Caesarstone Ltd. (CSTE) Q3 2013 Earnings Report, Transcript and Summary

Good day and welcome to the Caesarstone Third Quarter 2013 Earnings Conference Call. Today’s conference is being recorded. And at this time, I’d like to turn the conference over to James Palczynski of ICR. You may begin. James Palczynski – Senior Managing Director, ICR, Inc.: Thank you, operator, and good morning to everyone. I just want to remind you the company’s Safe Harbor language before we get started. Certain statements in today’s conference call in 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 final prospectus for its IPO, and in periodic filings with the Securities and Exchange Commission. In addition, the company will also make reference to certain non-GAAP financial measures, including adjusted net income, adjusted net income per share, adjusted EBITDA, and various metrics that may be presented on a pro forma basis. The reconciliation of these non-GAAP measures to the most directly comparable GAAP measures can be found in the company’s third quarter earnings release, which is posted on the company’s website. And with that, I’d like to now turn the call over to Yos Shiran, Caesarstone’s Chief Executive Officer. Yos Shiran – Chief Executive Officer: Thank you. Good day and thank you for joining us to discuss our third quarter. With another strong quarter and we are pleased with our record results. I’d like to start with some highlights for the quarter. Sales in the third quarter increased to a record of $94 million, our rate of growth is accelerated over the course of the year from 14% in the first quarter to 18% in the second quarter and now 21.6% in the third. Third quarter adjusted EBITDA was also a record a $25.2 million, up 18.4% compared to last year. Adjusted net income for the third quarter was $16.5 million, up 23.9% versus last year and we reported adjusted earnings per share of $0.47 versus $0.39 in the same quarter last year. Our growth was broad-based in the United States and Canada remained our fastest growing regions. Around the world, the Caesarstone brand continues to be a leader in the market, recognized for high quality and innovative design. We are excited about the future and we believe our long-term growth opportunity is promising. I’d like now to give an update on each of our major markets. I’ll start with United States where our sales grew by 47.8% to $34.1 million. This was by far our largest and fastest-growing market in the quarter. Our strong brand execution and improved market conditions all contributed. We’ve also made progress with our plans for US manufacturing location. This would be an important project to support our long-term growth. Canada, our third largest market, grew by 22.2% to $13.3 million. On a constant currency basis, growth was even stronger at 27.6%. Our business strategy in Canada is similar to the U.S. and the results are good. Australia sales were $22.6 million, down 1.5% compared to last year only because of the weak Australian dollar. On a constant currency basis, Australia was up 11.7%. We believe this market is stabilized and we are seeing the better trend in the business. Israel grew 13.2% in the quarter to $10.9 million held by a stronger shekel. On a constant currency basis, growth was 1.7%. Europe grew by 15.1% to $6 million and was up 8.4% in the constant currency basis. Revenue in the rest of the world was up 27.2% to $7.4% in the third quarter and was up 21.8% on a constant currency basis. As you may remember from last quarter both for Europe and the rest of the world, we were working on our ERP system to improve shipping processes to smaller accounts. As a result, we saw improvement in both regions this quarter. In general during the third quarter, we execute this well and managed capacity and inventory to drive the growth. The next step for us is to bring our new Bar Lev line into full operation. We just begun partial operation, the full line will be completed in the second quarter of 2014. I’m also glad to report that we selected Richmond Hill, Georgia as the location for our new manufacturing plants in the United States. We are pleased with this site which is located close to Savannah and carries operational advantages. Due to some site specific requirements we have revised our expected start date for production to the second quarter of 2015. Our planned capital spending for the project remains at approximately $100 million, but we now expected the initial spend to increase to approximately 70% of the total investment. This will support both the first line and expedite launch of the second US line which will be our seventh in total. On another note, we have decided to distribute the one-time dividend of $20 million or approximately $0.58 per share. We believe that due to a strong recent and expected cash flow and current position, this dividend will not affect our ability to fund our growth, planned capital expenditures and working capital needs. Thank you and I will turn the call over to Yair. Yair Averbuch – Chief Financial Officer: Thank you, Yos and good morning to everyone. I will start with our income statement for the third quarter. Sales in the third quarter increased by 21.6% to $94.3 million compared to $77.6 million in the third quarter of last year. This is another new record for any quarter. On a constant currency basis due to weaker Australian and Canadian dollar, sales increased by 24% versus last year. Gross margin in the quarter was 44.5% compared to 45% last year. We incurred additional labor cost related to the ramp-up of the new capacity Bar Lev and we’re negatively impacted by currencies. These factors were partially offset by an important mix of revenue and better economies of scale. Operating expenses in the third quarter were $21.1 million or 22.4% of sales versus $18.2 million last year, which was 23.5% of sales. Even as we increased cost to supported growth, we continue to deleverage. Operating income grew by 25.2% to $20.9 million as compared to $16.7 million in the third quarter of last year. Our operating margin grew to 22.2% from 21.5% last year. Adjusted EBITDA in the first quarter which eliminates share-based compensation, the excess cost of acquired inventory and other non-recurring items increased by 18.4% over the prior year to a new record of $25.2 million, a margin of 26.3% versus margin of 27.5% last year. Finance expenses in the first quarter were $1.1 million compared to expense of $2 million in the prior year. Our taxes in the third quarter were $5.3 million, 16.9% of income before taxes compared to a 13.9% rate last year. This higher rate reflects a $0.6 million deferred tax liability adjustment associated with a newly levied increase in our Israeli tax rates beginning in 2014. Adjusted net income attributable to controlling the interest in the third quarter increased by 23.9% to $16.5 million from $13.4 million last year. Adjusted earnings per share in the quarter were $0.47 on $35.3 million shares. Adjusted earnings per share last year were $0.39 on $34.4 million shares. Turning to our September 30th balance sheet, versus the end of the second quarter we grew our cash balance by $25.4 million to August in $4.9 million. This reflects cash flow from operation in the third quarter of $31.9 million. This level of cash combined with our expected cash flow leave us in an excellent position to fund our capital projects, fund our working capital needs and pay the one-time dividend we announced. I will note, the dividend record date is November 27, 2013 and is stable December 11, 2013. Receivables at the end of the quarter were $54.4 million, DSO of 53 days this quarter, in line with previous levels. Inventory at the end of the quarter was $53.7 million, similar to the level at the end of the second quarter, and now with respect to 2013 guidance. Following a strong third quarter, we are increasing revenue guidance for full year of 2013 to a new range of $343 million to $348 million as compared to our prior range of $330 million to $340 million. We’re also increasing our expected range of adjusted EBITDA for the full year to a range of $87 million to $89 million compared to our prior expected range of $82 million to $85 million. Thank you and we are now ready to open the call for questions.

