Caesarstone Ltd. (CSTE) Q1 2017 Earnings Report, Transcript and Summary

Greetings and welcome to the Caesarstone's First Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now pleasure to introduce your host Allison Cain of ICR. Thank you. Ms. Cain, you may begin.

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 first quarter 2017 earnings release, which is posted on the Company's Investor Relations Web site. With that, I would like to now turn the call over to Raanan Zilberman, Chief Executive Officer of Caesarstone. Raanan, please go ahead.

Thank you, Allison. Good day everybody and welcome to our conference call. This is my first quarterly call as the Chief Executive Officer of Caesarstone and I would like to thank you for joining us today. I'm looking forward to meeting many of you in person in the near future. I’m pleased to report that we have begun 2017 with a strong first quarter. Here a few highlights from the quarter. Our global sales increased by 17% to $130 million compared to $170 million in last year's opening quarter. Without currency impact, growth would have been 15%.Our adjusted EBITDA for the first quarter was $24 million, up by 6% year-over-year. This is a margin of 18%. Our adjusted net income was $13 million and adjusted EPS was $0.36. Now I would like to provide an update on each of our regions. We had a strength -- a strong first quarter to the year in the United States. Our revenue was up by 17.7% to $58 million compared to $49.3 million last year. We were pleased with our goal both in a core business and IKEA. In the U.S., we certainly need to stay focused and continue to execute well to ensure that we translate our opportunities into revenue growth. In Australia, sales in the first quarter were $29.5 million, up by 14.8% compared to $25.7 million in last year. On a constant currency basis, Australia was up by 9% in the first quarter, still strong giving the ongoing soft housing condition. Our team in Australia is continuing to do an excellent job of using Caesarstone dominant market position and strong brand to push the business forward. Canada sales in the first quarter grew at a good pace of $26.4 million to $22.3 million against last year's $17.6 million. On a constant currency basis, growth in Canada was 22.2% with a boost from good IKEA business. It is worth mentioning that since Q1 2015, we grew in Canada by over 70% on a constant currency basis with significant growth coming both from the core market and from our relationship with IKEA. Sales in Israel for the quarter were $11.7 million, up by 13.8 compared to last year. On a constant currency basis, sales was up by 7.4%. While Israel is the most mature of our market, we continued to leverage our premium brand position. And this is nice. Europe sales in the first quarter was $6.4 million, down by 2.8% compared to last year. On a constant currency basis, sales was down by 0.3%. Following the transition to direct distribution in the U.K., we’ve seen a significant increase in revenue, although we’ve started from a low base. We are looking forward to growing the business further. Revenue in the rest of the world grew at a rate of 15% to $8.5 million compared to $7.4 million in last year. On a constant currency basis, revenue grew was 17.6%. In Richmond Hill, our U.S plant, we’ve now seen six months of consistent improvement in volume and in years. That said, we still have work to do and we need to continue and improve our processes in the plant. So summing up, this was a solid quarter for the Company. We are in a process of strengthening our position and we remain confident of delivering the 8% to 10% of planned growth target. In Q1, we indeed deliver 70% revenue growth, that is nice. However, we believe that Q2 will be a little bit more moderate and we will bring the first half of the year to an annual growth of 8% to 10%. Now I would like to share a few general thoughts about the Company after few short months as the Chief Executive Officer. First, the market. I see very strong fundamentals to support the business. There is a solid and growing demand for quartz on a global basis, which represent a future opportunity for growth. Second, the Company DNA. I’ve joined the Company that is a true leader in its industry. It is now for a decade that Caesarstone continues to stay in the forefront in terms of innovation, technology, and design. Third, the brand. The Company has done an amazing job in building a world-class brand that has inspired consumers around the world. And at last and maybe most important of all the team, I’m surrounded by experienced, talented and motivated people. Indeed, like any business, we’ve challenges. However, the opportunities in front of us are tremendous and I’m excited. We are well positioned and driven to succeed and with hard work and focus, I’m confident that we can deliver value to our shareholders. I’d like to turn now the call over to Yair, our CFO, for a closer look at our financial results. Yair?

