks, Shiran. So you said 7 million exchange rate, 20 million U.S.
growth?
Yair Averbuch
No, no. 20 million we adjusted the guidance 20 million, so 7 million exchange rate and 13 U.S.
Michael Rehaut
And Yos, what gives you the confidence to see the better growth in the second half, is it due to backlogs or certain customers that you are working with or the fact that you know maybe you are getting through the start up in efficiencies of the new line?
Yos Shiran
No, I think today we are in a situation where we are not capacity constraint so this is behind us and we are in a very good shape. Also we did a lot of improvement in the production in Israel in terms of throughputs and the new line is coming up as we planned.
So this aspect is taken care of. We believe according to what we see, according to the demand for our products holding to the sales trend that we see already and of course there is no assurance always but according to our expectation this should be higher than that in the second quarter.
Michael Rehaut
All right and just one last one. Yeah, Yair if you could give us any sense of finance expense and tax rate for the back half?
Yair Averbuch
Yes we are expecting a fixed rate to continue and increase as the U.S. manufacturing gradually increase overall for the second half we expect a range of 17% to 20% tax rate gradually up.
In terms of finance expenses net of any impact or effect that we cannot anticipate it should be around 800 [Indiscernible] per quarter. That’s a run rate without FX.
Michael Rehaut
800,000 a quarter.
Yair Averbuch
8 to 900.
Michael Rehaut
Thank you.
Operator
Our next question is from Stephen Kim from Barclays Capital
Stephen Kim
Thanks guys. Yes my first question related to the gross margin benefit you saw this quarter offset by the plant cost.
So I was wondering if you wouldn’t mind Yair if you could give us a little bit of a breakdown like you’ve done in the past, like how much in basis points do you think you benefited from mix, polyester, lower polyester cost and the benefits of scale and how much the offset was in terms, in your view of higher plant cost?
Yair Averbuch
Yes so in the fourth quarter mix [ph] and polyester prices contributed the 478, [ph] 200 basis points each. Volume in fact was below 100 and those three positive factors were offset by a U.S.
manufacturing start up inefficiency that was approximately 250 basis points and negative assets infact of approximately 200 basis points.
Stephen Kim
Perfect, appreciate that. And then the next question I had related to the U.S.
So I think we heard that production capacity is ramping up with really no problems and you are not capacity constraint like you have been as much in the past. And I was curious if you could talk about are there any additional channels that you can go after now that you are not so capacity constraint and to what degree any of those initiatives are incorporated in your revised outlook.
Yos Shiran
Hi, so yeah definitely it helps us to better perform in the market for long term. It will take a while until this situation coming from capacity constraint to capacity not constraint will be translated into sales and growth but it’s definitely would improve our service and it would allow us to maybe go after projects let’s say that were not – we were not looking at when we were capacity constraints and this could be in all markets but also in lower margins maybe project but still healthy margins that we can address and this is you know like a general statement you know I cannot record [ph] the specific ends.
But we believe that it will allow us to do and to service much better and it would be reflect but it will take a while. So currently the guidance is what we seek for the rest of the year.
Stephen Kim
Okay, great. That’s helpful.
I guess if I could also ask a follow up regarding that the outlook. You had talked about some of the external factors in the U.S.
like maybe a greater mix of multifamily for example, a more robust and -- which doesn’t as much benefit U.S. But yes, single family is what I was sort of hearing in fact; could you elaborate a little bit more or what you were seeing in multifamily and what your outlook is – like how much of that is weighing in on the reduction in your U.S.
sales?
Yos Shiran
So again, we cannot – we don’t have a kind of data that’s a breakdown and can weigh each of the companies. But as a general statement, the multifamily growth is very strong, year-over-year, but the multifamily segment is part of it is very price oriented and its not a game that we are playing and again I don’t know whether multifamily is growing over a single family and maybe it’s a general trend that you know the new younger generation is investing more in the multifamily than in single homes.
We are stronger where a brand matters most and this is in the renovation and renovation and also single family group and there was a good growth but not very strong growth like the multifamily. So in light of that you know we are pleased with the results and we expect a continuous strong growth in the west which is not stronger as last year but strong growth and also for the reason that Yair mentioned last year we incorporated IKEA and other factors.
So this is what I can say about the markets, about the external factors.
Stephen Kim
Okay. Great, thanks very much.
Appreciate it.
Yos Shiran
Thank you.
Operator
We’ll go next to George Staphos with Bank of America.
George Staphos
Thanks, everyone good day. Thanks for the details.
I wanted just to check to the extent that you have any visibility on this, do you think that your peers are competing perhaps more effectively against your products in the course of the market and that’s leading to any of these slower than expected growth? Or is it purely comparison in market?
