Good day, welcome to the Caesarstone first quarter 2016 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Allison Cain of ICR. Please go ahead.
Thank you, operator, 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, subsequent filings with the Securities and Exchange Commission. Additionally, the company will make reference to certain non-GAAP financial measures, including adjusted net income, adjusted net income per share, 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. Yos?
Thank you, Allison. Good day, thank you everyone for joining us to discuss our first quarter. Our first quarter was generally as expected, our business is performing well. I would like to start with some highlights. Sales increased 8.4% to $116.9 million. Without currency impact, growth would've been 12.3%. Adjusted EBITDA for the first quarter was $23 million, a margin of 19.7%. Adjusted net income was $13.3 million, adjusted EPS was $0.38. Our growth rate was strongest in Europe, Canada, the U.S., excluding our IKEA business, Australia. This performance was partially offset by continued foreign exchange pressure, in the U.S., by an expected drop in sales to IKEA versus prior year related to previous quarter sales events interruptions. Our sales growth accelerates, we expect margins to improve.
I would like to give an update on each of our major markets for the first quarter. First quarter sales in the U.S. grew by 2.7% to $49.3 million. Similar to the past few quarters, growth was adversely impacted by significantly lower sales to IKEA. We mentioned before, IKEA resumed its promotional events in March, we expect this to have positive impact starting in the second quarter. We've continued to refine our growth strategy in the U.S. along three key lines, brand, execution, innovation. The Caesarstone brands and products have tremendous value, which we leverage mainly through creating a more compelling consumer purchasing experience in different channels, at the points of sale, other platforms. With respect to execution, we've also identified specific opportunities to enhance accessibility of our product samples and marketing tools throughout our value chain.
As to innovation, we believe we are on the cutting edge in terms of the breadth of new products we will introduce this year. Longer term, we believe that our innovation capability is a strong and solid competitive differentiator. Alongside our excellent quality and service, this position us as an industry leader. Australia sales in the first quarter were $25.7 million, up 10.1%. On a constant currency basis, Australia was up 19.6% in the first quarter. Housing conditions in Australia are slightly better than originally forecasted for 2016, and our business in Australia is proceeding very well. Canada sales in the first quarter grew 26.7% to $17.6 million. Canada's first quarter growth was 41.2% on a constant currency basis. Our business is strong and also our sales to IKEA continue to ramp up. Sales in Israel for the quarter were $10.3 million, up 4.4% compared to last year.
On a constant currency basis, sales were up 3.6%. Europe sales in the first quarter increased 41% to $6.6 million and were up 43.3% on a constant currency basis. We believe that in the first quarter, we benefited from timing of orders and are not expecting this level of growth to continue in Europe. Revenue in the rest of the world during the quarter was down 7.7% to $7.3 million. On a constant currency basis, revenue was down 6%. In general, during the first quarter, we achieved our plan, and we believe we are on track to achieve our yearly target. Thank you, and I will now turn the call over to Yair.
Thank you, Yosef, and good morning to everyone. I will start with our income statement for the first quarter. Sales in the first quarter increased by 8.4% to $116.9 million, compared to $107.8 million in the first quarter of last year. On a constant currency basis, sales increased by 12.3% versus last year. Gross margin in the quarter was 36.5% compared to 42% last year. This margin decrease is attributed to inefficiencies related to our Richmond Hill manufacturing facility. Favorable product mix and lower raw material cost, specifically polyester, were offset by negative exchange rate fluctuations. Our manufacturing costs in Richmond Hill were higher than expected. As a result, we have taken action to improve our performance, including operational process improvements. We have also made managerial changes in the plant.
Operating expenses in the first quarter were $28.4 million or 24.3% of sales versus $24.6 million last year, which was 22.8% of sales. Excluding an increase of $1 million in share-based compensation expenses derived from recent grants, and legal settlement and loss contingencies expenses of $0.7 million that were not incurred in the same period last year, operating expenses as % of sales would have been the same as last year. Operating income was $14.2 million compared to $20.7 million in the first quarter of last year. Our operating margin decreased to 12.2% from 19.2% last year. Adjusted EBITDA in the first quarter, which eliminates share-based compensation and legal settlements and loss contingencies expenses, was $23 million. This was a margin of 19.7% versus 23.7% last year. This lower EBITDA margin is a result of lower gross margin associated with the U.S. plant operation.
