Aug 2, 2017
Executives
Allison Cain - Investor Relations, Vice President at ICR Raanan Zilberman - Chief Executive Officer Yair Averbuch - Chief Financial Officer
Analysts
Susan Maklari - Credit Suisse John Baugh - Stifel Nicolaus & Company Lena Rogovin - Chardan Capital Markets
Operator
Good day and welcome to the Caesarstone Second Quarter 2017 Earnings Conference Call. Today’s conference is being recorded.
At this time, I would like to turn the conference call over to Allison Cain of ICR. You may 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 second quarter 2017 earnings press release, which is posted on the Company's Investor Relations website.
With that, I would like to now turn the call over to Raanan Zilberman, Chief Executive Officer of Caesarstone. Raanan, please go ahead.
Raanan Zilberman
Thank you, Allison. Good morning.
Good day and welcome to our conference call to discuss our second quarter results and our business outlook for the second half. Our second quarter topline was in line with our expectation and brings our first half year yield to above 10% growth.
However, gross margin came under pressure primarily as a result of cost related challenges, which I will address in few moments. I'd like to start with few highlights from the quarter.
The global sales increased by 4.6% and reached a new record of $149 million compared to $142 million in the last year second quarter. On a constant currency basis, growth in the quarter was 5%.
Adjusted EBITDA for the second quarter was $30 million, a margin of 20%. This was below our expectation.
Adjusted net income was $17 million and adjusted diluted EPS was $0.49. In the quarter, we had some challenges at the gross margin level.
This includes an approximately 35% increase in raw material for polyester compared to last year. It is worth mentioning that polyester prices have already began to show some improvements in Q3.
Additionally, we have continued to shift toward higher end differentiated products that are enabling the brand to maintain its leading and innovative position. This is generally a desirable change in the mix and we are very happy with the new products that we are launching.
Nevertheless, our overall throughput reflects the longer cycle time needed to manufacture these products. In Richmond-Hill, our throughput and years performance continue to show consecutive quarterly progress.
It is since Q3 2016. We are leveraging this progress and have decided to shift additional premium production to Richmond-Hill in the second half of the year.
We believe that this will improve our response to the global market demand, but may slowdown our improvement locally in the Richmond-Hill. Now, I would like to provide an update on each of our regions.
We have a good second quarter in the United States, which was up by 8.2% to $64.8 million compared to $59.9 million of last year. We are happy with our topline growth year-to-date and we continue to invest in sales and marketing to drive the revenue performance and we will remain focus on execution to meet our goals in the remainder of 2017.
Australia sales in the second quarter were $34.3 million, up by 2.3% compared to $33.5 million of last year. On a constant currency basis, Australia was up by 1.8% in the second quarter.
The increase in sales was achieved despite weakness in the overall outing market especially with single family completion and renovation which are the strongest sectors of our markets in Australia. Canada sales in the second quarter grew by 4.3% to $25.3 million compared to last year $24.3 million which was an unusually strong quarter.
On a constant currency basis, growth in Canada was 8.7%. Sales in Israel were $10.8 million for the quarter, down 2.6% compared to last year, and on a constant currency basis, sales was down by 8.1%.
This reflects the generally more challenging market condition. Europe sales in the second quarter was $7 million, up 1.6% compared to last year, and on a constant currency basis, sales were up 0.3%.
The increase was primarily related to our transition to direct distribution in the United Kingdom. Revenue in the rest of the world during the quarter was up by 0.6% to $6.7 million.
On a constant currency basis, revenue grew was 2.6%. Now before I turn over the call to Yair to cover financial, as you should have been already seen today, Yair decided to leave the Company and pursue other interest.
Although he will be with the Company till January of next year, it is appropriate to recognize his meaningful and important contribution and thanking for his seven years tenure with the Company. I’d like to say thank you Yair, and go ahead.
Yair Averbuch
Thank you, Raanan and good morning to everyone. Global sales in the second quarter increased by 4.6% to $148.9 million compared to $142.3 million in the quarter – in the second quarter of last year.
On a constant currency basis, sales increased by 5%. Gross margin in the quarter was 34.9%, compared to 42.1% last year.
