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Executives

Yos Shiran - Chief Executive Officer

Yair Averbuch - Chief Financial Officer

Analysts

Stephen Kim - Barclays

John Baugh - Stifel

Michael Rehaut - JP Morgan

Josh Chan - Baird

Michael Dahl - Credit Suisse

Lars Dollman - Adelphi Capital

Caesarstone Sdot-Yam Ltd (CSTE) Q4 2013 Results Earnings Conference Call February 12, 2014 8:30 AM ET

Operator

Good day ladies and gentlemen. Thank you for standing by. Welcome to the Caesarstone Fourth Quarter and Full Year 2013 Earnings Conference Call. Today’s conference is being recorded. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up with your questions.

I would now like to turn the call over to your host Mr. [Michael Callahan of ICR]. You may now begin sir.

Unidentified Company Representative

Thank you operator, and good morning to everyone. 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 actual events or results may differ materially. For more information, please refer to the Risk Factors contained in the company's annual report on Form 20-F.

In addition, the company will make reference to certain non-GAAP financial measures, including adjusted gross margin, adjusted operating expenses, adjusted net income, adjusted net income per diluted share, adjusted net income attributable to controlling interest, adjusted EBITDA and various metrics that maybe 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 fourth quarter earnings release, which is posted on the company's website.

With that, I’d now like to turn the call over to Yos Shiran, Caesarstone’s Chief Executive Officer.

Yos Shiran

Good day and thank you for joining us to discuss our fourth quarter which was a great finish for the year. We’re pleased to once again report record results.

I would like to start with some highlights for the quarter. Sales in the fourth quarter increased to a record of $97 million, 27% growth rate was in higher (inaudible) year. Fourth quarter adjusted EBITDA was $24.2 million, up 47% compared to last year. Adjusted net income for the quarter for the fourth quarter was $17.5 million, up 66% versus last year and we reported adjusted net income per diluted share of $0.49 in the quarter versus $0.32 in the fourth quarter last year. Overall we posted a solid finish to the year and our business continues to strengthen. We grew average (inaudible) region in which we operate. We also expanded margins significantly over the prior year as a result of higher volume, the success of our Super-Natural collection and good cost controls.

I would like to now give an update on each of our major markets both for the quarter and the totals for the year. Fourth quarter sales in United States were $34.7 million. Our year-over-year growth rate accelerated to 59%. This continues to be our largest and fastest growing market. For the full year, sales in the United States were $123.4 million, an increase of 42% over 2012.

We believe these results demonstrate the realization of our quartz penetration vision and our robust position in the U.S. markets. We continue to see a very large growth opportunity as the adoption rate for quartz is still low relative to our other key markets. We set the solid base in 2013 and believe we will also benefit from improving housing starts and remodeling activity.

I would like to note that during the fourth quarter we have completed our recruitment into all 48 stores operate here at U.S. which are now offering our countertops. Again us have been pleased to see the progress of our corporation translated into sales and demand and we believe that we are on a very positive path there.

Australia sales in the fourth quarter were $24.3 million up sequentially but down just slightly compared to last year. On a constant currency basis, Australia was up 7%. For the full year, Australia sales were $89.9 million up 1%. On a constant currency basis, the full year growth rates were 9%.

Canada sales in the fourth quarter grew 10% to $12.1 million and 17% on a constant currency basis. For the full year, Canada sales were $49.2 million up 22% and 26% on a constant currency basis. This was achieved despite weaker housing markets conditions.

Israel grew 21% in the quarter to $10.5 million held by stronger shekel. On a constant currency basis, growth was 11%. For the full year, Israel was up 16% and on a constant currency basis growth was 8%, this is a solid result for our most mature markets.

Europe strengthening the fourth quarter grew by 61% to $6.6 million, 44% on a constant currency basis. This was driven by our ability to fully grow on pent-up delivery (inaudible) which was created in connection with the change of our ERP system. For the full year Europe sales were $23 million up 11% and on a constant currency basis were up 8%.

Revenue in the rest of the world during the quarter was up 69% right from $6 million driven also by our ability to fully close backlog. On a constant currency basis growth was 63%. We are very pleased to see good results in this group which includes many smaller markets. For the full year, sales in the rest of the world were $29.1 million up 24% and up 21% on a constant currency basis.

In general, during the fourth quarter we continue to execute well. Our capacity expansion in Bar Lev in greater efficiency allowed us to achieve record production volume. In the second quarter of 2014, we expect to complete the next phase of line number five to a full line. We are also moving forward with our new facility project in Richmond Hill, Georgia. The first line in the U.S. is on schedule to start up in the second quarter of 2015 and at the same time we've begun preparations for the second line in our U.S. plans. We're excited to be in additional capacity to meet the strong demand for our products.

Thank you and I will turn the call over to Yair.

