Good day, and welcome to Caesarstone's Third Quarter 2016 Earnings Conference Call. Today's call is being recorded. At this time, I'd like to turn the conference over to Allison Kane of ICR. Please 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 Q3 earnings press release, which is posted on the company's website. With that, I'd like to now turn over the call to Yonathan Melamed, Chairman of the Board of Caesarstone. Yonathan, please go ahead.
Thank you, Elton. Good day, and thank you, everyone, for joining us. I will start by providing some highlights of the Q3. In the Q3, we grew sales by 5.5% to new record of $144,300,000 Our adjusted EBITDA was 37 $500,000 a margin of 26%. Adjusted net income was $24,300,000 and our adjusted diluted EPS was $0.70 The company achieved record performance and many of our reasons continue to demonstrate substantial strength.
At the same time, we are intendedly focused on reaccelerating growth in the United States. We are investing in expanding our marketing and sales capability in this region and are making other strategic and operational changes that we believe will improve the business and generate growth. With respect to our Richmond Hill manufacturing facility, we continue to face challenges steeper than anticipated and we have not been able to achieve optimal throughput and manufacturing efficiency to date. We have identified the major issues and we are focused on optimizing our manufacturing processes and on improving efficiency, throughput and cost. We expect the plant performance to improve significantly in 2017.
Yesterday, we filed our proxy material for the Annual General Meeting of Shareholders to be held on December 6, 2016, In line with our corporate objective to enhance the company's global growth and market positioning, we are pleased to announce some significant changes to our Board of Director. Doctor. Ariel Halterin will be the company's new Chairman of the Board. Ariel is a managing partner at Tenne Investment Fund and has a long history of guiding Caesarstone to success. Additionally, we have nominated 2 prestigious and very experienced individuals as new Director, Mr.
Roger Avarvanel and Mr. Eric Herschmann. Roger spent over 3 decades building Mackenzie and Co until his retirement in 2006 and has advised the stock management over 100 public and private companies. Roger also serves as Director for Federal Living Global Companies and has been instrumental to their growth. Eric previously served as Vice Chairman and CEO of Southern Union Company, a former Fortune 500 Energy Company, where he oversaw tremendous growth over his 11 years career there.
We are excited for Roger and Eric to join us and believe that once elected, they will provide significant value to our company and its growth objective. While I will remain interim CEO until Rannan Zilberman's arrival during the Q1 of the next year, I will be stepping down as Chairman of the Board upon conclusion of the Annual General Shareholder Meeting. It was been in the honor serving as the Chairman, and I wish the Board, including the existing and new directors and the company's management and employees best of luck. Thank you. And I would like to now turn the call over to Yair.
Thank you, Yonatan, and good morning to everyone. I will start with our regional performance for the Q3. 3rd quarter sales in the United States were $58,400,000 down 5.4% compared to last year's Q3. Core business slightly declined and the IKEA business sequentially improved, but still generated lower revenue than the same period last year. As Yonathan mentioned, we have made important investments to help expand our capabilities in the United States.
Over the past several months, we have appointed new executive management, added people and improved processes to our sales teams, increased our marketing activities, and we are implementing a revised and more focused go to market strategy. While there is some time required before these actions impact revenue, we believe we are taking the right steps to enhance growth. Although we are not yet providing guidance for next year, it is our expectation that we will resume revenue growth. Turning to Australia. We grew 3rd quarter sales to $35,600,000 up 21.8 percent compared to last year.
On a constant currency basis, Australia was up 16 point percent in the Q3. Our execution in Australia has been consistently strong as demonstrated by such growth rates despite declining housing conditions. We grew sales in Canada to $22,400,000 in the 3rd quarter, growth of 13% or 12.6% on a constant currency basis. Our business in Canada has remained strong, especially given challenging housing conditions and the 1st full quarter anniversary of our sales to IKEA. Sales in Israel for the quarter were $11,300,000 up 6.4% compared to the Q3 of last year.