Compared to last year, the binary factors of the decrease in margin were in approximately 34% increase in polyester prices, lower throughput due to an increased mix of premium product and a higher portion of total production coming from Richmond Hill, which continues to be higher costs production. Other factors were an increased component of publication and installation revenue related to strong growth at IKEA and exchange rate fluctuations that also pressured gross margin.
With all the partially offset to this factors with an ongoing improvement in our sales mix towards premium products. Operating expenses in the second quarter were $32.6 million, or 21.9% of sales versus $28.7 million last year, which was 20.2% of sales.
The increase in operating expense as a percent of sales primarily reflects our increased investments to improve sales and marketing capabilities, particularly in the United States, as well as the shift to direct distribution in the United Kingdom. Second quarter operating income was $19.3 million, down from $31.3 million in the second quarter of last year.
Adjusted EBITDA in the second quarter, which eliminates share-based compensation and legal settlement and loss contingencies, was $29.6 million, a margin of 19.9%, compared to $39.8 million, a margin of 27.9% last year. This reflects the changes in various gross margin and SG&A items I just described.
Finance expenses in the second quarter were $1.4 million, similar to last year level. Our taxes in the second quarter rose $3.1 million, 17% of income before taxes, compared to a 11.9% rate last year.
I would remind you that last year’s second quarter, we had one-time favorable tax settlement in Israel that sales up four percentage point of tax rate. These quarter increases in taxes from higher U.S.
production and higher taxable income in other regions were offset by a favorable reduction of tax brackets in Israel. Adjusted net income attributable to controlling interest in the second quarter was $16.9 million, compared to $25.4 million last year.
Adjusted diluted earnings per share in the quarter were $0.49 on 34.4 million shares. Adjusted diluted earnings per share last year were $0.73 on 34.9 million shares.
Turning to our June 30 balance sheet, we had cash, cash equivalents, and short-term bank deposits of $129.4 million. This compares to $121 million at the end of the first quarter.
With $9.3 million worth of free cash flow we generated during the quarter. We respect to our 2017 guidance, given our year-to-date results and outlook for the second half, we are maintaining our guidance for the full-year of 2017.
Accordingly, our revenue range for the year remains $580 million to $595 million Taking into consideration our performance in the second quarter and our cost related challenges, our expected range of adjusted EBITDA for the year, remains $119 million to $126 million. However, we currently consisted base it to be at the lower part of the range.
We’d expected continued improved in our revenue in U.S. we expect Q3 and Q4 to be similar in revenue and adjusted EBITDA.
Finally, while I will be year until the beginning of next year, I would like to take the opportunity to strength of the management team, the both of directors and many investors and analysts that I walked with further support and collaboration during my time at Caesarstone. It has been a pleasure to walk with so many good people both inside and outside the Company.
And I am very proud of what we have achieved as a team at Caesarstone during the last 7.5 years. Thank you.
And I was switch back to our Raanan for a quick summary.
Raanan Zilberman
Thank you, Yair. Before we go to question, I would like to take helicopter view on the second quarter and the challenges and opportunities ahead.
On the topline, the market is growing and we are growing by 10% year-to-date. I believe that we need to further refine our go-to-market strategy to fully capture our potential.
The competitive environment dynamics and effect that the mass market is developing, it will require from us on one hand to enhance our position as a premium brand and accelerate innovation. However, the same time to play in all the segments of the market.
In addition, I would like to see us continuing to shift to a world-class commercial organization. In pricing and emerging our offering and increasing, decrease on the entire value chain.
On the margins, an especially on the gross margin front although we had pressure from several direction in Q2, we stay focus on our eight target to reduce the cost [indiscernible] reduced in Richmond-Hill. This is achievable and as our qualities and yield are continuing to improve and as we increase utilization.
I believe cost of flat will come down. Thank you.
And we are now ready to open the call for questions.
Operator
Thank you. We will now be conducting a question-and-answer session.
[Operator Instructions] Our first question comes from the line of Michael Rehaut with JPMorgan. Please proceed with your question.
Unidentified Analyst
Hey, good morning. This is [indiscernible] in for Mike.
In Yair, we are not us happy with the other release this morning, but we will appreciate your to January. I guess starting the gross margin, the pressures you seen recently.
I guess a lot that was due to the polyester 35% year-over-year, but maybe you are beginning to see some release in Q3, so maybe could you add a little more detail on what you are seeing most recently with gross margins?