And similar question, are you seeing any signs of maybe price compression that you hadn’t seen previously again with your key products?
Yos Shiran
Hi, John. We don’t have visibility to the performance of the competitors and they are – some of the competitors are closer to our level.
Some of them – some of the competition is a cheaper product that are coming from the Far East and it’s not the same quality. And as I said, I think multifamily is more priced driven.
We don’t have any evidence of somebody that’s makes better than what we do. We cannot say that it’s not happening, but we are not aware of it.
So we feel quite strong in the market and we feel that we are launching the right product. We will continue to extend our new launches and new product that we show to the market of course.
And we believe that in that we continue to lead the segments and we also believe in our operation between our R&D, our marketing and our ability to read better in the competition, the trend to launch products. So, we don’t think that there is – we don’t see any evidence to somebody of players in our level that something that is better than ours.
Again I don’t know if this is the case. To the – and as I’ve said, in the multifamily there is definitely – its worst and it is – and part of it more price reoriented segments and still now we were not so much focus on it, because of our capacity, part of it we may consider in the future and of course prices in that segment are lower.
George Staphos
Okay. Does that suggest that you were planning to get more of the multifamily market with the growth in your business or you just assuming that slowdown you’re seeing is it by share shift to multifamily over the last six to nine months?
Yos Shiran
No. I don’t think we will – I don’t think it is something that we will go after in a big scale, but it’s something that we can maybe better analyze and see if within that segment there are some opportunities for us.
So this is the way -- the right way to look at it.
George Staphos
Okay. Understood.
To the extend possible, can you comment again within the U.S. were there any of your products that were less affected by the slowdown or more affected by the slowdown and can you tell us how Calacatta Nuvo and some of the other launches are doing?
And then my last question and I’ll it turnover, as we think about your revenue guidance what frames the upper and lower balance of that guidance in terms of inputs and assumptions? Thank you.
Yos Shiran
As to the products, Super Natural continues – Super Natural sales continues to do very well. And Calacatta sales are very good.
We launch Statuario, which is close friend of the Calacatta. We launched it in Canada and in Australia.
The reception is good. And we will launch it in the states around October.
So of course, we expect some impact but relatively small in the beginning. So this is to that extend.
As to the variation of the guidance Yair would you like to answer this?
Yair Averbuch
Yes. You know we are working all the time.
We have the sales on our projection estimate. Beside this we have the foreign exchange rate.
This matters lot to us and we don’t know how it will develop. So and just if you -- exchange rate.
And then like Yos said, I think we believe that we will be stronger in the U.S. in this year than Q2, and most of the things, the adjustments that we do for the more for the more longer trend within this year.
So, we’ll stick to our guidance.
Yos Shiran
I think John just to end to that. I’m sure if I’m answering your question, but the guidance and the projection, of course, we have no assurance because we don’t have a backlog.
It’s a day-to-day operation and some of it are projects which we of course have, but most of it is according to the markets and according to previous experience. What we do, we built it bottom up, so we go region by region and get the projections from each market and then incorporated to one projection and this is what comes out.
George Staphos
Okay. I’ll turn it over.
Thank you.
Operator
We’ll go next to Susan McCrory with UBS.
Susan McCrory
Good morning.
Yos Shiran
Hi, good morning.
Susan McCrory
At your Investor Day you spoke about perhaps starting to work more with the big U.S. homebuilders as your U.S.
capacity comes on line. Can you give us any update on your thoughts of pursuing that and maybe what your relationship with them is and where that could go?
Yos Shiran
So, again we -- Caesarstone started with the renovation and this is where we are strongest and we started to develop more strong relationships and more methodical approach to this segment around three years ago. And this is growing.
Of course opening the factory will help us and will allow us to grow this segment more. So, we have relationship with many of the bigger – biggest contractors but it’s not very deep.
So we can definitely to more work there.
Susan McCrory
Okay. And then, in Canada can you just give us an update in terms of how the rollout of Ikea is going there and your overall effort to gain some share in that market?
Yos Shiran
As you have seen it showed a very strong performance. Ikea contribution was significant, but of course we are very strong in Canada and other factors and other operations that we do on the day-to-day basis that contributed to this strong growth.
Ikea in general in Canada is going well. We are starting and we are pleased with what we see.
And the growth in Canada seems good, because of Ikea and because of our strength in the market.
Susan McCrory
Okay. Thanks you.
Yos Shiran
Thanks.
Operator
[Operator Instructions] And we’ll go next to Mike Dahl with Credit Suisse.
Mike Dahl
Hi. Thanks for taking my questions.
