May 4, 2016
Executives
Allison Cain - ICR Yos Shiran - CEO Yair Averbuch - CFO
Analysts
Michael Rehaut - JPMorgan Matthew Bouley - Credit Suisse Stephen Kim - Barclays Alex Wong - Bank of America Susan McCrory - UBS John Baugh - Stifel Lena Rogovin - Chardan Capital Markets
Operator
Good day and welcome to the Caesarstone First Quarter 2016 Earnings Conference Call. Today’s conference is being recorded.
At this time, I would like to turn the conference over to Allison Cain of ICR. Please go ahead.
Allison Cain
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.
Additionally, 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 first quarter earnings release, which is posted on the company’s website.
With that, I’d like to now turn the call over to Yos Shiran, Caesarstone’s Chief Executive Officer. Yos?
Yos Shiran
Thank you, Allison. Good day and thank you everyone for joining us to discuss our first quarter.
Our first quarter was generally as expected and our business is performing well. I would like to start with some highlights.
Sales increased 8.4% to $116.9 million, without currency impact growth would have been 12.3%. Adjusted EBITDA for the first quarter was $23 million, a margin of 19.7%.
Adjusted net income was $13.3 million and adjusted EPS was $0.38. Our growth rate was strongest in Europe, Canada, the United States, excluding our IKEA business and Australia.
This performance was partially offset by continued foreign exchange pressure and in United States by an expected drop in sales to IKEA versus prior year related to previous quarter's sales event interruptions. As our sales grow succeed rates, we expect margins to improve.
Now I would like to give an update on each of our major markets for the first quarter. First quarter sales in the United States grew by 2.7% to $49.3 million, similar to the past few quarters, growth was adversely impacted by significantly lower sales to IKEA.
As we mentioned before, IKEA resumed its promotional events in March and we expect this to have positive impact starting in the second quarter. We have continued to refine our growth strategy in the United States, along three key lines, brand execution and innovation, the CaesarStone brands and products have tremendous value which we leverage mainly through creating a more compelling consumer purchasing experience in different channels at the points of sale and other platforms.
With respect to execution, we have also identified specific opportunities to enhance accessibility of our product samples and marketing tools throughout our value chain. And as to innovation, we believe we are on the cutting edge in terms of the breadth of new products we will introduce this year.
Longer term, we believe that our innovation capability is a strong and solid competitive differentiator, alongside our excellent quality and service, this position us as an industry leader. Australia sales in the first quarter were $25.7 million, up 10.1%.
On a constant currency basis, Australia was up 19.6% in the first quarter. Housing conditions in Australia are slightly better than originally focused for 2016 and our business in Australia is proceeding very well.
Canada sales in the first quarter grew 26.7% to $17.6 million. Canada's first quarter growth was 41.2% on a constant currency basis.
Our business is strong and also our sales to IKEA continue to ramp up. Sales in Israel for the quarter were $10.3 million, up 4.4% compared to last year.
On a constant currency basis sales were up 3.6%. Europe sales in the first quarter increased 41% to $6.6 million, and were up 43.3% on a constant currency basis.
We believe that in the first quarter we benefited from timing of orders and are not expecting this level of growth to continue in Europe. Revenue in the rest of the world during the quarter was down 7.7% to $7.3 million.
On a constant currency basis, revenue was down 6%. In general, during the first quarter we achieved our plan and we believe we are on track to achieve our yearly target.
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 first quarter.
Sales in the first quarter increased by 8.4% to $116.9 million, compared to $107.8 million in the first quarter of last year. On a constant currency basis, sales increased by 12.3% versus last year.
Gross margin in the quarter was 36.5% compared to 42% last year. This margin decrease is attributed to inefficiencies related to our Richmond Hill manufacturing facility.
Favorable product mix and lower raw material cost, specifically polyester were offset by negative exchange rate fluctuations. Our manufacturing cost in Richmond Hill were higher than expected.
As a result, we have taken action to improve our performance, including operational process improvements. We have also made managerial changes in the plant.
Operating expenses in the first quarter were $28.4 million, or 24.3% of salves versus $24.6 million last year which was 22.8% of sales. Excluding an increase of $1 million in share-based compensation expenses derived from recent grants, and legal settlements and loss contingency expenses of $0.7 million that were not incurred in the same period last year, operating expenses as a percentage of sales would have been the same as last year.
Operating income was $14.2 million, compared to $20.7 million in the first quarter of last year. Our operating margin decreased to 12.2% from 19.2% last year.