Yair Averbuch
Yes, sure. So in terms of gross margin, we had few components in the place.
So as we mentioned polyester cost increase of approximately 35% was factor over around 200 basis points and we believe this is temporary, and as we mentioned prices are starting to go down, so I believe there will some relief. Also FX was another 100 basis points approximately and the environment in FX also appeals to be improving and again, it’s not in our control anyway.
Then we have the impact of the higher amount of new differentiated product that we have been manufacturing this quarter. This was a pressure of around 200 basis points.
Which regards to Richmond-Hill, it’s a bit more complicated to explain. On one hand, the Richmond-Hill improved as Raanan mentioned and improved consistently quarter-over-quarter since Q3 2016.
On the other hand, this is more and more production coming out of Richmond-Hill as a proportion to the total production, and Richmond-Hill is still not as efficient as this well. So overall, when you take those two elements together Richmond-Hill in total was 150 basis points headwind for us.
Then we had the increased publication and installation component that we view as a very positive and very good element of our value proposition. It helped our margin, but it’s good for our operating margin.
But in gross margin, it was a headwind of around 100 basis points as well. So all of those pressure drivers were partially offset, we have a better product mix because we continue to deliver and sell more and more differentiated product and that contributed 100 basis points positively.
Unidentified Analyst
Okay. That’s helpful.
I appreciate the detail and that’s good to hear the Richmond-Hill improvement. But I guess kind of how that factors into overall guidance kind of looking to revenue guidance maybe towards the low end on EBITDA.
So is it sort of that you are more expecting a bigger contribution from big-box retail and the builder channel and maybe a little more investment in the U.S. towards the back half or is this more a factor how you see commodities trending?
Yair Averbuch
So I would say the following; first, just to give us the prospective – as a matter of fact, for the first half of the year in total, our results both in revenue and adjusted EBITDA are pretty much in line with our original plan for the year. However, the margin challenge in the second quarter was quite significant and we do not have good visibility on the pace or extent of improvement in the second half.
Therefore, we believe that it will be more prudent and we expect that we will end up at a lower half of the EBITDA range.
Unidentified Analyst
Okay. That helps.
Operator
Thank you. Our next question comes from the line of Susan Maklari with Credit Suisse.
Please proceed with your question.
Susan Maklari
Thank you. Good morning.
Raanan Zilberman
Good morning.
Yair Averbuch
Good morning, Susan.
Susan Maklari
To start out with, can we talk a little bit about Australia? It seems like that’s the market that has held up well for you even that we’ve hearing about this housing slowdown and it seems like maybe that caught up with you this quarter.
Can you just talk about what changed there especially as we think about it more sequentially perhaps? And then how we should think about that going forward?
Raanan Zilberman
Yes. So we have a great business in Australia and we’ve been operating very well there for a long time, and even so some very tough market environment.
The products are doing extremely well there and we have a very solid execution. The current housing condition in Australia are not favorable for us.
In renovation and single family new completions are actually and which are all strongest segment as Raanan mentioned are actually dropping quite a lot. We believe however, that we have grown our share of premium product and we successfully continue to innovate and to remain the market leader in Australia in both retail and single-family.
Also we have strong expectation for our upcoming product launch in Australia, which is coming very soon. But again given the macro environment, now the housing environment, I’m not sure we will see a major rebound there in terms of growth rate.
Susan Maklari
Okay, that’s helpful. Thanks.
And then turning to the U.S., you mentioned that the mass market here is continuing to develop. I guess can you give us some update on maybe how your rollout of Lowe’s is going and any other initiatives that you have around thinking about increasing your distribution channels here?
Yair Averbuch
Yes, our launch of Transform in Lowe’s is actually – it continues to gain momentum, in terms of operational indicators with a very high level of consumer satisfaction for those projects that we executed on. It is still very slow in reduction and very small in revenue.
However, it is again a very nice part of the [indiscernible] satisfaction and currently there are discussions with Lowe’s on a next phase of the rollout and we believe there will be a rollout coming soon.
Susan Maklari
Okay.
Yair Averbuch
Not necessarily – it’s not going to be a national rollout. But it will be a second phase of a rollout.