(Operator Instructions) And we’ll take our first question from Michael Rehaut with JPMorgan. Michael Rehaut – JPMorgan: Thanks and congrats on the quarter. The first question I have is on sales in the U.S., great results, as you mentioned, accelerating throughout the year. I was hoping if you could go into a little bit more color or granularity as to the big drivers of the improved sales growth, if you are having particular success in one channel versus another, if you could go through your end markets where you are seeing the greatest strength, also if there are any new relationships or customers that you’ve been able to penetrate in those different channels, if that’s helped, any additional color there to get a sense for if this trend is sustainable, if we’re talking about a higher level of growth that you might expect in the next few quarters?

Hi, Mike. So, I think what is happening in the states is basically, first of all the result of all the hard work we’ve invested there and all the channels and I think we’ve seen improvement through all the channels, but I think the story of the state and this is a big change in also the mix, moving towards also towards innovation. Despite the innovation – despite that the big growth in the innovation is not huge, but because of the Supernatural success there we see more sales coming from innovation and this helps of course the sales, the margins and the brand momentum there. So again to summarize, everything was good there, the market is good, and coupled with it is the success of the Supernatural series which bring more sales from innovation. Michael Rehaut – JPMorgan: Great. And, Yair, I guess a question for you on the gross margins, still very strong in the mid 40s. You identified a couple of negative impacts of those gross margins. One, the labor cost due to the start-up in Bar Lev and also the negative effect from currency. I was hoping if you could give us a sense of the dollar impact of each of those items and for the labor if that’s expected to continue for another quarter or two or how lasting that impact might be?

I think (indiscernible) the Bar Lev impact will probably continue to some extent in Q4 and Q1 until we utilize the line in full capacity. And the dollar amount of which is I think a bit too detailed. Michael Rehaut – JPMorgan: Are you talking about the dollar amount – well, the dollar amount at the Bar Lev impact or also if you could give us a sense of the impact from the currency?