Adjusted EBITDA in the first quarter, which eliminate share-based compensation and legal settlements and loss contingency of expenses was $23 million. This was a margin of 19.7% versus 23.7% last year.
This lower EBITDA margin is a result of lower gross margin associated with the US plant operations. Finance income in the first quarter was $0.2 million compared to finance expenses of $1.9 million in the prior year.
The change was primarily due to $1 million of net gains related to currency exchange rates fluctuations in the first quarter of 2016 compared with net losses of $1.1 million in the first quarter of 2015. Our taxes in the first quarter were $2.4 million, 16.4% of income before taxes, compared to 13.1% tax rate last year, reflecting higher production portion from our US plant and certain non-deductible expenses occurred in this quarter.
Adjusted net income attributable to controlling interest in the first quarter decreased to $13.3 million from $16.4 million last year. Adjusted diluted earnings per share in the quarter were $0.38 on 35.4 million shares.
Adjusted diluted earnings per share last year were $0.46 on 35.5 million shares. Turing to our March 31 balance sheet.
We had cash, cash equivalents and short-term bank deposits of $59.9 million. Our net cash position went down by $7.1 million due to share repurchase of approximately 334,000 shares for a total of $11.8 million.
Our cash flow from operations improved to $9.1 million in Q1, 2016 compared to $2.7 million in the same period last year. With respect to 2016 guidance, our business is proceeding well and we are pleased to see some positive exchange rate changes.
At the same time, we are monitoring exchange rate trends and the development of our US sales, including IKEA, and therefore we believe that this early point of the yield, it is prudent to maintain guidance. Accordingly, our revenue guidance for the year remains $550 million to $565 million and our adjusted EBITDA guidance for the year remains $138 million to $145 million.
Thank you. And we are now ready to open the call for questions.
Operator
Thank you. [Operator Instructions] We'll take your first question from Michael Rehaut from JPMorgan.
Michael Rehaut
Thanks. Good morning, everyone.
Yos Shiran
Good morning.
Michael Rehaut
First question I had was on the gross margins and more specifically the costs with the plant and efficiencies, and I guess, you mentioned that the costs were higher than expected, and as a result, you made some changes, both operationally and from a management standpoint. At the same time, you reiterated your full year EBITDA guidance.
So, there's two parts to the question here. Number one, if you could go into more detail in terms of the changes that you made, both operationally and managerially and do those changes - when do you expect those changes to have an impact on the P&L.
And other offsetting positives that from your perspective, allow you to retain the EBITDA guidance despite at least at this point in the year a greater than expected headwinds in this area?
Yos Shiran
I think Mike, I will start with the plant, and then Yair will answer about the guidance question. But in the plants it’s not secret, it was also demonstrated in the fourth quarter, but we had some deviations from our expectation.
This quarter was better, but we think it should have been much better and we took some more aggressive steps in order to correct it. It has to do with the way we operate with expenses and with processes.
We are already seeing positive result there and this quarter for sure we'll suffer less than in the first quarter. And in general, the plant is progressing, it’s not that – its progressing, but it’s not progressing as fast as we would like to be.
So I think now with the measurements that we took, it is going to better. Now we will see improvement gradually during the year and it should be better of course through the course of 2017.
Yair? Regarding the EBITDA for the year?
Yair Averbuch
Yes. So again, as Yos said, we took immediate action.
Now, we believe that we were starting all this impact in Q2 and more noticeably in the course of the last year. We expect volume to grow, our revenue and EBITDA margins to improve significantly from Q1.
Michael Rehaut
So just to be little more specific as possible. Number one, when during the quarter were these changes made, either operationally or in terms of management?
And number two, again going back to the gross margin question, if 1Q was a little worse than expected, how are you able to maintain full year EBITDA guidance, were there other positives that came through, like less than expected FX headwind now or is it just that you expect this to really turn around and fix itself?
Yair Averbuch
So with regards to FX, as we said there is some positive FX trend. However, we prefer to remain cautious in those and to see this trend stabilize and also going backward.
We have some – Australia again, and Canada doing very well, US we believe will improve. So our visibility as of now is that we remain confident with our guidance.
Operator
And at this time we'll move to the next caller in the queue. And will come from Michael Dahl from Credit Suisse.
Matthew Bouley
Hi. This is actually Matthew Bouley on for Mike.
So thank you for taking my questions. So first, on the annual sales guidance, I just wanted to tie all that together.