Finance income in the first quarter was $0.2 million compared to finance expenses of $1.9 million in the prior year. The change was primarily due to a $1 million net gains related to currency exchange rate fluctuation in the first quarter of 2016, compared with net losses of $1.1 million in the first quarter of 2015. Our taxes in the first quarter were $2.4 million, 16.4% of income before taxes, compared to 13.1% tax rate last year, reflecting higher production portion from our U.S. plant and certain nondeductible expenses occurred in this quarter. Adjusted net income attributable to controlling interest in the first quarter decreased to $13.3 million from $16.4 million last year. Adjusted diluted earnings per share in the quarter were $0.38 on 35.4 million shares. Adjusted diluted earnings per share last year were $0.46 on 35.5 million shares. Turning to our March 31st balance sheet.
We had cash equivalent, and short-term bank deposits of $59.9 million. Our net cash position went down by $7.1 million due to share repurchase of approximately 334,000 shares for a total of $11.8 million. Our cash flow from operations improved to $9.1 million in Q1 2016 compared to $2.7 million in the same period last year. With respect to 2016 guidance, our business is proceeding well, and we are pleased to see some positive exchange rate changes. At the same time, we are monitoring exchange rate trends and the development of our U.S. sales, including IKEA, and therefore, we believe that at this early point of the year, it is prudent to maintain guidance. Our revenue guidance for the year remains $550 million-$565 million, and our adjusted EBITDA guidance for the year remains $138 million-$145 million.
Thank you. We are now ready to open the call for questions.
Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are joining us today using a speakerphone, please make sure mute function is turned off to allow your signal to reach our equipment. That is star one if you have a question or comment. We will pause for just a moment. We will take your first question from Michael Rehaut from J.P. Morgan.
Thanks. Good morning, everyone.
Good morning.
First question I had was on the gross margins, and more specifically, the costs with the plant inefficiencies. I guess, you mentioned that the costs were higher than expected, and as a result, you made some changes both operationally and from a management standpoint. At the same time, you reiterated your full-year EBITDA guidance. There's two parts to the question here. Number one, if you could go into more detail in terms of the changes that you made, both operationally and managerially. When do you expect those changes to have an impact on the P&L? Are there other offsetting positives that, from your perspective, allow you to retain the EBITDA guidance despite, at least at this point in the year, a greater than expected headwind in this area?
I think, Mike, I will start with the plant, Yair will answer about the guidance question. In the plant, it's not a secret, it was also demonstrated
In the fourth quarter that we had some deviations from our expectation. This quarter was better, but we think it should have been much better, and we took some more aggressive steps in order to correct it. It has to do with the way we operate with expenses and with processes. We're already seeing a positive result there, and this quarter, for sure, will suffer less than in the first quarter. In general, the plan is progressing. It's progressing, but it's not progressing as fast as we would like it to be. I think now, with the measurements that we took, it is going to be better. Now, we will see improvement gradually during the year, and it should be better, of course, through the course of 2017. Yair.
Yeah. I think.
No, regarding the EBITDA for the year.
Yeah. Again, as Yosef said, we took immediate action. Now we believe that we will start seeing all this impact in Q2 and more noticeably in the quarters thereafter. We expect volume to grow over revenue and EBITDA margins to improve significantly from Q1.
Just to be a little more specific as possible. Number one, when during the quarter were these changes made, either operationally or in terms of management? Number two, again, going back to the gross margin question, if 1Q was a little worse than expected, how are you able to maintain full-year EBITDA guidance? Were there other positives that came through, like less than expected FX headwind now, or is it just that you expect this to really turn around and fix itself?
With regards to FX, as we said, there is some positive FX trend. However, we prefer to remain cautious on those and to see this trend stabilize and not going backwards. We have Australia again, and Canada are doing very well. U.S., we believe, will improve. Our visibility as of now is that we remain confident with our guidance.
