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Caesarstone Sdot-Yam Ltd. (NASDAQ:CSTE)

Q1 2014 Results Earnings Conference Call

May 8, 2014 8:30 a.m. ET

Executives

Yosef Shiran - Chief Executive Officer

Yair Averbuch - Chief Financial Officer

Analysts

Michael Dahl - Credit Suisse

Stephen Kim - Barclays

John Baugh - Stifel

Operator

Good day and welcome to the Caesarstone first quarter 2014 earnings conference call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Ms. [Allison Townsend] (ph). You may begin Ma'am.

Unidentified Participant

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 the actual events or results may differ materially. For more information, please refer to the Risk Factors contained in the company's most recent Form 20-F and the 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 earnings release which is posted on the company's website.

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

Yosef Shiran

Thank you. Good day and thank you for joining us to discuss our first quarter. I would like to start with some highlights for the quarter. Sales increased by 24% to $94 million, a record first quarter. First quarter adjusted EBITDA was $22.1 million, up 25% compared to last year. Adjusted net income for the first quarter was $13.8 million, up 22% compared to last year. Reported adjusted net income per share was $0.39 in the quarter versus $0.32 in the first quarter last year.

Although all this is a good start for the year and our business remains strong. Our growth continues to be (indiscernible) all programs. I would like to provide an update on each of our major markets for the quarter. Third quarter sales in the United States were $37.6 million, a growth rate of 58.7%. The U.S. continues to be our largest and fastest growing market. The adoption rate of quartz in the United States continues to build and Caesarstone is positioned as a clear leader in the market.

Australia sales in the were (indiscernible) to $11.3 million in the quarter and on a constant currency basis growth was 0.5%. Europe sales in the first quarter were $4.7 million, down 20.3% compared to last year. On a constant currency basis sales were down 23.4%. This is attributable largely to the timing of shipments to certain distributors. Revenue in the rest of the world during the quarter was up 25.5% to $7.8 million. On a constant currency basis, growth was 22.4%. This growth continues to be healthy.

Our Bar Lev capacity expansion started to contribute to volume increase this quarter and we expect additional contribution in the following quarters. Our new facility in Richmond Hill, Georgia is on track to have the first line operational in the second quarter of 2015. Additionally, to meet growing demand, we have accelerated our investment for the second line which is now planned to be operational in the fourth quarter of 2015. In general, (indiscernible) during the first quarter we continue to focus on increasing throughput, building inventory, executing well and growth.

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

Yair Averbuch

Thank you, Yosef and good morning to everyone. Before I go through the quarter, I would like to note that the SEC staff has informed us that it has completed its review and does not object to the company's selection of the U.S. dollar as its functional currency. Accordingly, there will be no change to the results of operation previously disclosed by us and we will file our Form 20-F in the coming days.

I will now review our income statement of the first quarter. Sales in the first quarter increased by 23.5% to $94.4 million, compared to $76.4 million in the same quarter of last year. This is a record for any first quarter. On a constant currency basis, sales increased by 27.9% versus last year. Gross margin in the quarter was 41.5% compared to 44.8% last year. The decrease in margin was driven largely by currency impact and to a lesser extent by raw material price increases.

Operating expenses in the first quarter were $21.9 million, improving to 23.2% of revenue versus last year's $21.1 million which was 27.7% of sales. This efficiency improvement primarily reflects our increased volume. Operating income grew by 32.1% to $17.3 million compared to $13.1 million in the first quarter of last year. Our operating margin expanded to 18.3% from 17.1% last year. Adjusted EBITDA in the quarter which eliminates share-based compensation and the excess cost for acquired inventory increased by 25.4% over prior year to $22.1 million. A margin of 23.4% versus last year margin of 23.1%.

Finance expenses in the quarter were $1.6 million compared to $0.2 million in the first quarter of last year. This increase reflects foreign exchange rate fluctuations. Our taxed in the first quarter were $2.2 million. 14.2% of pre-tax income compared to last year rate of 16.9%. Adjusted net income attributable to controlling interest in the first quarter increased by 22% to $13.8 million, 14.6% of revenue compared to $11.3 million last year which was 14.8% margin.

Adjusted net income per share in the quarter was $0.39 on 35.4 million diluted shares. Last year adjusted net income per share was $0.32 on 35 million diluted shares. Our March 31 balance sheet was strong with cash, cash equivalents and short-term bank deposits of $90.8 million. Our inventory went up by approximately $11 million compared to year-end, reflecting strong manufacturing throughput that allowed us to build inventory ahead of Q2 and Q3.

