Caesarstone Sdot-Yam Ltd (CSTE) CEO Yos Shiran Q4 2015 Results - Earnings Call Transcript

| About: Caesarstone Ltd. (CSTE)

Caesarstone Sdot-Yam Ltd. (NASDAQ:CSTE)

Q4 2015 Earnings Conference Call

February 10, 2016 08:30 AM ET

Executives

Allison Cain - ICR

Yos Shiran - CEO

Yair Averbuch - CFO

Analysts

Stephen Kim - Barclays Capital

Michael Rehaut - JPMorgan

Michael Dahl - Credit Suisse

George Staphos - Bank of America

Susan McCrory - UBS

John Baugh - Stifel

Operator

Good day and welcome to the Caesarstone Fourth Quarter and Fiscal Year 2015 Earnings Conference Call. Today’s conference is being recorded.

At this time I’d like to turn the conference over to Ms. 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 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 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 fourth quarter and full year earnings release, which is posted on the company’s Investor Relations website.

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

Yos Shiran

Thank you, Allison. Good day and thank you everyone for joining us to discuss our fourth quarter. We had a good finish to the year we’d like to start with some highlights. Sales increase of 12.1% to a new fourth quarter record of $127.4 million, without currency impact our growth would have been 21.6%. Adjusted EBITDA for the fourth quarter was up 8.2% to $30.4 million a 23.9% margin. Adjusted net income of $19.7 million and adjusted EPS of $0.55 were both in line with our plan. We successfully grew our business this year, we opened a new state-of-the-art manufacturing facility in United States, we’ve strengthened our brand leadership position around the world and we introduced new innovative designs and expanded our product offering. We accomplished these things despite strong foreign exchange headwinds.

Now I would like to give you an updates on each of our major markets both for the quarter and the full year. Fourth quarter sales in United States grew by 14% to $56.5 million, with the strongest core market growth of the year offset by significantly lower sales to IKEA. As we mentioned last quarter we expect a tier promotional calendar to resume in the first quarter of 2016 with a positive impact starting in the second quarter.

For the full year sales in the United States was $233.3 million, an increase of 20.3% over 2014. United State continues to be our largest market. It [ph] also continues to hold the largest potential for growth. The quartz material conversion in United States continues to be powerful. In this past year, in addition to the growth at the mid to high end of the market, which is our primary target, this trend extended to a growing portion of the lower price market.

The level of competition within the cost category has increased mainly at the lower end. We continue to enjoy a leading position in the marketplace and a strong opportunity for growth. Our new U.S. manufacturing facility will provide scale benefits and flexibility to help us capture this opportunity.

I am pleased to announce that as of this week, Dan Clifford is our new President of our U.S. Distribution Organization Caesarstone USA. Dan has quickly proven himself as the Head of our Canadian business and we are excited to have him take on the leadership of our U.S. business. Dan spent over a decade working in the U.S. in leadership positions for a number of companies. I would like to thank Sagi who many of you know for his contribution in building our U.S. business. Sagi remains with the company and will be working on our global business initiatives from here in Israel.

Australia sales in the fourth quarter was $30.7 million, up 9.7%. On a constant currency basis Australia was up 31.4% in the fourth quarter. For the full year Australia sales grew 2.6% to $110.3 million. On a constant currency basis the full year growth rate was 24%, built up by strong new housing start activity. Our business in Australia is solid.

Canada sales in the fourth quarter grew 29.2% to $17.9 million. On a constant currency basis, Canada’s growth was 50.2%. For the full year Canada sales grew 22.2% to $70.7 million. Full year growth was 41.2% on a constant currency basis, reflecting also the IKEA impact. We have already hired a strong replacement for Dan Clifford as President of our Canadian business who will start his role on mid-March.

Sales in Israel for the quarter were $9.6 million, up 8.1% compared to last year. On a constant currency basis sales were up 9.9%. For the full year Israel sales were down 4% to $39.6 million, but up 5.3% on a constant currency basis. Europe sales in the fourth quarter increased 10% to $5.5 million, but were up 25.6% on a constant currency basis. For the full year Europe sales were $23.9 million, up 3.6% and up 23.6% on a constant currency basis.

Revenue in the rest of the world during the quarter was down 14.2% to $7.2 million. On a constant currency basis, revenue was down 5.2%. For the full year sales in the rest of the world were $31.6 million, down 1.4% and up 13.9% on a constant currency basis.

In general during the fourth quarter we achieved our plan executed well and positioned the business for the continued growth. We look forward to improving efficiency in our U.S. plant and gradually recapturing the temporary decrease in profitability that was created by this major expansion. Given our strong cash flow we are pleased that our Board has authorized a $40 million share repurchase. This reflects our commitment to drive values to shareholders.