At this time, we'll move to the next caller in the queue, and will come from Michael Dahl from Credit Suisse.
Hi, this is actually Matthew Bouley on for Mike. Thank you for taking my questions. First, on the annual sales guidance, I just wanted to tie all that together. You mentioned you're continuing to monitor the U.S. and IKEA sales. At the same time, foreign exchange has improved since the last guide. You're seeing Australia come in a little bit better than initially expected. Really, the question is, has anything really changed in your kind of organic assumptions given some of those trends?
No, I think the organic assumption, in general, are the same, and all in all, we feel that we stay with the same expected sales.
Okay. Thank you. Then, just more broadly, now that we're a few months into the leadership change that you made in the U.S., and you mentioned redefining the growth strategy in the U.S., I just wanted to get your updated thoughts on new channels, and specifically, what, if any, opportunities you might pursue in terms of the home centers.
Again, just to reiterate partially what I said, we've continued to refine the growth strategy there and along the three lines that I mentioned, the brand, execution, and innovation. First of all, we intend to leverage the brand mainly through the points of sales and other platforms. Execution of sales and marketing within the channel is very important, and we intend to apply more consistent processes to distribute samples of our newer products as well as marketing tools throughout the value chain. To the designers, architects, and of course, at the points of sales, and we believe this was part of the weakness, and we believe that we have a successful new product offering to introduce down the road this year. All of that, I think, provide us the confidence that the sales in the States will improve during the year.
We see the strength in the other market, in Australia and Canada, which are very strong. This is it.
Okay. Thank you very much.
Thanks.
We'll hear next from Stephen Kim from Barclays.
Oh, yeah. Thanks very much, guys, for taking my questions. I guess the first thing I wanted to understand is the IKEA effect. You had indicated that the promotions restarted in March and should help you. I just want to make sure, first of all, that they're going to benefit the entire quarter, or if there's going to be a lag that would make it peak at most of the quarter, but not all of it. Then the second part of the IKEA question is, can you just generally tell us what kind of seasonality, the IKEA business typically sees overall, excluding this promotion effect? 1Q, I would guess, would probably be the smallest quarter, but I just want to make sure that is correct, that the seasonality is lower in 1Q.
We believe that the IKEA business also will improve gradually because of the interruptions that we suffered a year ago. We should definitely benefit in Q2, but it should be more beneficial in Q3 and 4. In terms of seasonality, I don't think that we can identify any specific seasonality in the IKEA sales.
Okay. The second question relates to the small charge that was taken in the quarter regarding asbestos. What region of the world was that related to, and how much was covered by insurance?
Basically, it was all in Israel, related to a few additional claims. Today, if you remember, the first $5 million are not insured, anyway, we are exposing the first layer of $5 million.
I think maybe one comment to that. To the claims in Israel, we got one new claim in early proceedings in Australia by the end of the quarter, we don't know how to evaluate yet, but just worth noting.
Is that the first claim that you've had in Australia?
The first claim is against us and others, and other manufacturers. Yeah, it's the first claim there. We had, at the time, one claim in the U.S., but we were deleted from the claim afterwards. This was, I think, about two years ago or three years ago, and this is the first claim, apart from that of the U.S., that we are aware of outside of Israel for us.
I know you're probably going to be limited in what you can say regarding these, but in general, would you say that the nature of the claim or the complaint is very similar to that we've seen thus far in Israel, or is there anything substantively different about the claim that they are making?
No, the nature is the same, but it's too early for us to assess and to understand exactly what is the situation. The nature is the same nature.
Yeah. Okay, great. Thank you very much.
Thanks.
George Staphos with Bank of America, your line is open.
Hi, it's actually Alex Wong on for George. Thanks for taking the question. First question. Appreciate you identifying the IKEA impact for us last quarter. Was the growth in the U.S. this quarter in line with your expectations? On the outlook, can you maybe talk about what gives you confidence in the pickup? I know you talked a little bit about the change in the strategy and marketing tools, but are you seeing any change in the underlying demand, especially given a pretty strong start to the new home construction this year?