And now with respect to 2014 guidance. Following a strong first quarter and to reflect ongoing (indiscernible) demand and an improvement in both inventory and manufacturing throughput, we are increasing our 2014 revenue guidance from a range of $410 million to $420 million to a new range of $420 million to $430 million. We are also increasing our 2014 adjusted EBITDA guidance from an original range of $104 million to $109 million, to a new range of $108 million to $113 million.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Michael Rehaut with JP Morgan.

Unidentified Analyst

It's actually [Will Wong] (ph) on for Mike. Congratulations on the very strong quarter. My first question is with regards to U.S. A very strong growth of 58.7%. Just wondering if you could break out in terms of the different channels. What you are guys in terms of the growth? Is there any one channel in particular where you are seeing exceptionally strong growth or is it [predicted] (ph), seen across all the channels?

Yosef Shiran

Hi, Mike. So I think usually we don’t break it but what I could say is that there is no major change from the past of stronger growth from IKEA.

Unidentified Analyst

Okay. And then in terms of the gross margins, a little bit of a year-over-year decline. And Yair, you had talked about the FX being a bigger part of that. I was wondering if you could give us a little bit more granularity in terms of what the FX represented as well as what the raw material cost increases represented.

Yair Averbuch

The FX impact was north of 3 percentage points and on the field it was close to 1% point impact.

Unidentified Analyst

Great. And then just last question. In terms of the Super-Natural, just wondering if you could provide us with some additional color in terms of what its contribution was to sales and also margins. Are you guys still seeing it priced pretty significantly above the rest of your product line and also what percentage Super-Natural now is in terms of the overall company sales?

Yosef Shiran

So I think as usual it's difficult for us to provide information specifically about the Super-natural. What we can say is that this is getting more and more important for the company. And what I mean is first and foremost the technology that we created and developed for that. We are expanding the product offering around the Super-Natural and launching additional products. Part of them I think you can see in the markets, part of them you will see in the market. And we believe that we have strong capabilities on hand in terms of product wise and the ability to match the market traits and demands.

Operator

And our next question comes from Michael Dahl from Credit Suisse.

Michael Dahl - Credit Suisse

I wanted to just to follow up on the gross margin question. I think interesting thing was, you know gross margins were a bit weak this quarter but it looks like your margin guidance actually increased for the full year. So could you kind of walk us through what the puts and takes are for the rest of the year. Thanks.

Yair Averbuch

So as you know Q1 is generally our weakest quarter and actually the gross margin while it was may be low compared to previous quarter, as far as our planning it was within our expectation and even slightly more than that. And given our increased manufacturing throughput and better inventories and as for demand we believe to be, we can generate more volume in the coming quarters. And therefore with the increased revenue leverage also margin.

Michael Dahl - Credit Suisse

Okay. Thanks. And then on the capacity addition. I guess could you help us understand kind of what the thought process was for accelerating the plan and also what type of product we should expect to see in the initial stages coming out of the U.S. plants and how that might impact the revenue mix. Thanks.

Yosef Shiran

So as you may remember we are building a plant for two lines there. Initially we decided to start with one line. But we invested or we are in the process of investing in the infrastructure for two lines. Lastly, not long ago we decided to add another line and this is to meet the expected demand that we hope to add. So the first line there should be operational in the middle of year or let's say first half of 2015. And the second line which will be seventh of the total lines in the company, should be operational by the end of 2015 if everything works according to plan. This is what the expectations are now.

Michael Dahl - Credit Suisse

And just one quick one. What's your current, if you look at the productivity that you have been able to get out of the current lines. Where would that now stand as far as revenue per line?

Yair Averbuch

So last time we mentioned and I think the number is still valid. Each line in the full throughput yields around $95 million a year. Yes. That’s a bit up from previous numbers that we provided because of the increased mix of high-end products and some regional mix as well. So we have four full lines and partially the fifth line now.

Operator

And our next question comes from Stephen Kim from Barclays.

Stephen Kim - Barclays

Great quarter. It's getting to be a habit with your guys which is a good thing. I guess I have a few questions. One just on the FX. Was there any benefit in the quarter to your SG&A from FX?

Yair Averbuch

Yes. There was slight benefit from our spending in Canada and Australia relative to the U.S. dollar. Correct.