I wanted to continue kind of the questioning on the revenue guidance, because if we look at this, what it implies for the second half of the year, it looks like we’re talking up 10% to 14% and so that’s not really implying any reacceleration in the overall business. So one, to the extent the U.S.
is reaccelerating. Where are you seeing the offsets?
And then two, since this is such a big deal, is there anything specific you can share on the U.S. in terms of what the actual growth rates or annual dollar sales range would be for the U.S.
specifically?
Yair Averbuch
Well, I think that what we are comfortable to say about the U.S. is that the growth price will be better than Q2 and we prefer not to say more than this.
The revenue guidance in my mind does suggest that second half will be stronger than the first half. And yes, there are some swings in regions, some regions did very well in half one, may not do so well in half two and there is some shift between regions.
Mike Dahl
Got it. And then I guess to the extent you are seeing slightly lower than expected U.S growth.
How is that impacting your view on the opening and ramp up line seven and does it also -- is there any impact on your view as you look out to, what you may think about for lines eight and nine as well?
Yos Shiran
So, you know line number six is now ramping up. What we do now is we are balancing the dates of the ramping in the states with the throughput from Israel and we focus on quality and on a very good production in the states.
We have the time for that. And we can do it step by step in a good manner that will assure that all the product that we shift to the market from United States from day one will be good products in the same level that we do in Israel.
Line number seven, there are no changing in blends on, line number seven and we are on track to operate it in the fourth quarter. Of course, when these two lines are up and running this is an excess capacity and this is what we wanted to achieve.
So again this was build up in our plans and according to our plans and we will continue to work towards additional growth in the future to use those lines. But this is everything is roughly according to what we expected.
Mike Dahl
Got it. Thank you.
And then one final question I guess related, you are still seeing inventory levels build on the balance sheet. Is this really just tied to the early ramp of the sixth line or how should we think about the inventory management?
Yos Shiran
I think we will try not to increase the inventory now. In fact we have not the excess capacity allowance to plan the inventory in a better way and to operate closer to the demand and not to count on anticipation and also it will allow us to produce the right mix in a better way.
So, we will look – we are not looking to increase the inventory anymore on this at least for the time being.
Mike Dahl
Okay. Thank you.
Operator
Our next question is from John Baugh with Stifel.
John Baugh
Good morning. Thanks for taking my questions.
Just following up on that inventory level question, would we project that production in, I guess Israel since line six is still ramping, production rate may slower little bit there or would you see any gross margin pressure second half versus first half as a result of that?
Yos Shiran
Yes, please.
Yair Averbuch
Okay, John. No.
I think as we mentioned in Q1 and we repeated this quarter we improved our throughput here in Israel quite a bit. There still now to realign all of our capacity planning and put less pressure on the lines and producing good quality and good rate.
And that’s what we are going to do. I don’t think it’s necessarily.
We’ll put pressure on [Indiscernible] because 24x7 is quite costly and leaving some of it out does not necessarily means higher cost per slab [ph].
John Baugh
Thanks for that. And then, you mentioned at the start of the year the startup expense guidance, is now that you’ve outlined pick [ph] growing, is there any update on that annual number for 2015.
Is it tracking in your expectations better or worst?
Yair Averbuch
We are seeing alignment with what the offset given the throughput here in Israel. There is less pressure on our sides to ramp up U.S extremely quickly.
We’re taking the time and doing it in more methodical fresh end and worry more about quality than how many slabs are running of the line that allow us to do in less costly way. And therefore before we indicated around $11 million annual EBITDA impact from this ramp up, now it has been reduced by around $1.5 million.
John Baugh
Okay. As far as the guidance of $11 million, I think it could be a $1.5 million less?
Yair Averbuch
Yes. Correct.
John Baugh
Thanks. Then my last question, are there any uptick in like key ideas but access the other in terms of big customers or impact moving revenue that you contemplating over the next 12 to 24 months now that the U.S.
maybe is a little slower than you have maybe more capacity that sale into parts of the worlds or other big customer?
Yos Shiran
I think the capacity situation allows us not to access in a better fashion and also in a wider angle of the market, but I cannot be more specific to that. But generally you are right, its allow us to do more things.
John Baugh
Great. Thank you.
Good luck.
Yos Shiran
Thank you.
Operator
That concludes today’s question and answer session. Mr.
Shiran, at this time I would like to turn the conference back to you for any additional or closing remarks.
Yos Shiran
Thank you. Thank you for your continued interest in our company.
And we are pleased with the quarter’s results and they are dedicated to deliver continued growth. Have a great day.
Thank you.
Operator
This concludes today’s call. Thank you for your participation.