I think regarding the IKEA, I'm not sure if I fully understand your question, IKEA restarted the events, and this is why I said that we expect it to grow gradually from as of Q2. As to the business in the States in general, many parts of the business are very good. I think we have opportunities to be more consistent in the channels in sales and marketing, this is what we are doing. The business has grown, we thought that it needed a different treatment, this is why we did the change, we believe that it will bear fruits.
Understood. Would you characterize the confidence and the outlook more related to these internal initiatives that you're implementing, or is the underlying market also giving you a pretty high sense of confidence in the acceleration?
In general, when we try to do our best to project, and it's a process that we do bottom up, and it's a thorough process, and this is from the low level. From the bird's view, we see the markets, we see the trends, and we believe that we are confident with the projection that we provided.
Appreciate that. Just as a follow-up, mix has been a tailwind for margins in recent quarters. Can you comment to what's driving the favorable mix shift, and how sustainable do you think this trend is? If you could talk about any new products by market or what the pipeline looks like.
We continue to work on differentiating Caesarstone from the competition. We believe we have a very strong R&D and very strong operation organization to execute.
Upon the R&D inventions. It's a game, it's a race. We launch products, and we launch series of products, and then, there are limitations, and all the time you have to invent your collections and also to understand the trends to be ahead of the competition, and better from the competition. We have succeeded to do it so far, and we believe that we will continue to succeed to do it in the future.
We'll move next to Susan Maklari from UBS.
Good morning.
Morning.
First off, I wanted to get a little bit more details on the raw material costs. I know that you said that that was a little bit better during the quarter. How are you thinking about that as we move through the year?
It's basically all related to polyester prices. This tends to be volatile. We don't know how it will develop, but we're basically locked for the first half.
You'll maintain these prices through the second quarter then?
Yes.
Yes. Okay. In terms of the share repurchases, you spent about $12 million or so of the $40 million that you've been authorized. Can you just give us some sense of timing, how you're thinking about using the remaining $28 million or so?
Yeah. The execution of this authorization continues under a predetermined plan, and we will report our progress, each quarter on the earnings.
Okay.
Susan, do you have anything further?
No, I'm all set. Thank you.
We'll hear next from John Baugh from Stifel.
Thank you. Good afternoon. I guess I wanted to ask a couple things on the U.S. gross margin again. Was there any unusual discounting or promoting going on? Or was it really largely, if not solely, the U.S. plant utilization weighing on the gross margin percentage?
Basically, the whole swing in gross margin relative to last year was due to the U.S. plant. Again, as Yosef mentioned, part of it was expected, because we are not in efficient utilization yet, but part of it was more than we expected. Basically, all the rest was of the impact offsetting each other. There was a negative FX impact that was offset with the lower material cost and the volume impact.
Great. I think I heard one of you comment about sort of a sales growth ex IKEA, with Canada maybe leading Australia. Anyway, I couldn't remember the order. Could you restate that?
Yeah. On a constant currency basis, again, Europe and Canada were the fastest-growing region this quarter, each above 40%. Australia was 19.6% overall constant currency growth. With regards to U.S. revenue in the first quarter, again, we are not breaking out revenue without IKEA, but I just want to remind everybody that IKEA revenue dropped significantly from the first quarter of last year.
Okay.
That's what I can say about this. Regarding Canada, I can say that Canada, even ex IKEA, is a very healthy growth.
Great. Oh, that's helpful. Then, there were stories around the kibbutz and what they may or may not do. I realize you may not be able to comment on their intent, but ask the question anyway.
Yeah, I think you realize right.
Okay. Is there anything on the plant? You talk about process. You mentioned progress. I don't know, maybe you could talk about two or three metrics you're looking at. Is it scrap rates? Is it utilization rates? Is it labor per foot? What kind of metrics are you looking at? Any kind of feel for what you've seen sequentially, January through April, in any or all of those metrics you're willing to share? Thank you.
In a high level, it's the regular industrial KPIs. Processes should be controlled, deviation should be lower. You have usage of material, hours of work, and general expenses that needs to be better controlled. In general, as I said, we see a progress, the progress is not fast enough. We are improving all the time, we definitely took some more strong steps toward the end of Q1.