Yes, are quite comparable in magnitude. Michael Rehaut – JPMorgan: And so if you had neither of those, do you have a sense of what the gross margin might have been?

I will tell you this would be at least 1.5% better. Michael Rehaut – JPMorgan: Great, thank you.

And we’ll take our next question from Stephen Kim with Barclays. Stephen Kim – Barclays: Thanks very much guys. Yes, again congratulations, really, really great results. I guess we were curious. Could you give us a sense for how much Supernatural represents of your overall production currently?

Yes, we cannot get to this kind of detail, of course first of all, because of competition, even though it sounds that this is a successful series. We cannot get into quantifying the numbers. Stephen Kim – Barclays: Okay.

But it was very much more than we expected I think when we – you first saw it. Even though, we believe it’s a hit, but it works very well for us. Stephen Kim – Barclays: Clearly and…

It becoming significant. Stephen Kim – Barclays: Yes, I would bet. Okay, that’s fine. Could you talk a little bit about the fifth line, I think, yes, Yair, I thought I heard you say that you thought it would be until – not until the fifth line is running at full capacity that you think some of the labor issues might dissipate. But let me ask the question slightly differently, how long do you think it will take before the fifth lines overall level of profitability would be in line with the company’s overall average?

I think it will be in the second quarter of 2016. Stephen Kim – Barclays: Okay, great.

2014, sorry. Stephen Kim – Barclays: Yes, I was – okay.

But anyway I think that’s the negativity of it which you saw in the first quarter and to a limited extent in fourth quarter, I think we’ll manage quite soon because it will start to make money, it will not be in the same profitability or the rest of the company, but it will definitely add to the profit. Stephen Kim – Barclays: Surely, yes. And then with respect to the FX, last year I think in the third quarter we have in our notes that the elevated level of interest expense that we had was, about $1.7 million of that was driven by FX. How much of that was – how much FX contributed to the interest expense number this year?

Yes, it was $0.7 million. Stephen Kim – Barclays: $0.7 million.

Out of the $1.1 million. Stephen Kim – Barclays: Wonderful. And then last question from me right now is the tax rate. You talked about the tax rate this quarter. But can you give us a sense for what would be a reasonable to use for a model – for modeling purposes as we go into next year?

Yes, so, the tax rate – the new legislation in Israel change our tax rate starting in 2014 onwards. And in Bar Lev it was 7% this year, and it’s going up to 9%. In Sdot-Yam, it was 12.5% and it’s going up to 16%. For simplicity, it’s the blended rate between the two was 50-50 last year because we have two lines in each plant now because we have another line in Bar Lev it should be on probably more proper 60-40 so if you do the math, it’s probably 2% impact increase and then you have to add some of the profitability (indiscernible) subsidiary so I will say that our run rate this year is around between 13% to 15% and it will – should go up around 2%. Stephen Kim – Barclays: Perfect. Thanks a lot for that, Yair, and congratulations.

Thank you.

And we’ll take our next question from Dan Oppenheim with Credit Suisse. Dan Oppenheim – Credit Suisse: Thanks very much. I was wondering if you can talk a bit more in terms of Bar Lev, congrats in having the expanding capacity there, and as you think about to the over capacity utilization given the good problem of having the demand that continues to improve as it is, where is capacity utilization at this point, where is current demand around?

Again, Dan, you’re asking about the utilization of line number five or about… Dan Oppenheim – Credit Suisse: No, overall, overall please.

So, overall I think as we said last quarter we are running closed to full capacity so, and then what you see is more or less what we can – we can make, it doesn’t make that cannot be plus or minus few million dollar, but it is where we are and of course with the line number five when it reaches to full capacity to led another 90 or may be bit more $90 million a year, right, because each line now can provide about $90 million per year, little bit more this quarter and line number five will be able to do the same. Dan Oppenheim – Credit Suisse: And that’s, to fully understand, so the $90 million does that include sort of the better mix including more Supernatural and as you think about the coming quarters even if you are at full capacity revenue can be going up based on the improving mix as well, correct?

This is hard to say because it’s quite different according to where we sell each product, but overall I think it’s a good and what you see today, a good number to rely upon. Dan Oppenheim – Credit Suisse: Okay, thank you.