Thank you, Raanaan, and good morning to everyone. I will start with our income statement for the first quarter. Global sales in the first quarter increased by 16.7%, to $136.4 million compared to $116.9 million in the first quarter of last year. On a constant currency basis, sales increased by 14.5%. Gross profit in the quarter increased by $6.6 million compared to last year. Gross margin was 36.1% compared to 36.5% last year. The slight decrease in margin was driven primarily by higher manufacturing costs in Israel related mainly to new project introduction, a higher portion of revenue from IKEA, which incorporates the low margin fabrication and installation component and an increase of raw material costs. Those drivers were partially offset by favorable project mix and positive exchange rate fluctuations. Operating expenses in the first quarter were $34.1 million, or 25% of sales versus $28.4 million last year, which was 24.3% of sales. The increase in operating expense as a percent of sales primarily reflect our investment, improving sales and marketing capabilities, particularly in the United States as well as the shift to direct distribution in the United Kingdom. First quarter operating income was $15.1 million up from $14.2 million in the first quarter last year. Adjusted EBITDA in the first quarter, which eliminates share-based compensation, legal settlements and loss contingency expenses and other nonrecurring items was $24.3 million, a margin of 17.8%. This is an increase of $1.3 million relative to last year, but with lower margin primarily the result of the investment we’ve made in marketing and sales. Finance expenses in the first quarter was $1.5 million compared with finance income of $0.2 million in the same quarter of last year. This swing was primarily due to net losses related to currency exchange rate fluctuation relative to net gain last year. Our taxes in the first quarter were $2.3 million, 17.2% of income before taxes compared to a 16.4% rate last year. Despite a decline in tax rate in Israel, we were impacted by increase in volume production in Richmond Hill with its higher tax bracket [ph] and by increased taxable income in our distribution subsidiaries where tax rate are higher. Adjusted net income attributable to controlling interest in the first quarter was $12.5 million compared to $13.3 million last year. This decline was mainly a result of the swing in finance expenses. Adjusted diluted earnings per share in the quarter were $0.36 on 34.4 million shares. Adjusted diluted earnings per share last year were $0.38 on 35.4 million shares. Turning to our March 31 balance sheet. We had cash, cash equivalents, and short-term bank deposit of $121 million. This compares favorably to $106 million at year end. During the quarter, we generated $30 million in free cash flow. Our cash balance is roughly double the level reported at the same period last year, even after the execution of our share repurchase program. With respect to our 2017 guidance, we’re pleased with the first quarter results. However, we need to continue to make progress and market condition remain fluid. Therefore we are maintaining our guidance for the full-year of 2017. Accordingly, our revenue guidance for the year remains $580 million to $595 million, and our expected range of adjusted EBITDA for the year remains $119 million to $126 million. We would like to note that we’re expecting the second quarter year-over-year growth to be lower than the growth in the first quarter, potentially low single-digit growth. For the most part, this is related to a tough comparison versus a strong second quarter last year, and an IKEA comparison. Thank you. And now we are ready to open the call for questions.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Mike Rehaut with JPMorgan. Please proceed with your question.

Hi, thanks. Good morning, everyone, and welcome to Raanan. Looking forward to meeting you next week and I can already tell you’re a great marketer because of the anticipation that you’ve built on your arrival.

Thank you, Mike.

First question, Raanan, you kind of mentioned some of your early observations with the Company and maybe without getting too far ahead of yourself, I was curious on your initial thoughts if possible around the U.S market, which is obviously the key market for you in terms of a growth opportunity going forward. What are your initial impressions in terms of your competitive position, in particular, there's obviously a few good competitors out there and a lot of product innovation across the industry. So how do you think about maybe what -- how you want to lay out the priorities in terms of a growth strategy, particularly around brand and product differentiation?

That’s a tough one, Mike. But anyhow …

And I apologize if it's again a little maybe premature to answer this, but I guess any initial thoughts?

I will try to cope with it. First of all, before we dive to the U.S., I like to say something in general for the Company, okay? Because its -- U.S is a second derivative of the challenges that we’ve. In general, as you know, Caesarstone was established as a manufacturer, a plant with a very innovative product. And over the year it started to buy and consolidate sales channels and developed a premium leading brand. I believe that the Company should continue the journey into the same direction and increase its proximity and relationship with its customer. In other words, I would like to see the center of gravity of the Company continuing to shift for many industrial organization to a world-class commercial organization. Along this journey, we need to use our unique and special tools, which are innovation, premium brand, and experienced and motivated team. So this is an umbrella, okay, Mike? It is relevant for every region, but I think it's kind of a statement of what I would like to see in the U.S., a world-class commercial organization. If we drill down to the U.S. at this moment, I like to say that we are pleased to see the business perform well in the first quarter. That said, it's still not consistent enough to draw a conclusion for me. I do believe that there is a good opportunity for us in the U.S., that’s our biggest market. There is a clear and solid demand for quartz. We just need to come to the party. Basically I see four fundamentals that need to be in place to continue and capture growth in the U.S. One is a good plan. Two is relevant sources. Three, is a solid team with a drive and four, very high level of execution. Together with the U.S leadership team, we will be closely and carefully reviewing and managing the different elements to ensure that we leverage on the opportunity that we have in the markets. So as I said, we’ve the umbrella, we are working on the four elements, we’re coming to the money time when it is about execution. So I hope it gives you a little bit of my first thoughts, Mike.

That’s perfect, Raanan. I appreciate those comments. Secondly, for Yair, you mentioned low single-digit growth potentially in the second quarter and I guess getting the first half in line with the full-year growth outlook of 8% to 10%. And you mentioned, you got a tougher comparison in the second quarter, but if I drill down and look at the U.S and Canada, in particular, the U.S the comparison is similar, it's 5% versus 3% in the first quarter, Canada is actually pretty similar and a little easier on excluding currency. So I was just curious if there's other things going on perhaps that helped the first quarter that might hurt the first quarter, I don’t know.