Yair Averbuch

Thank you, Yos and good morning to everyone. I will start with our income statement for the fourth quarter. Sales in the fourth quarter increased by 27% to $96.8 million compared to $76.2 million in the same quarter of last year. This is another quarterly record for us. On a constant currency basis, sales increased by 29.7% versus last year.

Gross margin in the quarter was 43% compared with 41.8% last year. This increase was driven mainly by scale on our volume and increase ever in selling price. The price increase mainly reflects growth in our Super-Natural collection sales. I also note that our gross margin improvement was partially offset by a significantly unfavorable exchange rate impact.

Operating expenses in the fourth quarter were $21.8 million or 22.5% of sale versus $19.7 million last year, which was 25.8% of sales. This efficiency improvement primarily reflects our increased volume. Operating income grew by 62.2% to $19.8 million compared to $12.2 million in the fourth quarter of last year. Our operating margins go to 20.4% from 16% last year.

Adjusted EBITDA in the quarter which eliminate share-based compensation expense, the excess cost of acquired inventory and other non-recurring items, increased by 47.1% over prior year to $24.2 million in margin of 25% versus last year margin of 21.6%.

Finance expense in the quarter was $0.4 million compared to finance income of $0.2 million last year.

Our taxes in the fourth quarter were $2.3 million, 12.1% of the income before tax, compared to last year rate of 11.6%. Adjusted net income attributable to controlling the interest in the fourth quarter increased by 55.9% to $17.5 million or 18.1% of revenue compared with $11.2 million last year, which was 14.7% of revenue.

Adjusted earnings per share in the quarter were $0.49 on $35.4 million diluted shares. Last year adjusted earnings per share were $0.32 on 34.6 million diluted shares.

I would like now to quickly make some observation on our full year financial performance. Sales were up 20.2% and up 21.6% on a constant currency basis. Gross margin was 45.5% in 2013 compared to 43% last year.

I will remind you that the second quarter of this year we recorded $3.5 million positive inventory adjustment related to our ERP implementation. Excluding that benefit our gross margin was up 150 basis points versus last year.

Operating margin also excluding the inventory adjustment was 20.3% this year, an improvement of 350 basis points versus last year.

Our adjusted EBITDA was $91.7 million, a 25.7% margin, up 230 basis points versus 2012. We grew adjusted earnings per share by 34.6% to $1.82 and we drove operating cash flow of $75.7 million with free cash flow of $48.3 million.

Our year-end balance sheet was strong with cash and short-term deposit increasing by $90.5 million to $92.2 million after $20.1 million dividend paid in Q4. We are very pleased with the strong performance.

Now with respect to our 2014 guidance, we are expecting revenue in the range of $410 million to $420 million and adjusted EBITDA in the range of $104 million to $109 million.

Thank you. And we are now ready to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions). And we’ll take our first question from Stephen Kim from Barclays.

Stephen Kim - Barclays

Thanks very much, guys. Congratulations very strong quarter, very nice to see.

Yos Shiran

Thank you.

Stephen Kim - Barclays

And quite a few questions, but let me just get a couple of out. So, first of all I was wondering if you could clarify the expansion plans, any anticipated impact in the 2014 guidance that we should be thinking about? And can you also remind us any cost from Bar Lev that came through in the income statement if you said it, I missed it?

Yair Averbuch

Okay. So regarding 2014, the U.S. line should not expect taking out CapEx on the P&L, it shouldn’t have a major impact in 2014 and most of the impact will be towards the end of the year naturally as we prepare ourselves more towards opening the line. With regards to Q4 this year, there was some impact on opening line size, if some inefficiency some of you invoiced when you startup the line and it doesn’t produce immediately group [search]. So it does, it did have a new factor which is part of the reason to that gross margin difference between Q3 and Q4 this year.

Stephen Kim - Barclays

Can you quantify that for us anyway? I think you had said in the third quarter that the price maybe…

Yair Averbuch

Yes it was -- the impact of this was around 1%.

Stephen Kim - Barclays

1% okay got it. That’s great. Okay. And then can you talk a little bit about the IKEA initiative I know that that is going well and you are encouraged by. I am curious as to what potential benefit the loading represented in the quarter? And also longer term what are your plans for IKEA potentially outside the U.S. or share of your overall business that you think might go through that channel?

Yos Shiran

Stephen, so in the fourth quarter we finished the requirements of -- into the 38 IKEA stores. It was the first time actually that we have a chance to sell across the broad there. And this was towards the end of the quarter. So, the reaction that we see is very positive and we expect this trend to continue. So, we cannot discuss yet what will be the size of it, but it seems quite promising.

At the moment, we operate in this manner only in the states. And we work with IKEA in annual different arrangements in other countries over the world, nothing but very significant. So, most of the focus with IKEA is in the United States.