On a constant currency basis, sales were up by 5.8%. Europe sales were down by 1.2 percent to $7,000,000 and were down 1.4% on a constant currency basis. Revenue in the rest of the world after 2 consecutive quarters of decline was up 14.8 percent to $9,600,000 in the quarter, growth of 14.4 percent on a constant currency basis. This region tends to be smaller and includes more volatile individual markets. Altogether, global sales for the 3rd quarter increased by 5.5 percent to a new record of $144,300,000 compared to $136,800,000 in the Q3 of last year.
On a constant currency basis, total sales increased by 3.8%. Gross margin in the quarter was 40.5% compared to 39.5% last year. This full point of stronger margin was driven primarily by lower raw material costs. Operating expenses in the Q3 were $30,300,000 or 21% of sales versus $29,400,000 last year, which was 21.5 percent of sales. Excluding legal settlements and loss contingencies related to silicosis, operating expenses in the 3rd quarter were 29,300,000 dollars 20.3 percent of sales compared with $24,700,000 or 18% of sales last year.
This increase was primarily due to increased strategic investment, specifically in marketing and sales in the United States. I note that legal settlement and loss contingency expenses were $1,000,000 in the Q3 of this year, compared to $4,700,000 in the same quarter last year, when we initially recorded the liability related to silicosis. Operating income was $28,200,000 compared to $24,700,000 in the Q3 of last year. Our operating margin was 19.5% this quarter compared to 18.1% same quarter last year. Adjusted EBITDA in the 3rd quarter, which eliminates share based compensation, legal settlement and loss contingencies expenses, as well as other non recurring items, was $37,500,000 a margin of 26%.
This compares with last year adjusted EBITDA of $36,200,000 a margin of 26.5%. This slightly lower margin mainly reflects our increased spending to support stronger growth in the United States. Finance expenses in the Q3 was $1,100,000 compared to finance expense of $100,000 in the prior year. This increase was primarily due to $200,000 losses related to currency exchange Taxes in the 3rd quarter were $4,300,000 or 16.8 percent of income before taxes, compared to a tax rate of 17% last year. The lowest tax rate this quarter related to elimination of certain deferred tax liabilities.
Adjusted net income attributable to controlling interest, which eliminate the same items as mentioned above, was $24,300,000 in the 3rd quarter as compared to $24,400,000 same period last year. Adjusted diluted earnings per share in the quarter were $0.70 on 34,500,000 shares. Adjusted diluted earnings per share last year was $0.69 on 35,500,000 shares. We completed our full share repurchase authorization during the quarter. In total, since the plan was put in place, we used $39,400,000 to buy back a total of 1,100,000 shares.
Turning to our September 30th balance sheet. We have cash, cash equivalents and short term bank deposits of $74,500,000 up $11,900,000 from the end of the second quarter, despite a share repurchase activity of $9,700,000 during the 3rd quarter. Our net cash position from the end of 20 15 went up by $6,400,000 even after we consumed $39,400,000 for share repurchase. For the 1st 9 months of this year, we generated $48,700,000 of free cash flow. With respect to our 2016 guidance, we have updated our view of the full year to include softer than expected performance in the United States.
We now expect full year revenue in the range of $524,000,000 to $534,000,000 and full year adjusted EBITDA in the range of $125,000,000 to $130,000,000 Thank you. And we are now ready to open the call for questions. Thank you.
We will now be conducting a question and answer session. Our first question today is coming from Michael Rehaut from JPMorgan. Please proceed with your question.
Thanks. Good morning, everyone. First question I had was on the United States. I was just curious, obviously, you guys are in the middle of making adjustments, investing and revising your go to market strategy. I'm curious from a competitive standpoint, if you can give us a sense of an update of number 1, where the market is today, if you've seen continued growth in the broader quartz, engineered quartz market?
And number 2, if there's been any change from a pricing standpoint more broadly?
Yes. So thank you, Mike. So we believe that countertopmarket in the U. S. Is doing well and specifically quartz.