Susan Maklari
About how many stores you were now?
Raanan Zilberman
Go ahead Yair.
Yair Averbuch
So we are today at around 200 stores in selective state of the U.S. But Raanan, you wanted to add something on that?
Raanan Zilberman
Yes, this is Raanan. So as Yair said we are in 200 store and we have decided together, we flows to expand the test and the [indiscernible] to another 200 stores.
So it’s a positive development, but if you recall when we met we discussed about the position of Caesarstone in the mass market. And historically as you know, Caesarstone is a premium brand, which target mainly the [KNB] which is a premium sector, and the builder on contract.
So the two ends of the market and actually pretty much neglected the mass market, and this is remain a target for the Company and it’s more than a discussion and definitely a target and I believe this is a potential future development for the Company, because this is a market that is growing what is expected by wider part of the population and Caesarstone to be there.
Susan Maklari
Okay. Thank you, Raanan.
Raanan Zilberman
You’re welcome.
Operator
Thank you. Our next question comes from the line of John Baugh with Stifel.
Please proceed with your question.
John Baugh
Thank you. Good morning.
Yair thanks for your efforts and good luck in your future endeavors. I’m sure will be in touch.
Yair Averbuch
Thank you.
John Baugh
I guess my questions – thank you for all that color on gross margin. So I did all the math that narrowed to 650 basis point headwinds were not to be nitpicking, but I think that would be a 41.4% gross margin, down slightly from prior year at 70 basis points.
And my question is simply is there in terms of the competitive pressure, is there any thing going on that’s affecting your gross margin that promotion or discount or responded a competition in these results or really no, it’s minor factors that are accounting for that other 70 basis point?
Raanan Zilberman
Thank you, John. Now the answer is clear, the gross margin headwind is not coming from ASP and I think that we are doing very good days.
Yair, think actually given a little bit positive and this is in line with what you’ve explained about the differentiated product to slowdown the cycle time and the throughput. So the strategy to keep on depreciating with the product, with the offering and now it is a good strategy because we have been able until now to maintain the average sales price.
Although, as you mentioned and it’s fell to say there is a competition. Going back to Yair explanation above the gross margins if you could follow the different lines, you could have notice that they are breakdown into full buckets.
Few of them our total external in temporary like the 300 points, the 200 organic from the polyester and 100 from the FX, it’s temporary and it’s an external. The ongoing F&I that is developing which is all in all positive think with 100 basis point.
Our main challenge what we believe in the negative impact and we will remain with first may be few quarters, one, two, three and we will have to cope with them. And this is as Yair said the transition to Richmond Hill because you’ve understand that every flat that we move from Israel to the states we are taking a slab from a low cost manufacturer and we are moving it to a manufacture this right now this with prior cost.
At the end of the day once it will be fully-utilized and fully-loaded the costs will be in a different place. So this is a painful transition and this is will remaining time for some time until we will make this breakeven point for at least growth rate and then the differentiated products.
So to Caesarstone still we showed with some of the headwind we have concerns as they are going to stay for sometime and some are external and temporary and this is small as the picture.
Yair Averbuch
John, just to add all the rest of the difference that they didn’t full reconcile towards the bunch of various months and so I just to enter the highlight of the story.
John Baugh
Okay. Thank you for all that color.
And I point to clarification, Yair, you’d mentioned something about Q3 and Q4 are being similar there in revenue and EBITDA. Was that the first half was that to Q2 just to clarify what you are saying that?
Thank you.
Yair Averbuch
No, what I am saying is that normally in our normal seasonality Q3 is very strong quarter or strongest normally. However, do you see what I am saying the reason increased and increased momentum in the U.S.
for us or that the case what we expect to have. And therefore it will results in our expectation in a way that the results on the topline as well as the adjusted EBITDA on dollar wise with very similar for Q3 and Q4.
John Baugh
Okay.
Yair Averbuch
Am I clear now?
John Baugh
Yes. Thanks for that.
So the commentary around Canada I know Ontario just kind of real estate tax and you mentioned that will tough compared to the prior year. How do we think about Canada I don’t know for the next several quarters in terms of growth outlook and you can pro in the IKEA commentary on that as well?
Thank you.