So you mentioned you are continuing to monitor the US and IKEA sales and at same time foreign exchanges improve since the last guide and you're seeing Australia come in a little bit better than initially expected. So really just the question is, has anything really changed in your kind of organic assumptions given some of those trends?
Yos Shiran
No, I think the organic assumption in general over the same, and all in all, we feel that we stay with the same expected sales.
Matthew Bouley
Okay, okay. Thank you.
And then just more broadly, now that we're few months into the leadership change that you made in the US, and you mentioned redefining the growth strategy in the US. I just wanted to get your updated thoughts on new channels and specifically you know, what if any opportunities you might pursue in terms of the home centers?
Yos Shiran
So again, just to reiterate partially what I said, we have continued to work to refine the growth strategy there and along the three lines that I mentioned, the brand execution, innovation. And so first of all we intend to leverage the brands mainly through the points of sales and other platforms, and execution, execution of sales and marketing within the channel is very important and we intend to apply more consistent processes to distribute samples of our newer products, as well as marketing tools throughout the value chain.
So these designers, architects and of course at the point of sales and we believe this hope was part of the weakness. And we believe that we have successful newer products offering to introduce down the road this year.
So all of that I think provides us the confidence that the sales in the States will improve during the year and we see the strength in the other market in Australia and Canada which are very strong. So this is it.
Matthew Bouley
Okay. Thank you very much.
Yos Shiran
Thanks.
Operator
We'll hear next from Stephen Kim from Barclays.
Stephen Kim
Oh, yes. Thanks very much guys for taking my questions.
I guess the first thing I wanted to understand is the IKEA effect. You had indicated that the promotions restarted in March and helped you, just want to make sure first of all, it picking and benefit the entire quarter or if there's going to be a lag that would make if you get most of the quarter, but not all of it.
And then the second thing part of that would be the second part of the IKEA question is, can you just generally tell us what kind of seasonality the IKEA business typically sees overall excluding this promotion of back 1Q I would guess, would probably be the smallest quarter, but just want to make sure that is correct in seasonality is lower 1Q?
Yos Shiran
So we believe that the IKEA business also will improve gradually as because of the interruption that we saw for the year ago, so we should definitely benefit in Q2, but it should be more beneficial in Q3 and 4. In terms of seasonality, I don’t think that we can identify any specific seasonality in the IKEA sales.
Stephen Kim
Okay. And then the second question relates to the small charge that was taken in the quarter regarding silicosis.
What region of it – of the world was that related to and how much of that was, how much was covered by insurance?
Yos Shiran
So basically it was all in Israel related to a few additional claims and today if you remember of the first $5 million not insured, so anyway we are exposing the sales delay of $5 million.
Yair Averbuch
And maybe one comment to that, so to the claims in Israel, so we got one new claim in early proceedings in Australia by the end of the quarter, so we don’t how to evaluate yet. But just to worth notice.
Stephen Kim
Is that the first claim that you’ve had in Australia?
Yos Shiran
The first claim is against us and others and others, and manufacturers, yes, it’s the first claim there. We had at the time one claim in the States, but we were deleted from the claim afterwards, this was I think about two years ago, so three years ago and this is the first claim a part of that of the State that we are aware of outside of Israel for us.
Stephen Kim
And I know you're probably going to be limited in what you can say regarding these. But in general, would you say that the nature of the claim of the complaint is very similar to that we've seen thus far in Israel or is there anything substantively different about the claim that they are making?
Yos Shiran
No the nature is the same, but it’s too early for us to assess and to understand exactly what is the situation. But the nature is the same nature.
Stephen Kim
Yes, okay. Great.
Thank you very much.
Yos Shiran
Thanks.
Operator
George Staphos with Bank of America. Your line is open.
Alex Wong
Hi. It’s actually Alex Wong on for George.
Thanks for taking the question. First question, I appreciate you identifying the IKEA impact for us last quarter, but with the growth in the US this quarter in line with your expectations.
And then on the outlook can you maybe talk about what gives you confidence in the pick-up, I know, you talked a little bit about the change in the strategy and marketing tools. But are you seeing any change in the underlying demand, especially given a pretty strong start to the new home construction this year?
Yos Shiran
So I think regarding the IKEA, I am not sure if I fully understand your question, but IKEA restarted the events and this is why I say that we expect it grow gradually from as of Q2. As to the business in the States in general, so many parts of the business are very good.
I think we have opportunities to be more consistent in the China's in sales and marketing and this is what we are doing. The business is growing and we saw that it needed a different treatment and this is why we did the change and we believe that it will bear fruits.