The housing conditions are also reasonable. With regards to competition, yes, although we don't have current data, we believe that the quartz market continues to grow. And as the quartz opportunity grows, the competition grows as well. And we also see Chinese manufacturers entering the market more intensely. It seems that the lower segments of the market has had more growth in general and is led by Chinese manufacturers.
We are currently competing in the mid to high end of the market. Our product quality service, innovation, design and service matters. Low cost manufacturing competes with us as well, but we believe that our differentiation and multi channel strategy will prevail.
But in particular in terms of the Chinese competition, that's not obviously a new trend. And would you say that trend has changed dramatically or accelerated negatively in the most recent quarter? Or are you referring to more just a general trend over the last couple of years?
No. I think it's a general trend that continues. There isn't a big change here.
Okay. Just second question on the manufacturing. I think in the prepared remarks, Yonatan referred to challenges in the new plant. But at the same time, if I heard it right, you've identified some recent some of the issues and are hopeful that you'll see more improvement in 2017. So I was curious, if you could give me a little more detail give us a little more detail on what was identified, what you believe you've been able to correct, if I have that right?
And what perhaps that was in terms of a drag on gross margins in the quarter?
Yes. Okay,
Mike. So the bottom line performance of the plant in Q3 was disappointing for us in both throughput and yield rates. However, we have established few very important improved processes now in order to shorten idle time and maintenance interruptions and to reduce the number of substandard slabs and improve the overall efficiencies. We also continue to recruit experienced people as we go and in ENG training. So while the bottom line of Q3 was not good, I believe that there is now some momentum for improvement.
It will take time, but there is positive momentum. Now, if I'm going on a year over year, how it impacts our margin, basically, Richmond deal kind of dragged us around 150 basis points. On the other side, our Israeli plants performed very, very well and basically offsetted all of this drag.
Great. Thank you.
Thank you. Our next question today is coming from Susan Maklari from UBS. Please proceed with your question.
Thank you. Good morning.
Hi, good morning.
You mentioned in your remarks that as part of your U. S. Strategy, you're revising your go to market and how you're Yes. So, Susan, as you know,
Yes. So Susan, as you know, we are in the process of improving our performance in the U. S. To accommodate the current business scope and our challenges. We have been implementing several steps, including new local management, organizational changes, expansion of our marketing and sales team, adding talent, updating certain sales processes and enhancing visibility for the brand and other strategic and operational steps.
However, this improvement process is proving to take more time to implement than we anticipated, and it is also evident that some more time will be required before we can see the benefit of it. It's clear that the U. S. Revenue was below our expectation this quarter and we are unable to meet our plans for the year as for the U. S.
Having said that, we are optimistic that there is a significant growth potential in the U. S. And that we are taking the right steps to leverage it. We are rolling out the new product launch in the U. S.
As we speak and are planning to extend the market scope we are covering with our product offering. We believe that the step we take in reorganizing our sales operation in the U. S. Will lead to more robust and focused performance and to gradual better achievement in our core business. There has been and will be other changes to improve our presence in all the market segments, but a couple of those changes are competitively sensitive and I cannot specify them right now.
So I think we are looking at 2017, Yes, we are not providing guidance for 2017, but we expect U. S. Business to return to notable growth next year.
And Yair, is the new local management here, is that in addition to the changes that you made earlier this year? Are those like people that you are re swapping out? Or are they just further additions to those?
So, at the beginning of the year, we just did the change and brought Dan from Canada into the U. S. Dan had to identify all the organizational gaps that he has in his current organization. And very recently, in the last 3 months, he bought a lot of executive talent in and we bought a lot of strength into our sales force. We grew our marketing and sales headcount by 20% so far for the year in the U.
S. And expecting to complete the 25% growth by the end of the year. So there is I mean bringing them in was not a final solution. He needs to make changes and it takes some time.
Okay. And then can you just also kind of give us an update on those new product introductions? I know that those launched a little earlier this year in the U. S. How has the traction been with that?
And how does that compare to where you expected it to be?