Thank you and I would 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 to $127.4 million, up 12.1% compared to $113.6 million in the fourth quarter of last year. On constant currency basis, sales increased by 21.6% versus last year.

Gross margin in the fourth quarter was 37.9% compared to 43% last year. The decrease was primarily driven by cost related to the ramp up of both lines in our U.S. manufacturing facility and the impact of significant negative exchange rate fluctuations, which were partially offset by favorable product mix and lower raw material costs.

Operating expenses in the fourth quarter were $25.6 million or 20.1% of sales versus $25.9 million last year, which was 22.8% of sales. This margin improvement was due primarily to scale benefit as well as some favorable currency impact. Operating income was $22.6 million or 17.8% of revenue compared to $23 million last year 20.2% of revenue. This decrease was primarily a result of lower gross profit.

Adjusted EBITDA in the fourth quarter, which eliminate the impact of share-based compensation, the excess cost of acquire inventory, legal settlement and loss contingencies expenses and other non-recurring items increased by 8.2% over the prior year to $30.4 million. This was the margin of 23.9% versus margin of 24.8% last year.

Finance expenses in the fourth quarter were $0.7 million compared to finance income of $0.9 million in the prior year. This year we had lower net gains related to foreign exchange risk fluctuation compared to last year. Our taxes during in the fourth quarter were $2.6 million 11.7% of income before taxes compared to 13.9% rate last year. The decrease in effective tax rate is mainly due to two factors, one relates to a larger portion of production in Bar-Lev where tax rate is only 9% compared to production in Sdot-Yam where tax rate is 16%. The second relates to a U.S. tax credit on an interest payment of an inter-company loan provided to the U.S. manufacturing plant as part of its capital structure.

Adjusted net income attributable to controlling interest in the fourth quarter was $19.7 million compared to $21 million last year. Adjusted diluted earnings per share this quarter were $0.55 compared to $0.59 last year.

Now I would like to highlight some of our full year financial performance. Sales for the full year were up 11.6% and up 22.1% on a constant currency basis. Gross margin was 40.1% in 2015 compared to 42.4% last year. The decrease was primarily driven by excess cost related to the ramp up of our production lines in the U.S. manufacturing facility and the impact of significant negative exchange rate fluctuations, which were partially offset by favorable product mix and lower raw material cost.

Operating margin was 19.3% this year compared to 21.2% last year. The decrease was primarily due to lower gross margin and to the $12.7 million non-cash expense related to legal settlement and loss contingencies. Our adjusted EBITDA grew by 7.8% to $125.7 million, a 25.2% margin down 90 basis points from last year margin.

Adjusted diluted earnings per share grew by 1.3% to $2.36. Our year-end balance sheet was strong with cash, cash equivalent and short-term bank deposits of $62.8 million compared to $54.3 million in the prior year. Our cash flow from operations for the full year was $85.7 million compared to $76 million in 2014.

With respect to our 2016 guidance, at currency exchange rate we are expecting revenue in the range of $550 million to $565 million and adjusted EBITDA in the range of $138 million to $145 million. We believe our business will accelerate following the single-digit first quarter year-over-year growth rate both in the U.S. primarily as we respect a stronger business with IKEA and worldwide because of the year-over-year currency impact.

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

Question-and-Answer Session

Operator

[Operator Instructions] And we’ll go first to Stephen Kim with Barclays.

Stephen Kim

Thanks very much guys and yeah congrats on pulling out a good quarter. What is...?

Unidentified Analyst

Hi guys this is actually Trace [ph] for Steve, it sounds like Steve is breaking up. So we were wondering if you could possibly parse out for us the qualification in margin or in dollar terms of the FX impact on your margin in the quarter as well as the startup cost from the plant in the U.S.?

Yair Averbuch

Okay. The general picture is that the decrease in the quarter in gross margin was due to the U.S. manufacturing ramp up with around 500 basis points impact. The FX impact of approximately 300 basis points was offered by product mix and lower raw material cost each contributing approximately 200 basis points. This is for Q4. A same picture is for the year with slightly different numbers, U.S. manufacturing ramp up impact was approximately 360 basis points and FX was approximately 200 basis points. May not setting positive drivers where product mix, which impacted our margins positively by around 200 basis points and lower raw material cost of approximately 160 basis points.

Unidentified Analyst

Got you, thanks. That was helpful. And looking forward to 2016, could you give us a sense for guidance in terms of your D&A and your tax rate that you’re expecting?