Okay, Mike. I mean, I look at this a little bit differently. I mean, if I look at U.S and Canada last year in comparing Q2 to Q3, normally we expect Q3 to be our peak quarter and we’ve -- it has been traditionally the story of Caesarstone. And last year in North America, in Q3, in both region, we did in Q2 better than in Q3, which is quite unusual in terms of seasonality for the Company. So indeed, last year Q2 was a very strong in seasonality and this year it's more back to the -- to our historical rates where Q3 is the peak.

Thank you. Our next question comes from John Baugh with Stifel. Please proceed with your question.

Thank you for taking my questions and welcome Raanan. Look forward to meeting you next week. I was curious maybe following up on that question, if you could comment just on the core business? I appreciate IKEA could be lumpy and I believe there is a Canadian lapping going on with IKEA here. Is there any change to the tone of the core business as you see it, or was there some lumpiness there that is explained by something other than demand -- normal demand?

Okay. So in Q1, IKEA as we alluded before, should have been an easy comp and indeed it was an easy comp. So IKEA in both U.S and Canada go significantly. However, the core growth was very strong as well.

Okay. And I guess my question here is, as you look at, you got April in the books, as you look at Q2 is there much of a change from the pace in the core business from Q1?

Okay. So I will start with IKEA first. IKEA, certainly, the year-over-year growth will decline significantly, because it's a different comp and this is after the resumption of the promotional event last year. So we’re in a more reasonable comparison as far as IKEA. And in the core growth, we expect to go in both regions. But again, the comparison is not as its compared to last year in Q2 than in Q1.

Okay. Thank you.

Or in other words, as Raanan said it, back to Raanan's statement which is just another easy way to look at it. Taking together Q1 and Q2, we see the first half as a normalized growth for overall with the global company and North America.

Okay. And we’re trying to parse out your commentary about Richmond Hill than the production. And I appreciate you not going to give us volumes and yields or scrap rates or whatever, but my recollection was you pull down one line in the fourth quarter and restarted that line after tinkering with the one line and getting it to where you wanted. Is there any additional color you can give us that gives us comfort about where you’re on the process of continuing to improve volume or yield or both?

John, this is Raanan. And yes in general I think that we are in a good direction. There is certainly some good news coming from Richmond Hill. Over the last six months we’ve made consistent progress in the plant. This is reflected clearly in both quantities and the yield. That said, it's important that we continue to improve. We’ve a little plan in place and we are strictly following and monitoring. We are working on both of the lines and we’re on a consistent base plumping up the capacity. So all in all, it was a good quarter for Richmond Hill.

Okay. And no concerns about -- at this point the production you need out of there to hit the annual guidance on revenue?

I think it's -- it will be the destiny of the industry. We will run always after the demand. This is the good news and the bad news together. We are living in an industry that is growing and we will need to keep on developing the demand. I can tell you that the Company is already dealing with discussion and source, what and where will be our next move.

Okay. And any update on Lowe's and how that program is going?

Yes, Lowe's we started a few initial deliveries in Q1. We are already in around 200 stores in few of the state, that Lowe selected. It is the first step. In terms of revenue, it was immaterial for the quarter.

Great. [Indiscernible] and others thank you so much.

Thank you, John.

We are looking forward for this business to develop. So just a matter of time, I believe.

Thank you. [Operator Instructions] Our next question comes from the line of Lena Rogovin with Chardan Capital Markets. Please proceed with your question.

Good afternoon. Congratulations on the strong revenue growth. Raanan, welcome and good luck. My -- one of my questions has been already answered, so my main question is about new product, which is being manufactured in Israel. Could you provide some more details about what it is and what pressure on margin should we expect in the coming quarters, if any? Thank you.

Yes. So in the first quarter we did engage the lines in Israel in few production of new SKUs that we believe are important for us for our position, for differentiation. So over time, it's a necessary step for us, but there were some hiccups. It's always not trivial to start new model and getting more and more complicated and it takes time to bring them to speed. So we paid a bit for that in Q1. We believe that we will improve the throughput in the outer quarters and we believe that for the long time it's what we need to do.

Thank you. Is it the product being sold in Israel or across geographies?

It's -- we started off in Israel and rest is all practical optimization and where we prefer to produce anything where the demand is all. It depend, but we started in Israel this time.

Okay. Thank you.

Thank you. There are no further questions at this time. I’d like to turn the call back over to Raanan Zilberman for closing remarks.

Thank you, Allison and thank you gentlemen and ladies for your attention today. To quickly summarize, I’d say that we’re very pleased with the first quarter results. Nevertheless we know that we need to continue to execute well. Personally I’m looking forward to meeting you soon again. Take care and have a good day.

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.