We already seeing it getting better.
Ladies and gentlemen, if you have a question or comment, it is star one at this time. We will move next to Lena Rogovin from Chardan Capital Markets.
Hello?
Lena, line's open.
Hi.
I have got a couple of questions on your U.S. business. First is, I realize that you do not disclose separately IKEA and the organic growth. Just in terms of the trends, in terms of like-for-like revenue in this first quarter, how is it compared to growth rates in the previous quarters, and do you see any like-for-like growth slowdown at IKEA? My second question is regarding the Richmond facilities. Is it possible to quantify utilization rate and the progress there in the year? The last question is also on IKEA business, since it has structured a lower gross margin for you, and you are saying that the effect on IKEA is going to be stronger in the coming quarters, what is the effect on your overall gross margin in basis points? Thank you.
Regarding IKEA business, again, we do not break it out. But as I mentioned before, revenue in IKEA in Q1 in the U.S. was a major drop compared to last year. That is what I am willing to say on that part. To your last question, when IKEA business grows, for us, it dilutes a bit our gross margin, but there is a significant OpEx leverage. Basically, it is a very good business for us in terms of operating margin, which is what count, and therefore, this should not be a problem for us, and it should not reduce our EBITDA margins at all. With regards to Richmond Hill, can you remind me again the question?
Yeah, sure. I asked if it is possible to quantify utilization rates in Richmond and what the dynamics there you expect.
We are not specifying utilization rate, but currently they are not high. We expect the utilization rate to continue and improve during the year, and this will also benefit our margins.
At this time, we'll take a follow-up from Michael Rehaut from J.P. Morgan.
Thanks. Just wanted to circle back to a couple quick items. Number one, in the U.S., with the expected improvement now in the second quarter from IKEA, I was wondering if we should be expecting a return to double-digit sales growth in the second quarter, or would that more be a two second half event?
I think, overall, we don't provide guidance according to quarters. I think this would be the direction.
Are you saying the direction for 2Q or for second half? When you say this is the direction, I'm just not sure I understand what you mean.
Direction, starting with Q2 and improving in Q3.
Okay. Also, I just wanted to be clear on the managerial changes. I don't think I got an answer from my previous question. If you could just give us a sense of when during the quarter did you make the managerial changes at the Richmond Hill plant?
Richmond Hill managerial changes, part of it is part of the regular process and part of it starting just now, and it's a natural development. We had relatively few people from Israel there for relocation, and we are replacing them step-by-step by local people. Now we appointed a new general manager that will be starting now, basically.
Okay. Thank you.
As a final reminder, that is star one. We'll move next for a follow-up from George Staphos from Bank of America.
Yeah. Thanks for taking the follow-ups. Just two quick questions. One on IKEA, can you maybe provide a little color in terms of what you're monitoring when you talk about the IKEA sales for the rest of the quarter? Can you remind us what drives the promotional timing? How much visibility do you have on this? Then just as a second part to that, when do we anniversary the Canada IKEA sales, if you can remind us?
The IKEA promotions are usually about three or four a year. This was started on March, was the first event this year, and we will have probably two more events this year for promotions. The timing in Canada is quite similar, I think, to the time in the U.S.
Thanks.
Maybe to continue on your question, we do have a little bit more visibility on IKEA because the orders are normally fulfilled in a lag of time, so there is some visibility about how many orders were generated.
Thanks for that, Yair. Just last one for me. Can you talk about the sales growth in Australia? I think in your formal remarks, you mentioned maybe better than expected housing statistics, but I believe you've also introduced some new products over the last few quarters, so maybe that's also driving the growth, but if you could provide some additional color. Thank you.
Yeah. The dominant factors behind our growth in Australia are increased quotes penetration, of course, and then improved product offering, combined with our strong execution there. The housing environment is currently slightly better than we assumed in the beginning of the year. Australia performance is very good overall. Alex?
At this time, there are no further questions in the queue. I'd like to turn the conference back over to Mr. Shiran for any concluding remarks.
Thank you for your continued interest in Caesarstone, and we look forward to sharing more with you next quarter. Have a great day. Bye.
That does conclude today's teleconference.