Stephen Kim - Barclays

Can you give us some range in basis points maybe of what that was you think?

Yair Averbuch

Not much. It was way short of $1 million.

Stephen Kim - Barclays

Okay. Thank you. All right. And then the second question relates to your new Georgia -- the line coming on earlier. I guess one thing that I was curious about is, the acceleration there, is that attributable to just simply things going your way. You know not running into problems that you have maybe anticipated you might. Or is this due to something deliberate that you have done differently than you would have done differently, than you would have done, let' say, three or six months ago. So I am trying to figure how much of this is just things going well as you had been progressing along similarly or if it's something that you actually did differently.

Yosef Shiran

Well, I think overall what is happening is -- I mean strategically is according what we anticipated. Particularly we see the demand especially in the States accelerating and according to what we expect and the position that we would like to be in general capacity, although structures call for accelerating with the seventh line. So there is no specific incidence or positive incidence that's happened that’s caused us to take these decisions. This is something that we, all the time we monitor and try to balance between the capacity and the tax rates and the future income.

Stephen Kim - Barclays

Yes, absolutely. That’s great. When this new line comes on, when the first of the Americas lines comes on in, let's say, let's call it 2Q of next year. What kind of expense increase, fixed expense increase should be thinking that that would add per quarter do you think?

Yair Averbuch

So according to our analysis cost structure of the facility in the U.S. on an operational level should be similar to that of plants in Israel. And the only difference between the two is the tax rates. As you know in the U.S. it's a lot higher. We estimate it to be $3 million annually pre line.

Stephen Kim - Barclays

Okay. And that’s a pretax number, right?

Yair Averbuch

Yes. Pretax number is we believe operationally the same as they are same cost structures although there are many puts and takes to those. So line wise the U.S. is higher but energy is a lot lower.

Yosef Shiran

Also bear in mind that it will take a few months or a few quarters until we get to full capacity there.

Stephen Kim - Barclays

Great. Naturally, sure. And, yes, that’s a good segue to may last question which relates to impressive inventory build this quarter despite decent sales. Is the improvement in productivity if you are now saying per line you can do about $95 million, it sounds like obviously some of that is better mix. You know richer mix of product. But I was curious if there was a component of that where you are actually increasing the volume of material that you are able to produce on a finished basis and add up your lines. And if you could give us some sense for, if that is the case how much of the increase is coming from volume versus mix.

Yosef Shiran

We don’t have this breakdown, how much comes from each of them. But I think both contributed.

Operator

And the next question comes from John Baugh from Stifel.

John Baugh - Stifel

Congratulations on a great quarter and thanks for not using the word weather in the presentation. I wanted to ask about Bar Lev. Could you update us there on the speed of that line? Where you are relative to full production and when you will get there?

Yosef Shiran

Pardon, John, can you repeat please?

John Baugh - Stifel

I was asking about Bar Lev and the fifth line there. Where you were in terms of production rates currently and when you would be at full speed.

Yosef Shiran

So we are beginning the capacity there. So first quarter it helped us a little bit, second quarter it will be a bigger contribution. And in the third quarter probably we will enjoy most of, like a full, almost full capacity out of these lines.

John Baugh - Stifel

Okay. And then with your granite product, how was the production of that going? And I know you are not in the U.S. with that product but how are the revenues, sales going with that new introduction?

Yosef Shiran

It is going well. And so both, also the production goes well and also the sales are encouraging. Again, I cannot get into specifics and to quantify it. But it looks good.

John Baugh - Stifel

Is that priced similarly to Super-Natural?

Yosef Shiran

Not all of it, most of it, yes. All of it, no. Part of it in a lower price.

John Baugh - Stifel

Then my last question was on IKEA. I was curious if you could give any color, are you in all the stores? Are you in service or inventory position fully where you want to be with all the stores and are you starting to see a sell-through rate in IKEA that you are pleased with. Thank you.

Yosef Shiran

Yes. So as we said last time, we are already in the 38 stores of IKEA and in general we are very happy with the sales on IKEA business. As I said, I think the IKEA share in the first quarter and expected to be in the all here more significant. And in terms of inventory, we are not at the level that we want to be but it has been improved a lot during this quarter.

Operator

And it appears there are no further questions at this time. That concludes today's call. Thank you for your participation.

Yosef Shiran

Okay. So thank you for being with us. We are happy to start the year with a strong quarter and we will be in touch next quarter. Bye.

Yair Averbuch

Thank you, bye.

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