Nov 2, 2016
Executives
Allison Cain - Investor Relations Yonathan Melamed - Chairman Yair Averbuch - Chief Financial Officer
Analysts
Michael Rehaut - JPMorgan Susan Maklari - UBS John Baugh - Stifel Lena Rogovin - Chardan Capital Markets
Operator
Good day and welcome to the Caesarstone Third Quarter 2016 Earnings Conference Call. Today’s call is being recorded.
At this time, I'd like to turn the conference over to Allison Cain of ICR. Please begin.
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 caution you that such statements reflect only the company’s current expectations and that the actual events or results may differ materially. For more information, please refer to the Risk Factors contained in the company’s most recent Annual Report on Form 20-F and subsequent filings with the Securities and Exchange Commission.
In addition, the company will make reference to certain non-GAAP financial measures, including adjusted net income, adjusted net income per share, and adjusted EBITDA. The reconciliation of these non-GAAP measures to the most directly comparable GAAP measures can be found in the company’s third quarter earnings press release, which is posted on the company’s website.
With that, I’d like to now turn over the call to Yonathan Melamed, Chairman of the Board of Caesarstone. Yonathan, please go ahead.
Yonathan Melamed
Thank you, Allison, good day, and thank you everyone for joining us. I will start by providing some highlights of the third quarter.
In the third quarter we grew sales by 5.5% to new record of $144.3 million. Our adjusted EBITDA was $37.5 million a margin of 26%.
Adjusted net income was $24.3 million and our adjusted diluted EPS was $0.70. The company achieved record performance and many of our regions continue to demonstrate substantial strength.
At the same time we are intensely focused on reaccelerating growth in the United States. We are investing in expanding our marketing and sales capability in this region and are making other strategic and operational changes that we believe will improve the business and generate growth.
With respect to our Richmond Hill manufacturing facility, we continue to face challenges better than anticipated and we have not been able to achieve optimal growth [ph] and manufacturing efficiencies to date. We have identified the major issues and we are focused on optimizing our manufacturing processes and are including a few changes throughput and goals.
We have expected the planned performance to improve significantly in 2017. Yesterday we filed our proxy material for the Annual General Meeting of Shareholders to be held on December 06, 2016.
In line with our corporate objectives to enhance the company's global growth and market positioning we are pleased to announce some significant changes to our Board of Directors. Dr.
Ariel Halperin will be the company's new Chairman of the Board. Ariel is a managing partner of Tene Investment Funds and has a long history of guiding Caesarstone to success.
Additionally, we have nominated two prestigious and very experienced individuals as new Directors, Mr. Roger Abravanel and Mr.
Eric Herschmann. Roger spent over three decades building McKinsey & Co until his retirement in 2006 and has advised top management over 100 public and private companies.
Roger also served as Director for several leading global companies and has been instrumental to their growth. Eric previously served as the Vice Chairman and CEO of Southern Union Co.
a former Fortune 500 energy company where he oversaw tremendous growth over 11 years career there. We are excited for Roger and Eric to join us and believe that once elected they will provide significant value to our company and its growth objectives.
While I will remain interim CEO until Raanan Zilberman's arrival during the first quarter of the next year, I will be stepping down as the Chairman of the Board upon conclusion of the Annual General Shareholder Meeting. It has been an honor serving as the Chairman and I wish the Board including the existing and new directors and the company's management and the employees best of luck.
Thank you and I would like to now turn the call over to Yair.
Yair Averbuch
Thank you, Yonathan and good morning to everyone. I will start with our regional performance of the third quarter.
Third quarter sales in the United States were $58.4 million down 5.4% compared to last year's third quarter. Core business slightly declined and IKEA business sequentially improved, but still generated lower revenue than the same period last year.
As Yonathan mentioned, we have made important investments to expand our capabilities in the United States. Over the past several months, we have appointed new executive management, head people and improved processes to our sales team, includes our marketing activities and we are implementing a revised and more focused go to market strategy.
While there is some time required before these actions impact revenue we believe we are taking the right steps to enhance growth. Although we are not yet providing guidance for next year it is our expectation that we will resume revenue growth.
Turning to Australia, we grew third quarter sales to $35.6 million up 21.8% compared to last year. On a constant currency basis, Australia was up 16.6% in the third quarter.