And we’ll take our next question from Peter Lisnic with Baird. Josh Chan – Baird: Hi, good morning. This is Josh Chan filling in for Pete. I wanted to go back to gross margin and I was wondering if you can give us some thoughts about the factors that would affect gross margin in 2014, so whether that will be some of the Bar Lev costs, how is raw materials looking and how is the mix? Could you walk through some of those factors to see – so that we can see what are some of the positives and negatives as you look into next year?

Well, I think fair to probably provide guidance for 2014 in the next earnings call so that will be probably a more appropriate time to discuss it, but in general exchange rates are unknown, so we never know those will go. This temporary impact of Bar Lev as Yosef mentioned we’ll probably diminished and the rest depends on how good we continue to launch new product and to do well in the market. Josh Chan – Baird: Okay. Well, and my second question is on CapEx with the change in terms of your timing for the US plant. Is there a change in terms of CapEx? Could you update us on what your expected CapEx might be for 2013 and 2014?

Well, as Yosef mentioned that on one hand is a slight delay, on the other hand we are expediting CapEx to make all the infrastructure for the second line to be there rather soon than later. So we haven’t yet timed each investment now to sale different it is, but I don’t think it is much different than it was before.

And we’ll take our next question from Michael Rehaut with JPMorgan. Michael Rehaut – JPMorgan: Thanks (indiscernible) other one. So, couple of quick ones, just going back to the tax rate question, if I understood you right, you had originally thought this year, you will be looking at 13% to 15% tax rate and now for next year you’re basically saying 15% to 17%, is that right, Yair?

That’s the way again, you know I’m not tax rates are bit tricky to determine what will be the actual tax is tricky, but I mean if you can take this year number so far for the nine months exclude out the $0.6 million that you just discussed which is the one-time adjustment that will take you throughout $13.5 million. The effective tax rate in Israel should go up by 2% so I think it’s probably safe to say that overall we will go 2% up next year. Michael Rehaut – JPMorgan: Okay, now that’s helpful. And just on Canada if you could give us a sense obviously good results there as well. If there is any particular region or end markets that are helping that continued solid growth trends, any additional color in terms of what you are seeing in Canada with your operations?

I think in Canada, basically we are deploying the same strategy as in the States, and the market, new home starts and all the construction market there is a bit – it is weaker than in the status, but still because of this general trend that we speak all the time in material conversion, the Caesarstone brands and the new launches that we do and of course the structure there this all bring the results and but nothing and – but nothing specific that I can pinpoint. Michael Rehaut – JPMorgan: Great, thank you.

We’ll take our next question from (indiscernible) with Fair Fund.

Thank you for taking my question. Is it right to say that EBIT margins in the U.S. are higher than the group average?

We are not – I want to be cautious here we are not important, we don’t have segments reporting or geographical reporting, but I would say that in general – first of all in general, our direct market carries higher ASP and therefore higher gross margin, but at the other end you have the cost structure to operate those markets. So, it is not significantly different than the indirect market and because of that I do not want to get into specific regions.

Okay, can you break down your top-line growth for price, volume and mix?

We are not providing quantity details except for some trend in the annual reporting and that I can just say that dollar growth this year is an organic growth even if the ASP is higher, and it is higher, because of Supernatural it’s still an organic growth, there is nothing – there is an acquisition, there is nothing, there is no pro forma.

But I think overall all the three…

Elements contribute, yes.

Yes, all the three elements contributed.

All of them are positive.

Yes, right.

And we’ll take our next question from Lars Dollmann with Adelphi, London. Lars Dollmann – Adelphi, London: Hello, gentlemen, congratulations on the quarter again. I have a couple of questions to follow-up on the Bar Lev, the speeding up of the capacity utilization because demand is very strong. What is the difference between, the slight time difference between the full scale speeding up of the operations versus what you expected earlier?

The difference is not big, but basically without getting into too much detail, what we did right now allow us to more or less the ability to get to about half of the capacity of the full line. And by the media, we’ll have the additional capacity of the full line and in between it will grow up gradually so, this is how you can look at it roughly. Lars Dollmann – Adelphi, London: Okay. And then that leads me directly to the other question on the U.S. investment because you mentioned that there is because of specific reasons there is a slight delay in the U.S. but you actually will speed up the second line of the U.S. then. What does it mean exactly? So you do the investment, it takes slightly longer to start-up but then you already made the decision directly to start with the second line?