Operator

And we'll take our next question from John Baugh from Stifel.

John Baugh - Stifel

Good morning and my congratulations as well. Could you comment on whether you got any capacity expansion in Q4 from Bar Lev? Whether you were able to increase the production of any of the other four lines or were the incremental revenue over what we believe it was more or less capacity on those four lines driven by the mix shift at Super-Natural?

Yos Shiran

Hi John. So, overall the four lines are working very good. And if you look what we have achieved in the last few years you can notice that we've improved our efficiency. So, the years and manage also with some small investment for that we need to improve the throughput out of these lines. Line number five has just begun towards the end of Q4. And it will produce more and more as we progress into 2014. The full line will be deployed by the end of Q2. But until then we can still use power [grids] and use other machineries that we have in the companies to produce more and to increase the throughput. So, you don’t see -- you see a very small part of it in the throughput that we did in Q4.

John Baugh - Stifel

Okay. Thank you. And then in terms of the ‘14 guidance, do we have FX headwinds, what are we thinking about in terms of a start-up expense or any other factors that are impacting the ‘14 EBITDA number negatively? Thank you.

Yair Averbuch

So, with respect to the guidance in 2014, do with significant expecting (inaudible) us. If I compare the current exchange rate to what they were in 2013, the impact is around $4 million cost for us. And that’s in our guidance.

Operator

Okay. And we will take our next question from Michael Rehaut from JP Morgan.

Michael Rehaut - JP Morgan

Thanks. Great quarter everyone, congratulations.

Yos Shiran

Thank you.

Michael Rehaut - JP Morgan

First question, just to go into the 2014 EBITDA it does imply a similar ratio to sales as 2013 and so here you just broke out that you expect FX to be -- and if I understood it right an incremental $4 million headwind versus 2013. Please correct me if that’s not the case. But I was wondering if you could…. sorry.

Yair Averbuch

No, the exchange rate I may have misstated myself. The exchange rate is a negative impact for us in 2014, so it dragged our profitability down by around $4 million compared to 2013.

Michael Rehaut - JP Morgan

Okay. So, that’s incremental, it’s an incremental negative impact because you already had some negative impact in 2013?

Yair Averbuch

Correct.

Michael Rehaut - JP Morgan

So, just bigger picture though you have a negative impact from currency, what would be sort of the positive drivers to the margin in ‘14 and the negative ones? It would appear that volume in Super-Natural be positive ones. Are there any other negative impacts that offset to keep the ratio or the margin at the same level versus ‘13?

Yair Averbuch

Yes, there are two negative impacts; one is the exchange rate that Yosef discussed. The other one is raw material price increases mostly in the quartz or due to the significant demand there are some price increases, which are based again into the guidance. So, the impact of the raw material cost increase is similar to that of the FX.

Yos Shiran

Okay. If I can just add to that I think that the trend is very strong, very strong positively. And then of course we have something that could work negatively something that could work to the other side also. So, overall this is how we see it.

Michael Rehaut - JP Morgan

Okay. And just in terms of couple of below the operating line items. The finance expense at $0.4 million in the quarter sometimes that works as a positive hedge against currency, it doesn’t appear that that was the case in the fourth quarter. I just wanted your thoughts around that and also how to think about the tax rate for 2014?

Yair Averbuch

Okay. So exchange rates this quarter in finance expenses we got was insignificant. So, probably what you see now is I would say good run rate maybe it’s like more than best. There was some positive impact, but very small. On tax rate as we have discussed before, those should go up a little bit given that the tax rate in Israel are going in from 12.5% to 16% next year and in Bar Lev from 7% to 9% next year. Overall, I believe that our…

Yos Shiran

Just to mention that the 9% would be with the higher rate.

Yair Averbuch

Yes with higher rates was Bar Lev because now we will have three lines there instead of two so there will higher mix of low tax benefit. But overall, I believe that anywhere between 13% to 16% tax rate without any major adjustment or any kind would be ongoing. That’s what I foresee.

Operator

(Operator Instructions). And we will take our next question from Josh Chan from Baird.

Josh Chan - Baird

Just wondering given the pace of growth that you are experiencing, what is the capacity utilization. Are you having to squeeze incremental capacity before the fifth line becomes fully productive in order to meet demand; I mean how much of constrain is capacity is right now?

Yos Shiran

So capacity is quite a constrain. However, we have demonstrated that we can squeeze it a little bit more in the past year and also specifically in the fourth quarter. We continue to work on improving the capacity of the current production line. Of course we will try to accelerate the operation of the fifth line. And other thing that you should bring into account is also the product mix. We are focused in general increasing our differentiated lines as example is Supernatural but there are also other products in our offering today and also there will be future products of course that we suppose to launch during this year. So overall, capacity is constrain but we have seen a little bit (inaudible).