Our execution in Australia has been consistently strong as demonstrated by such [indiscernible] despite declining housing conditions. We grew sales in Canada to $22.4 million in the third quarter, growth of 17% or 12.6% on a constant currency basis.
Our business in Canada has remained strong especially given challenging housing conditions in the first full quarter and also of our sales to IKEA. Sales in Israel for the quarter were $11.3 million, up 6.4% compared to the third quarter of last year.
On a constant currency basis, sales were up by 5.8%. Europe sales were down by 1.2% to $7 million and was down 1.4% on a constant currency basis.
Revenue in the rest of the world after two consecutive quarters of decline was up 40.8% to $9.6 million in the quarter growth of 40.4% on a constant currency basis. This region tends to be smaller and includes more volatile individual markets.
Altogether global sales for the third quarter increased by 5.5% to a new record of $144.3 compared to $136.8 million in the third quarter of last year. On a constant currency basis total sales increased by 3.8%.
Gross margin in the quarter was 40.5% compared to 39.5% last year. This full point of stronger margin was driven primarily by lower raw material cost.
Operating expenses in the third quarter was $30.3 million or 21% of sales compared to $29.4 million last year which was 21.5% of sales. Excluding legal settlement and loss contingency related to silicosis operating expenses in the third quarter were $29.3 million, 20.3% of sales compared to $24.7 million or 18% of sales last year.
This increase was primarily due to increased strategic investment especially marketing and sales in the United States. I note the legal settlement and loss contingency expenses were $1 million in the third quarter of this year compared to $4.7 million in the same quarter of last year when we initially called it liability related to silicosis.
Operating income was $28.2 million compared to $24.7 million in the third quarter of last year. Our operating margin was 19.5% this quarter compared to 18.1% in the same quarter last year.
Adjusted EBITDA in the third quarter which eliminates share-based compensation, legal settlements and loss contingencies expenses as well other nonrecurring items was $37.5 million, a margin of 26%. This compares with last year's adjusted EBITDA of $36.2 million a margin of 26.5%.
This slightly lower margin mainly reflects our increased spending to support longer growth in the United States. Finance expenses in the third quarter was $1.1 million compared to finance expense of $0.1 million in the prior year.
This increase was primarily due to $0.2 million losses related to currency exchange rate fluctuations in the third quarter of 2016 compared with net gains of $0.7 million in the same quarter of last year. Taxes in the third quarter were $4.3 million or 15.8% of income before taxes, compared to a tax rate of 17% last year.
The lower tax rate this quarter related to elimination of certain deferred tax liabilities. Adjusted net income attributable to controlling interest, which eliminates the same items as mentioned above was $24.3 million in the third quarter as compared to $24.4 million in the same period last year.
Adjusted diluted earnings per share in the quarter was $0.70 on 34.5 million shares. Adjusted diluted earnings per share last year was $0.69 on 35.5 million shares.
We completed our full share repurchase authorization during the quarter. In total since the plan was put in place we used $39.4 million to buyback a total of 1.1 million shares.
Turning to our September 30, balance sheet, we had cash, cash equivalent and short-term bank deposits of $74.5 million up $11.9 million from the end of the second quarter despite the share repurchase activity of $9.7 million during the third quarter. Our net cash position from the end of 2015 went up by $6.4 million even after we consumed $39.4 million for share repurchase.
For the first nine months of this year we generated $48.7 million of free cash flow. With respect to our 2016 guidance, we have updated our view of the full year to include softer than expected performance in the United States.
We now expect full year revenue in the range of $524 million to $534 million and full year adjusted EBITDA in the range of $125 million to $130 million. Thank you and we are now ready to open the call for questions.
Operator
Thank you. [Operator Instructions] Our first question today is coming from Michael Rehaut from JPMorgan.
Please proceed with your question.
Michael Rehaut
Thanks. Good morning everyone.
The first question I had was on the United States, I was just curious, obviously you guys are in the middle of making adjustments investing and revising your go-to-market strategy. I am curious from a competitive standpoint if you can give us a sense of an update of number one, where the market is today if you've seen continued growth in the broader engineered quartz market?
And number two if there has been any change from a pricing standpoint more broadly?
Yair Averbuch
Yes, so thank you, Mike. We believe that competitive market in the U.S.
is doing well and specifically quartz. The housing condition is also reasonable.
With regards to competition, we don’t comment that, we believe that the quartz market continues to grow and as the quartz opportunity grows the competition grows as well. And we also see Chinese manufacturers entering the market more intensely.