Yair Averbuch
Yes, so actually I don’t think we need to discuss Ontario stuff. For the first half if you look at the first half of the year.
Growth in Canada on a constant currency basis was almost 15%, which is very stronger in line we were expectation. Q2 growth rate should be taken in the context of a very tough comp of Q2 2016, which is what we said to begin we’ve entering to the quarter both for the U.S.
and for Canada. We believe that U.S.
and Canada will be still our fastest growing market in 2017 and since we maintain the revenue guidance, I guess we know what that means.
John Baugh
Great. And my last question maybe for Raan, you mentioned that, I think it was eight, I can’t remember the precise number you were asking internally sort of eight key strategic questions of the organization.
And just curious where you are in that process or journey and what if anything you could share with us that’s perhaps different from when we last visited in New York in May? Thank you.
Raanan Zilberman
The situation is like that. I think that I have accomplished – you know when I shared with you the things, it was my insights.
I am now in a situation that I am fully aligned not just with my Management, but also with the Board of Directors on the strategic direction that we need to take as a Company. Obviously, not so – I feel not so comfortable to talk about strategy over the phone, but I would say that I have the full support of the Board of Directors and the Management on the direction that we want to take.
And many of the vectors that I shared or that I had in mind few [indiscernible] are ongoing. So it’s not in the draw, it’s definitely ongoing and I allocate for that a big part of my time because the way to go forward is not to work harder.
It’s not going to get better just by sweat. We need to evolve because the market is evolving.
And we have high ambitions and therefore, we will have to ingress some bold steps.
John Baugh
Great. Thank you.
Good luck.
Raanan Zilberman
Thank you, John.
Operator
[Operator Instructions] Our next question comes from the line of Lena Rogovin with Chardan Capital. Please proceed with your question.
Lena Rogovin
Thank you. Good afternoon.
I’ve got two questions if I may. My first question is about operating expenses as a percentage of revenues which we see on a quarter-on-quarter basis declined quite significantly.
So the question to you does this means that in Q1 there were some one-off and what should we expect linked quarters in Q3 and Q4? And my second question relates to recently announced partnership with Nebraska Furniture Mart, so the question is how significant this could be for your U.S.
business. And if it is significant, who is in charge of F&I in this partnership?
Thank you.
Raanan Zilberman
Okay. Thank you, Lena.
In terms of operating expenses, in Q1 you’ve two combinations, one, it’s a massive marketing and sales effort because there are major exhibitions that are both in the U.S., in Canada and in Milan the very beginning of Q2. And so there is a lot of spending that goes to those exhibitions.
For Q1, on one hand is very loaded in marketing and sales expense is on one hand and then because its lowest revenue quarter in percentage is even makes it a tougher thing. So the drop this quarter was not a major surprise to us.
And then there is no site saving in OpEx here, we intent to continue and support our expanded effort in the U.S. and in the UK.
So we expect the trend of OpEx on a year-over-year basis to continue to not be favorable.
Raanan Zilberman
On Nebraska Corporation, this is exactly inline with what I say that we are aiming for the mass market. In the United States, when we think about the mass market and retail, we normally talk about the two monster, Depot or Lowe’s.
But there are many regional and national mid size player and Nebraska Furniture Mart is one of them and this deal that we strike is really in line with our new approach, let’s get into the retail. Let’s be a mass market partner to the consumer.
Lena Rogovin
Okay. Thank you very much.
In the case of Nebraska, who is going to do publication and installation?
Raanan Zilberman
We have our value-added capabilities on this. We are not doing it definitely.
We are working with selective fabricators on that part.
Lena Rogovin
.
Raanan Zilberman
We do not have all the data here. And – but I guess it’s part of what we have been discussing for quite a while which is using a value proposition to be able to be a various solution to retail channel in terms of delivering safer solution to the consumers.
Lena Rogovin
Okay. This is very helpful.
Thank you.
Raanan Zilberman
You’re welcome. End of Q&A
Operator
Thank you. There are no further questions at this time.
I would like to turn the call back over to Raanan Zilberman for closing remarks.
Raanan Zilberman
Thank you, Allison. I think we are pretty much at the end.
Thank you for your attention today and we are looking forward to talking to you in the next quarter. Have a good day.
Operator
Thank you. This concludes today’s teleconference.
You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.