So to be quite honest, there was a launch earlier this year, but there was some operational issues that we had with it and we did complete a relaunch with some brand new product, but also relaunch of few products that we launch early in the year and not in a very successful manner. This time we did a major marathon through all the regions in September October. We see some very good initial response on those and are looking forward to leverage ourselves as a result.
Okay. Thank you.
Thank
you. Our next question is coming from John Baugh from Stifel. Please proceed with your question.
Thank you for taking my questions. Good morning. Could you maybe address your and I guess two things on the U. S. Where IKEA goes in the Q4 year over year, I recall that it was very weak in the prior year Q4.
And I assume the guidance for revenues assumes U. S. Declined in the 4th quarter. So that implies core U. S.
Is down year over year. Do I have that right? And then what would be your assessment as to why your core U. S. Sales are down, you've lost market share?
So in terms of IKEA, we'll start with IKEA, John. We see sequential growth of the IKEA business from the bottom that we experienced in the 4th quarter of 2015 and the Q1 of 2016, so the recovery has been slower than we expected. So overall, our outlook for IKEA is positive. Yes, we are expecting our U. S.
Revenue to be down year over year in the Q4. And you're right that we expect a better year over year IKEA growth in Q4 and therefore the conclusion is that the core will be weaker on a year over year comparison. As I already said before, the implementation of the transition plan is taking longer than expected. However, we are optimistic that we will return to notable growth next year.
Yes. Is it possible to be specific on where you've lost business in terms of distribution channels or price points or anything more granular in terms of why or where the erosion is occurring?
The overall performance now is just not good enough. We are taking steps and measures and revising our strategy and organization. And we believe that we will return back to growth. There is not specific segments now that are worth discussing.
Okay. And then on the plant here, is it your expectation that as we move into 2017 or maybe inclusive of the Q4 that the throughput and yield results you've seen, you mentioned some momentum are going to narrow that gross margin drag?
So, first of all, I want to just remind us that we bought the new executive to the plant actually at the very beginning of Q3. And I think there is a lot of steps being taken out, significant steps to improve oil processes. So we anticipate that many of the issues will be resolved in 2017 and expect to be in a reasonable utilization rate by the end of 2017. It will be a gradual improvement. And with the growing global demand, we expect utilization rates and associated costs to be much better next year.
Again, it's not only a matter of gross margin leverage or not, it's a matter that we need to we intend to grow our top line and we need to throughput from this plant.
Okay. And then any update on the silica lawsuit? Any numbers around additional claims or any color there? Thank you.
No, there was a few new claims are coming in and few settlements that we closed on. So the overall $1,000,000 is the result of all these blended events. We'll give more specific numbers as to number of litigation at the 20 F. But in general, the picture is basically the same.
Thank you. Good luck.
Thank you.
Thank you.
Our next question today is coming from Lina Rogovin from Chardan Capital Markets. Please proceed with your question.
Yes, sure. Thank you for taking my question. I actually have two questions. The first is very similar to the previous one. So during the last conference call, you mentioned that you expect some U.
S. Revenue recoveries over the second half of the year. And you also mentioned some positive signs you see there. So what exactly happened? Why the core business was so slow even quarter on quarter?
And the second question is if U. S. Production facilities can be used for production for other regions, not just for the U. S. In order to improve utilization rate if there is not enough potential demand in the U.
S. Itself? Thank you.
Okay. So with regards to the first question, as we said before, we are implementing a lot of things and we are now in a transition plan execution and it just take longer than we thought. So on the plant, basically the plant for the most part serves the North America market. We can send product from there to other regions, but it's basically up to how we divide the whole supply that we have. So the U.
S. Utilization now in Q3 was not a demand dictated result. It was our own performance that we want to improve.
Okay. Thank you.
Thank you. We've reached the end of our question and answer session. I'd like to turn the floor back over to management for any further or closing
comments. Thank you, everyone. We are pleased to see the strength of our brand and success of our product translating into good performance in most of our regions. We believe that we are taking the right steps to reenergize our business in the United States. Thank you for your attention today.
Thank you. That does conclude today's teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.