Yair Averbuch

Yes we are expecting tax rate range of 17% to 20% given a better utilization and higher throughput of our U.S. manufacturing plant. With regards to D&A it should grow quite a bit compared to this year, but I’m not sure this we won’t disclose accurate numbers here.

Unidentified Analyst

Got it, all right guys thanks for the help.

Yos Shiran

Thank you.

Operator

We’ll go next to Michael Rehaut with JPMorgan.

Michael Rehaut

Thanks, good morning everyone.

Yos Shiran

Good morning.

Michael Rehaut

Or good afternoon. First question just wanted to dig into the thoughts around the first quarter for growth . I believe you said single-digits for the U.S. and overall. And just to think about the U.S. for a moment. What that growth might have been excluding the still difficult comp that you’re facing in the first quarter with IKEA? And what the growth should accelerate to in the rest of the year?

Yos Shiran

Hi, Mike. So there are two factors that will make the first quarter softer than the rest of the year. The first is in the U.S. while the U.S. core business continues to grow at solid rate, and just mentioned that in Q4 it grew very nicely, in Q1 it will grow less than Q4, but still in a solid rate. We expect IKEA to be significantly down versus last year. And IKEA’s kitchen promotion events which an important part of our volume with IKEA will be resumed in March, but the positive impact of it will be seen starting in the second quarter.

The second factor is currency and given that there has been continuous FX deterioration through 2015. The biggest negative impact occurs in the first quarter comparison given current rates. Now as we move through the rest of the year we expect to have the benefit of a normal IKEA business in the U.S., a decreasing FX differences and on the bottom-line ongoing improvements in our utilization and margin in the new facility in the U.S. So this will also help us see stronger results as the year progresses. I hope this answers your question.

Michael Rehaut

Yeah. Well I don’t know if it’s possible Yos, I was asking more just to try and quantify what the FX impact might be in the first quarter and for the full year to quantify that. And also from a U.S. growth rate if you expect single-digit growth and I assume that means mid-single-digit growth in the U.S. what that might accelerate to as you work pass the IKEA comparison in the first quarter?

Yos Shiran

So not by quarter but for the full year based on exchange rates at the beginning of February and this is extremely volatile these days. But based on early February the FX impact on revenue is at least $16 million for 2016.

Michael Rehaut

That’s 16?

Yos Shiran

Yes.

Yos Shiran

Okay. Okay, second question, I was hoping you could kind of discuss the leadership change in the U.S? And what initiatives you are expecting under the new head of the business? And what perhaps you feel he brings to the table to take the organizations to the next level relative to Sagi that’s been running the business for the last couple of years. And if there was any areas in the last year or two where you’ve felt that there was some good room for improvement not -- but if I leave it at that.

Yos Shiran

Yeah Sagi did a good job and implemented very well our growth strategy in the U.S. and we are happy to have him with us going forward to lead the other business initiatives. And we move down from Canada with an experienced skilled executive and we believe that he is the right person to take this business to the next level.

Michael Rehaut

Any specific initiatives that you want to highlight?

Yos Shiran

Not specific initiatives I think that the business is becoming bigger and bigger and we expect it of course we have quite aggressive long-term growth initiatives hopefully they will be matured of course there are no assurance, but we expect a lot from the emerging market. And it’s a different -- in a ways it’s a different in magnitude and it require different skills.

Michael Rehaut

Alright, thank you.

Yos Shiran

Thanks.

Operator

We’ll go next to Mike Dahl with Credit Suisse.

Michael Dahl

Hi, thanks for taking my questions. Wanted to start with some of the guidance on EBITDA margins and maybe break it down a little more if we can into gross margin versus some of the SG&A line items I guess on the gross margin line obviously as you outlined a lot of negative impacts that some of which would be as we go through this year. So if we’re looking at EBITDA margins kind of flat to up modestly. Could you give us a sense of how much in plant startup cost you expect in ‘16 versus ‘15? And then should we expect gross margin to be up and how meaningfully and then the reverse on SG&A what should expect in terms of leverage or additional areas of spend there?

Yair Averbuch

Basically we expect our utilization in the U.S. plant to improve significantly next year and this better utilization is expected to slightly contribute to gross margin in 2016, but a bit more to adjusted EBITDA given that we take out the depreciation aspect. Basically on the adjusted EBITDA the improvement if you take the mid-range 24.5% it’s 0.2 percentage point improvement, basically the story behind this is FX, headwinds of around 100 basis points offset with a better utilization in the U.S. plant and some savings on lower raw material cost mainly polyester.