In a way yes, what’s – what we do is – there you said we had some issues that cause some delay. On the other hand, we decided to go ahead and invest additional infrastructure to accommodate and to speed up the instillation of the seventh line and it seems that on one hand we will start may be a little bit late with the fixed line, but we will start a little bit earlier than before the seventh line. Lars Dollmann – Adelphi, London: Is that as you can already see a highly visible demand in the U.S. as it’s growing so fast?

Yes, so this is – what I wanted to add because we didn’t say before – of course we have estimation, but we wouldn’t like to go out with estimation for so far. However, we feel in light of what is happening in the market that it makes sense to expedite the infrastructure for the seventh line as to the actual rates of course and this will be judged of the actual performance and demand in the market in due time, but it reflects our overall perspective. Lars Dollmann – Adelphi, London: Then another question related to the U.S. demand. You had fantastic growth figure obviously in the U.S. Do you know or do you have any data if you take a market share, and how quickly actually the quartz market within the high end market is growing versus marble and granite?

Yes, so this is – we don’t – this kind of data till now the only data that we saw came from Freedonia and we don’t have any updated data about it so, we don’t know exactly how much each competitor, how much market share each competitor holds and we don’t know also exactly how much granite and quartz, but what you can see is that quartz is becoming stronger in the phase and this is – and this is evidenced and also in some of the professional research that done in the states and it is something that we feel. Lars Dollmann – Adelphi, London: Okay. And lastly on the cash distribution, you distribute – because you have a very strong balance sheet, the $20 million. If we go further next year, you obviously have some CapEx, but how is management generally seeing, because you have a nice cash flow business, as a strategy with obviously increased investment into the CapEx because demand is so strong. But you said specifically it’s a one-time dividend. When is the time for the management to consider a dividend policy?

I think overall the one-time dividend will decided by the board in light of the recent success and in – with the aim to share the success with the shareholders and of course under the calculation that we have enough cash to our – to fulfill our CapEx and future cash needs. As we said in the past, the company did distribute dividends in the past before it became public and we say that it’s – we might consider distributing dividends from time-to-time. However, this is only a one-time dividend and we may consider in the future, of course together with us, whether there is a room to distribute dividends again at least what we do now is subject to our growth plans and bear in mind that we also can – we can also – we have access to funds if we need. Lars Dollmann – Adelphi, London: Okay, (indiscernible). Thank you guys.

Thanks.

And we’ll take our next question from Stephen Kim with Barclays.

Hey guys. It’s actually John (indiscernible) here. On the topic of capital allocation outside of the one-time dividends, how do you think about the potential for share repurchases relative to dividends?

The many different ways to and options that might deals to drive value to shareholders and this time, this seems to us to be the right method at this point of time.

Okay. Hey, guys, it is Steve Kim. So we shouldn't read anything into this particular decision to go with a one-time dividend as being something that’s sort of a philosophy that you have of a method that is superior to others. You’re basically saying that every time you have the funds available you will consider various strategies. And there is no particular emphasis that we should place on a one-time dividend versus repurchases in the future?

I don’t think you may, Steve, we don’t think you can get to general conclusions out of this one-time dividend and it’s – what there is, is what there is, now this is what we can said, one thing that we can conclude out of it, what will be the decision in the future as to catch capital distribution or any other method that we may take.

Okay, that’s fine. If I could get one more in there, a question I had related to your IKEA relationship. Just if you could give us some general update on how that has been evolving, that would be helpful.

Yes, overall it is evolving well and however, I think as we said in the past it’s still not something which is very significant in our overall sales, we have – of course we have expectations in the future from this, but we will have to wait and also we have to – you know remember that this is also information of the regulatory IKEA and wasn’t like to discuss this too much in detail.

Sure. Okay, well, thanks very much guys.

Thank you.

And there are no further questions at this time. I would like to turn it back to Yos Shiran for any closing or additional remarks. Yos Shiran – Chief Executive Officer: Thank you very much for your interest in Caesarstone. We are working hard to deliver consistent performance in growth and we are pleased with the results of the year so far and feel strong about our business. Thank you and have a great day. Bye.

And that concludes today’s conference. Thank you for your participation.