Alex Wong
Understood. So would you characterize with the confidence and the outlook more related to these internal initiatives that you're implementing or is the underlying market also giving you a pretty high sense of confidence and the acceleration?
Yos Shiran
In general, when we try to do our best to project and it’s a process that we do bottom up and it’s a thorough process and this is from the lower level, from the bells view, we see the markets, we see the trends. And we believe that we are confident with the projection that we provided.
Alex Wong
Appreciate that and then just as a follow-up. Mix has been a tailwind for margins in recent quarters.
Can you comment to what's driving the favorable mix shift and how sustainable do you think this trend is? And if you could talk about any new products by market or what the pipeline looks like?
Yos Shiran
So we continue to work on differentiating the sales from the competition. We believe we have a very strong R&D and very strong operation organization to execute upon the R&D inventions.
It’s a game, it’s a race. So we launched products and we launched series of products and then, the limitations and all the time you have to invent your collections and also to understand the trends to be ahead of the competition and better – from the competition - all the competition.
And we have succeeded to do it so far and we believe that we will continue to succeed to do it in the future.
Operator
We'll move next to Susan McCrory from UBS.
Susan McCrory
Good morning.
Yos Shiran
Morning.
Susan McCrory
First off, I wanted to get a little bit more details on the raw material cost. I know that you said that, that was a little bit better during the quarter.
How are you thinking about that has been moved through the year?
Yos Shiran
It’s basically all related to polyester prices and we – this tends to be volatile, we don’t how it will develop, but we are basically locked for the first half.
Susan McCrory
Okay. So we're - you'll maintain these prices through the second quarter then?
Yair Averbuch
Yes.
Susan McCrory
Yes, okay. And then in terms of the share repurchases, you spent about $12 million or so of the $14 million that you've been authorized.
Can you just give us some sense of timing, how you're thinking about using the remaining $28 million or so?
Yair Averbuch
Yes, so the execution of this authorization continues under a full determined plan and we will report our progress each quarter on their earnings.
Susan McCrory
Okay.
Operator
Susan, do you have anything further?
Susan McCrory
No. I am all set.
Thank you.
Operator
We'll hear next from John Baugh from Stifel.
John Baugh
Thank you and good afternoon. I guess I wanted to ask a couple of things on the US gross margin again.
Was there any unusual discounting or promoting going on, or was it really is largely if not solely the US plant utilization weighing on the gross margin percentage?
Yair Averbuch
So basically they all sling in gross margin, relative to last year was due to the US plant. Again, as Yos mentioned part of it was expected because we are not an efficient utilization yet, but part of it was more than we expected.
And basically all the rest was offset - impact of setting a charge or so there was a negative FX impact that was offset with the low material cost and the volume impact
John Baugh
And I think I heard one of you comment about sort of sales growth ex-IKEA with Canada maybe leading Australia, anyway, I couldn't remember the order. Could you restate that?
Yair Averbuch
Yes. So on a constant currency basis, Europe and Canada will be the fastest growing region this quarter, each above 40%, Australia was 19.6% overall constant currency growth.
Now with regards to US revenue in the first quarter, again, we are not breaking out revenue without IKEA. But just want to remind everybody that IKEA revenue dropped significantly from the first quarter of last year.
And so that’s what I can say about this. Regarding Canada, I can say that Canada even ex-IKEA is a very healthy growth.
John Baugh
Great. That’s all folks.
And then the – there were the stories around, like aborts [ph] and what they may or may not do, I realize you may not be able to comment on their intent, but pass the question anyway?
Yos Shiran
Yes, I think you realized right.
John Baugh
Okay. And then is there anything on the plant, you talk about process.
You mentioned progress, I don’t know, maybe you could talk about two or three metrics you're looking at, is it scrap rates, is it utilization rates, is it labor per foot. What kind of metrics are you looking at and any kind of feel for what you've seen sequentially January through April in any year all of those metrics you're well on this year?
Thank you.
Yos Shiran
So, in a high level, it’s the regular industrial KPIs. So processes should be controlled, aviation should be lower and then you have usage of material, hours of work and general expenses that needs to be better controlled.
In general, as I said, we see a progress, but the progress is not fast enough, and we are improving all the time, but we definitely took some more strong steps toward the end of Q1 and we already are seeing it getting better.
Operator
[Operator Instructions] We'll next to Lena Rogovin from Chardan Capital Markets.