Michael Rehaut

Got it. And then I think Yos you mentioned in your opening remarks some comments around competition and still being primarily contained to the well end or with the increased competition. I think we had heard maybe some of your higher end competitors had actually raised price recently. So could you talk about kind of the competitive dynamics and pricing in particular actually which two of your larger premium competitors?

Yos Shiran

So I think overall as I said the core segment is growing and with it the competition is growing. As I said before I think we lived with competition in the last let’s say 15 years and we are used to competition and we’ll continue to operate in a competitive landscape. I believe what we saw this year is that cost penetration also expanded into lower segments and most of the competition occurs there, but the competition also expands into and impacts also higher segments including ours. We live with this okay our ASP was even improved a little bit and we achieve this by all the core competitiveness of Caesarstone and like all the differentiation factors like design, quality innovation, so on and we will continue to do so. So of course there is no assurance. But we expect to continue and perform well with the competition.

Michael Rehaut

That’s great. Thanks.

Yos Shiran

Thank you.

Operator

We’ll have next to George Staphos of Bank of America.

George Staphos

Hi, everyone. Good day, thanks for the details. I guess I want to pick up on that question on competition. The increase in competition at the low end has it been more from foreign entrance and here I am thinking specifically within the U.S. or has it been the existing players also going down market in terms of what they are pursuing? That’s question number one. Question number two, can you talk to any investments that you are planning or may need on customer service as you continue to grow out the U.S. piece of the portfolio? So then third, I just want to come back to the question on the organizational evolution recognizing that you made some changes and that you don’t necessarily want to advertise what you’re going to do for your competition to know. Are there any specific changes if we’re having this conversations 12 months from now on your fourth quarter conference call for ‘16 what will you have hoped to have achieved from these management changes in terms of things that we would see from where we sit? Thank you.

Yos Shiran

So in terms of competition we don’t have an accurate data of who does what. So -- but what we see is a lot of Chinese imports coming to the lower end and we see also other players of course responding and compete. So this affects all the competitive landscape, but again as I said we managed in the past to live with this and we still feel very good with our strategy. So this is what I can say on competition again as I said I don’t have an accurate data it’s all based on company impression.

In terms of what we need to add in terms of customer service, there is nothing particular that we need to add, but of course the company growth we will need to add more sales people and we do. And of course we added people in the factory in the United States last year. So these are the two first things that you asked. Now what was the third one? Yeah regarding the leadership change in the State. So as I said first of all Sagi did very good work and he is a good manager and he executed very well our growth strategy there.

We basically there the business growing in the last few years from $70 million to $223 million this year and now its hundreds of million dollars business. So we would like to set the infrastructure for growth and to make sure that procedures are adequate for the -- and all the attitude that needed to take this business forward. Again not that Sagi couldn’t do it, he could do it, but we thought that we can use his skills to other things better and we saw that Dan is a very good manager that could -- that is very suitable for this mission. And this is why we did it.

George Staphos

Okay, thank you very much. Good luck on the quarter.

Yos Shiran

Thank you.

Operator

We’ll go next to Susan McCrory with UBS.

Susan McCrory

Hello.

Yair Averbuch

Hi.

Susan McCrory

Can you talk a little bit to the share repurchase authorization that you also announced this morning? Have you bought back any shares using it already and sort of any thoughts on the timing for those in 2016?

Yair Averbuch

Yeah. So it is our intention to execute the authorization relatively quickly. Though that is dependent on market conditions among other things. And the Board strives to consider all alternatives to drive value for shareholders and this is our first repurchase and other current consensus our Board find it to be proper use of capital and we haven’t started it yet.

Susan McCrory

Okay. And then in terms of your the U.S. plant it certainly sounds like you’ve made some further progress on that in the last quarter. Can you just kind of talk a little bit to where the lines are in terms of production and perhaps how you’re thinking about them coming through as we go through the year?

Yair Averbuch

I think we went a long way in 2015, it cost us also a lot of money. We saw the impact on Q4 without the negative impact of the factory in Q4 we could have achieved the additional 500 basis points in gross margins, which is a lot. But side by side with that the factory becoming more efficient and the throughput is growing. So in ‘16 we expect to have a significant throughput from the factory in the States and we expect it to be much more efficient. So this is what we can say in general about the factory there. Other than this the progress is good. It cost more than we thought a little bit, but the progress in terms of quality efficiency is improving.

Susan McCrory

Okay, thank you.

Yair Averbuch

Thank you.

Operator

[Operator Instructions] And we'll go next to John Baugh with Stifel.