It seems that the large segment of the market is at more growth in general and is led by Chinese manufacturers. We are currently competing in the mid-to-high end of the market, with product, quality, service, innovation, design, and service measures.
Local manufacturing compete with us as well, but we believe that our differentiation and multichannel strategy will prevail.
Michael Rehaut
In particular in terms of the Chinese competition, that's not obviously a new trend and would you say that trend has changed dramatically or accelerated negatively in the most recent quarter or are you referring to more just a general trend over the last couple of years?
Yair Averbuch
I think it’s a general trend continues, there isn’t a big change here.
Michael Rehaut
Okay, just second question on the manufacturing, I think in the prepared remarks Yonathan referred to challenges in the new plant, but at the same time, if I heard it right, you've identified some recent, some of the issues and you are hopeful that you'll see more improvement in 2017. So I was curious if you can give me a little more detail, give us a little more detail on what was identified, what you believe you've been able to correct if I have that right and what perhaps that was in terms of a drag on gross margins in the quarter?
Yair Averbuch
Yes, okay Mike, so the bottom line performance of the plant in Q3 was disappointing for us in both throughput in Israel. We have established very important proved processes now in order to shorten idle time and maintenance interruptions and to reduce the number of substantial [ph] slips and improved overall efficiencies.
We also continue to recruit experienced people as we go in enhanced training. So while the bottom line of Q3 was not good I believe that there is now some momentum for improvement.
It will take time, but there is positive momentum. Now if I'm going on year-over-year how it impacts our margin, basically Richmond Hill kind of dragged us around 150 basis points.
On the other side our Israeli plants performed very, very well and basically off-setted all of this drag.
Michael Rehaut
Great, thank you.
Operator
Thank you. [Operator Instructions] Our next question today is coming from Susan Maklari from UBS.
Please proceed with your question.
Susan Maklari
Thank you, good morning.
Yair Averbuch
Hi, good morning.
Susan Maklari
You know you mentioned in your remarks that as part of your U.S. strategy you are revising your go-to-market and how you are approaching that.
Can you just give us a bit more detail there on the changes that are coming through and how we should expect those to come together for next year?
Yair Averbuch
Yes, so Susan, as you know we are in the process of reporting our performance in the U.S. to accommodate the current business growth and our challenges.
We have been implementing several steps, including new local management, organizational changes, expansion of our marketing and sales team, adding talent, are building certain sales offices and enhancing visibility for the brand and other strategic and operational steps. However, this improvement process is proving to take more time to implement than we anticipated and it is also evident that some more time will be required before we can see the benefits of it.
It is clear that the U.S. revenue was below our expectations this quarter and we are unable to meet our plan for the year as for the U.S.
Having said that, we are optimistic that there is significant growth potential in the U.S. and that we are taking the right steps to leverage it.
We are running out a new product launch in the U.S. as we speak and are planning to expand the market scope we are covering with our product offerings.
We believe that the steps we take in reorganizing our sales operation in the U.S. will lead to more robust and focused performance and to gradual better achievements in our core business.
There has been and will be other changes to improve our presence in all the market segments, but a couple of those changes are competitively sensitive and I cannot specify them out now. So, I think we are looking at 2017, yes we are not providing guidance for 2017 but we expect U.S.
business to return to notable growth next year.
Susan Maklari
And is the new local management here, is that in addition to the changes that you made earlier this year, are those like people that you are re-staffing out or are they just further additions to those?
Yair Averbuch
So, you know, at the beginning of the year we just did the change and brought Dan from Canada into the U.S. Dan has to identify all the organizational gaps that he has in his core organization and very recently in the last three months he brought a lot of executives [indiscernible] and we brought a lot of strength into our sales force.
We grew our marketing and sales headcount by 20% so for the year in the U.S. and expecting to complete the 25% goal by the end of the year.
So there is, I mean bringing Danny in was not a final solution, he needs to make changes and he'll take some time.
Susan Maklari
Okay, and then can you just also kind of give us an update those new product introductions? I know that those launched a little earlier this year in the U.S.
how has the traction been with that and how does that and how does that compare to where you expected it to be?
Yair Averbuch
So to be quite honest, there was a launch earlier this year, but there was some operational issues that we had revealed and we did complete a re-launch with some brand new products because of re-launch of the product that we launched earlier in the year and not in a very successful manner. This time we did a major marathon through all the regions in September and October.