Lena Rogovin
Hello?
Yos Shiran
Hi.
Lena Rogovin
I've got a couple of questions on your US business. First is that, I realized that you don't disclose separately IKEA and organic growth, but just in terms of the trends, in terms of like-for-like revenue in this first quarter, how the - is it compared to growth rates in the previous quarters in the Russia and EMEA like-for-like growth slowed down as IKEA.
And my second question is regarding your Richmond's facilities, is it possible to quantify a utilization rate and the progress there that are in the year. And the last question is also on IKEA business, since it has structured lower growth gross margins for you and you are saying that the effect from IKEA is going to be stronger in the coming quarters.
What they stacked on your overall gross margin in basis points? Thank you
Yair Averbuch
Okay. So regarding IKEA business again, we do not break it out, but as I mentioned before Q1 revenue in IKEA in Q1 in the US was a major drop compared to last year.
So that’s what I am willing to say on that part. To your last question, when IKEA business grows, for us the little bit gross margin, but there is significant OpEx leverage.
So basically it’s a very good business for us in terms of operating margins which is what count and therefore it shouldn’t be a problem for us and it shouldn’t reduce our EBITDA margins at all. With regards to Richmond Hill, can you remind me again the question?
Lena Rogovin
Yes, sir. I asked if it is possible to quantify utilization rates in the Richmond…
Yair Averbuch
No, we are not specifying utilization rate, but currently they are not high, we expect the utilization rate to continue and improve during the year and this will also benefit our margins.
Operator
At this time we'll take a follow up from Michael Rehaut from JPMorgan.
Michael Rehaut
Thanks. Just wanted to circle back to a couple of quick items.
Number one, in the US, with the expected improvement now in the second quarter from IKEA, I was wondering if we should be expecting a return to double-digit sales growth in the second quarter or that more be a two second half event?
Yair Averbuch
I think overall we don’t provide guidance according quarters, but I think this will be the direction.
Michael Rehaut
Are you seeing the direction for 2Q or for second half, I mean, when you say this is the direction, I'm just not sure I understand what you…
Yair Averbuch
Direction starting with Q2 and improving in Q3.
Michael Rehaut
Okay. And then also just on the - I just wanted to be clear on the managerial changes that I don't think I got an answer from my previous question.
If you could just give us a sense of when during the quarter did you make the managerial changes at the Richmond Hill plant?
Yos Shiran
Richmond Hill managerial changes, part of it is, part of the regular process and part of it starting just now and it’s a natural development. We had relatively few people from Israel there for relocation and we are replacing them step by step by local people and now we appointed a new General Manager that will start – starting now basically.
Michael Rehaut
Okay. Thank you.
Yos Shiran
Thanks.
Operator
[Operator Instructions] We'll move next for a follow up from George Staphos from Bank of America.
Alex Wong
Thanks for taking the follow-up, just two quick questions. One on IKEA, can you maybe provide a little color in terms of what you're monitoring when you talk about the IKEA sales for the rest of the quarter.
Can you remind us what drives the promotional timing, how much visibility do you have on this? And then just as a second part to that, when do we anniversary the Canada, IKEA sales, if you could remind us?
Yos Shiran
So, the IKEA promotions are usually about three or four a year and this was now by the end of – started on March was the first event this year and we will have probably two more events this year for promotions and the timing in Canada is quite similar I think to the time in the States.
Alex Wong
Thanks…
Yair Averbuch
And maybe to continue on your question, we do have little bit some visibility on IKEA because all of those are normally fulfilled in a lag of time. So there is some visibility about how many orders were generated.
Alex Wong
Thanks for that Yair. And just last one for me, can you talk about the sales growth in Australia.
I think in your formal remarks, you mentioned maybe better than expected housing statistics. But I believe you have also introduced some new products over the last few quarters or maybe that's also driving the growth, but if you could provide some additional color?
Thank you.
Yos Shiran
Yes, so the dominant factors behind our growth in Australia, our increase of course, beneficiation of course, and then improved product offering combined with our strong execution there. And the housing environment is currently slightly better than we assume in the beginning of the year.
So Australia performance is very good overall. Alex?
Operator
And at this time there are no further questions in the queue. I'd like to turn the conference back over to Mr.
Shiran for any concluding remark.
Yos Shiran
Thank you for your continued interest in Caesarstone and we look forward to sharing more with you next quarter. Have a great day.
Bye.
Operator
And that does conclude today’s teleconference. We thank you all for your participation.