John Baugh

Thank you, good afternoon. Great quarter. I was wondering if we can talk a little about Canada and Australia and maybe talk in local currencies excluding FX. And I guess for Canada excluding IKEA, can you tell us what you’re seeing in those markets results are obviously good and sort of what the outlook for ‘16 is in those markets?

Yos Shiran

I think both markets did very good during 2015. Canada as we said and as we said the results are also affected by the addition of IKEA. But of course also without IKEA it was a very good year and also in Australia. The Australian performance was good because of core penetration, because of our product mix and of course the execution there and also it was backed up by stronger housing market, which is going to change in ‘16.

So overall, we expect of course continued growth in Australia, but not as strong as it was in 2015. And the same goes for Canada, we expect continued growth again we don’t know what will be the impact of FX, but both markets performed very well. In Canada again, the impact of IKEA will be lower next year because we operate in all the IKEA stores in 2016. So again we’ll have a lower growth rate now when you compare the same store sales on the IKEA part. So again overall still very good market, very good performance and we expect it will continue, but in a lower growth rate.

John Baugh

Great. Could you talk about the U.S. the advertising plan I think ramped that up in the fourth quarter? Any comments on the effectiveness of that campaign and what you plan to do in ‘16 to drive the top-line of the U.S. business further?

Yos Shiran

So it cannot be related to a specific campaign. I think overall, we operate to enhance the Ceaserstone brand and I think this is done in a very successful manner. And we will continue with this next year. As some of you maybe have seen in Las Vegas in [indiscernible] we have few new product we are going to launch in the States and we expect of course a lot from these products, although as always there is no assurance. We have to wait, but the [indiscernible] for example we launched in Australia and the reaction from the market is very, very good and this is going to get to the States soon.

And the [indiscernible], if some of you again have seen in our booth in Las Vegas 1 to be the number one concept of -- regard there was to be the number one contractor by the consumer reports. So again very nice product that incorporates our special technology and we are going to launch it down the road in the States also. So we have few very special products that we are going to continue and launch in the States. We are going to continue increase the sales force. And we believe that if we work consistently along all channels we will continue to see growth there.

John Baugh

Great and my last question. Could you comment here on capital spending if not just for ‘16 thoughts around on ‘17 refreshes us on what’s maintenance and when you think you would might start spending again on capacity? And then was line 7 fully depreciating within the fourth quarter? Thank you.

Yair Averbuch

With regards to CapEx next year, we believe it will be lower than this year where this general rule of around $3 million per line maintenance CapEx, regarding the timing of the second phase in the U.S. it still not determined our aim is to try and increase the efficiencies and increase throughput and delay this as much as possible. So not yet an accurate timeline we will announce when the time comes. Regarding depreciation I believe this Q4 stands for is probably U.S. where some our depreciation to come to an expected depreciation for next year.

John Baugh

Thank you for that color. Good luck.

Yos Shiran

Thanks.

Yair Averbuch

Thanks.

Operator

We’ll take a follow-up from Michael Rehaut with JPMorgan.

Michael Rehaut

Thanks. Some of my questions have been answered, but just wanted to go back to the U.S. for a moment and I think I guess, George said I guess appreciate the fact that you don’t want to show your hand and kind of review the different new initiatives, the new strategies that you might be putting in place over the next year or two, at the same time perhaps you could kind of give us a sense of the background of the new manager and his experience and what impressed you to give the rains over to this new manager. Sorry, I forget the name, Dan I couldn’t hear the last name. But just review kind of -- [indiscernible] just to review again his experience set and what he has done and why that impresses upon you?

Yos Shiran

So we brought down last year to Canada from the States where he spend around 13 years in the States running companies like Rexnor, the Moncasting [ph] I don’t know if you are familiar with those. He works also for [indiscernible] and he has a lot of experience in consumer products and all very good channels and the different channels, the retail also the commercial side also the big boxes. And he did very well in Canada.

So basically after one year in Canada he understand and he knows Caesarstone very well and we had enough time to know him and we believe that he is the right person in the right place to take the company to the next stage as I've said before. So we believe that it would be a good addition to the U.S. team. We believe that it will be a good -- that we will be out of this test there will be a good contribution for the whole company. And this is what I can see to that measure.

Michael Rehaut

Great, thank you.

Yos Shiran

Thanks.

Operator

At this time I'd like to turn the call back to Mr. Yos Shiran for any closing remarks.

Yos Shiran

So thank you for your continued interest in our company. Despite some turbulence events we’ve experienced this year it was a very fruitful year for Caesarstone. We are please with the quarter and annual results and look forward to sharing more with you next quarter. Have a great day. Bye.

Operator

This does conclude today’s conference. We thank you for your participation.

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