We see some very good initial response on those and are looking forward to leverage our sales as a result.
Susan Maklari
Okay, thank you.
Operator
Thank you. [Operator Instructions] Our next question is coming from John Baugh from Stifel.
Please proceed with your question.
John Baugh
Thank you for taking my questions. Good morning.
Can you maybe address your and I guess two things on the U.S. where IKEA goes in the fourth quarter year-over-year?
I recall that it was very weak in the prior year fourth quarter and I assume the guidance for revenues assumes U.S. declined in the fourth quarter.
So that implies core U.S. sales is down year-over-year.
Do I have that right? And then what would be your assessment as to why your core U.S.
sales are down you've lost market share?
Yair Averbuch
So, in terms of like restocking of IKEA John, we see sequential growth of the IKEA business from the bottom that we experience in the fourth quarter of 2015 and the first quarter of 2016 resulted recovery has been slower than we expected. So overall our outlook for IKEA is positive.
Yes, we are expecting our U.S. revenue to be down year-over-year in the fourth quarter and you are right that we expect a better year-over-year IKEA growth in Q4 and therefore the conclusion is that the core will be weaker on year-over-year comparison.
As I already said before, the implementation of the transition plan is taking longer than expected. However, we are optimistic that we will turn to notable growth next year.
John Baugh
Yes, is it possible to be specific of where you've lost business in terms of distribution channels or price points or anything more granular in terms of why or where the erosion is occurring?
Yair Averbuch
Yes, you know, the overall performance now is just not good enough. We are taking steps and measures and revising our strategy and organization and we believe that we will return back to growth.
And there is no specific segments now that are worth discussing.
John Baugh
Okay and then on the plant is it your expectation that as we move into 2017 or maybe inclusive of the fourth quarter that the throughput and yield results you're seeing, you mentioned some momentum are going to narrow that gross margin drag?
Yair Averbuch
So, you know, first of all I want to just remind that since we brought the new executive to the plant actually at the very beginning of Q3 and I think there is a lot of steps being taken now, significant steps to improve our processes. So we anticipate that many of the issues will be resolved in 2017 and expect to be in reasonable utilization rate by the end of 2017.
It will be a gradual improvement and with the growing global demand we expect to utilization rates and associated costs to be much less over the next year. Again, it's not only a matter of gross margin leverage or not.
It is a matter that we need to – we intend to grow our topline and we need the throughput from this plant.
John Baugh
Okay and then any update on the silicosis lawsuits any numbers around additional claims or any color there? Thank you.
Yair Averbuch
No, there were the fewer new claims coming in and fewer settlements to close on so the overall $1 million were the results of this blended event. We will give more specific numbers as the number of litigation on the 20th.
But in general the picture is basically the same.
John Baugh
Thank you, good luck.
Yair Averbuch
Thank you.
Operator
Thank you. Our next question today is coming from Lena Rogovin from Chardan Capital Markets.
Please proceed with your question.
Lena Rogovin
Hi, gentlemen, thank you for taking my question. I actually have two questions, the first is very [indiscernible] pretty good [indiscernible] during the last conference call you mentioned that you expect some you actually [indiscernible] towards the second half of the year and you also mentioned some just positive signs you see there.
So what exactly happened since the way the core business as so slow even quarter-on-quarter? And the second question is, if U.S.
production facilities can be used for production for other regions not just for the U.S. in order to improve utilization rates if there is enough potential demand in the U.S.
itself? Thank you.
Yair Averbuch
Okay, so with regards to the first question, as we said before we are implementing a lot of things and we are now in a transition plan execution and just take longer than we thought. So on the plans basically the plans for the most part is sales in the North America market.
We can send product from there to other regions, but it is basically how strongly we divide the supply this year. So the U.S.
utilization now in Q3 was not a demand dictated result. It was our own performance that we want to improve.
Lena Rogovin
Okay, thank you.
Operator
Thank you. We've reached the end of our question-and-answer session.
I'd like to turn the floor back over to management for any further or closing comments.
Allison Cain
Thank you everyone. We are pleased to see the strength of our brand and success of our products translating into good performance in most of our regions.
We believe that we are taking the right steps to reenergize our business in the United States. Thank you for your attention today.
Operator
Thank you. That does conclude today's teleconference.
You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.