Josh Chan - Baird

Okay, thanks for that. And if I look at the sales growth for 2014, if I take out currency, it seems like you are assuming that sales growth is pretty similar to what you generated in 2013. I was just wondering as you look across the different regions, are there certain regions that you think could accelerate versus ‘13 and are there other regions that you think that could slow down a bit?

Yair Averbuch

Well, we are not providing revenue guidance by region. But given our trend, I think that you can guess that our growth in North America will continue to be strong.

Josh Chan - Baird

Okay. Thank you for your time.

Yos Shiran

Thanks.

Operator

And we'll take our next question from Michael Dahl from Credit Suisse.

Michael Dahl - Credit Suisse

Hi, thank you. I wanted to ask about just to how to think about the revenues given your current mix, if we think about 4Q being $97 million that's really only reflecting the four full lines. Would that mean at the current mix levels that once you get the fifth line open, we should really be thinking about $475 million to $480 million as what your full capacity would be?

Yos Shiran

So, in general, each line, if you look to what we have completed in Q3, you can see that each line can produce around $95 million. So, if we have five lines and all of them are fully operated and all the throughputs and there is an equivalent demand for all the throughput, then you can get five times 95, which is 475. But this is of course not the case right now first of all not the line number five is not still up and running. And second as we always say, the fact that we increase production does mean that immediately we get the ability to sell all that, it takes time.

So of course we have the time when we get there, but as for this time, our guidance is what we believe we can achieve in life of all the constraints.

Yair Averbuch

I would add to what Yos said that we need to also recognize that Q1, there is a seasonality in Q1 that is unrelated to capacity. So all-in-all as Yos said, this is all built into our guidance.

Michael Dahl - Credit Suisse

Thank you. That's helpful. And then second question, if we think about the IKEA relationship, then clearly it’s very new here, but as we see some successes there, does that change the way you think about expanding relationships or building relationships with some of the, call it mass merchants or bigger home centers here in U.S. as you bring on new capacity?

Yos Shiran

So, I think in the short term of course, I think we will continue with the strategy that we are currently taking in the market, because of course it doesn’t make sense in eyes of the capacity constraint right now to enter into a mass market. In addition, IKEA, we choose to cooperate with IKEA, because we believe that IKEA is very focused on kitchens.

Again, as we said in the past, once we have excess capacity in the future, we may reconsider this approach and then we may approach other mass retailers that are in the market in the U.S. or in other places, all over the world.

Michael Dahl - Credit Suisse

Great, thanks. And if I could squeeze one last one, and you mentioned that you’re seeing the raw material price increases. What are you doing on the price side, your own pricing, obviously there is a strong demand here, so there should be some pricing power, is there anything in plan as far as increases for ‘14?

Yos Shiran

So in general we try to base our relationship with the customers for long-term and no to use short-term situations and try to raise prices even though we have disability. Of course, special products like the Supernatural that brings special variances to the consumers, we will try to price in a way that recognizes this hand or this contribution to the consumers and to us. So, there we will be very sensitive around pricing.

As to raw materials, there is some increase in quartz prices. And from time-to-time, we didn’t experience so much this year but in the past we experienced also a full year price increase. And again as we said, we have the full ability to pass it on to our consumers but we will be very cautious with that again everything due to our strategy to build long-term relationship.

Michael Dahl - Credit Suisse

Okay, thank you.

Operator

And we will take our final question today from Lars Dollman from Adelphi Capital.

Lars Dollman - Adelphi Capital

Hi gentlemen, congratulations on the year. Just want to follow on the pricing power you have. As you are obviously this close to capacity and you see some cost increases, would it be fair to say that if you see further cost increases and obviously unfavorable exchange rate, what you are already expecting for to come, but you should be at least able to catch on further cost increases as obviously your competitor with the competitive products will have some cost increases. So what…

Yos Shiran

Yes. If we see that raw materials or other expenses are going up, we will -- or there will be currency negative currency effects or certain hurdle, then we will raise prices.

Lars Dollman - Adelphi Capital

Okay, thank you very much.

Yos Shiran

Thank you. Operator.

Operator

Yes. That does conclude today’s question-and-answer session. And I would like to turn the conference back over to Mr. Shiran for any additional comments or remarks.

Yos Shiran

Okay. So, thank you all for joining us today. We are very pleased with the fourth quarter and the year we had in 2013. As we are starting 2014, we see another strong and exciting year of growth ahead of us as the growth story unfolds globally and particularly in the United States. We are working hard to capture that opportunity to big capacity to serve the demand in the market and to launch new differentiated and attractive products that will fair enhance the Caesarstone global brands. Thank you again for your support, time and attention. And have a good day, bye.

Operator

And this does conclude teleconference. And we thank you for your participation.

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