May 9, 2018
Executives
Yair Averbuch - Interim CEO Ophir Yakovian - CFO
Analysts
Susan Maklari - Credit Suisse Unidentified Analyst - JPMorgan Dillard Watt - Stifel
Operator
Greetings and welcome to the Caesarstone First Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode.
A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Sarah Vicnel [ph] of IRC. Thank you, you may begin.
Unidentified Company Representative
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 on this call, the company will make reference to certain non-GAAP financial measures, including adjusted net income, adjusted net income per share and adjusted EBITDA. Reconciliation of these non-GAAP measures to the most directly comparable GAAP measures can be found in the company's first quarter 2018 earnings release, which is posted on the company's Investor Relations website.
Thank you and I would now like to turn the call over to Yair Averbuch Caesarstone's Interim Chief Executive Officer. Yair, please go ahead.
Yair Averbuch
Thank you, Sarah, and good morning to everyone. As you should have seen in the earnings press release today, we experienced a disappointing first quarter.
Before we turn to discuss the quarter highlights, I would like to make three comments about how we save the remainder of the year. As for gross margin, we are very focused to an improved capacity utilization, increased production efficiency and better execution with respect to inventory management.
The first quarter included charges related to inventory and logistical inefficiencies, the majority of which we do not expect will continue in the remainder of the year. While margin pressure for raw material prices and from lower manufacturing throughput associated with increased mix of differentiated products will continue, our goal is to end 2018 with higher and more stable margin and a clear line of sight to additional improvement opportunities in 2019.
My second comment is with respect to the company management. Caesarstone is a strong team, but we saw the need to make changes that are better-aligned with implementing our goals for growth resumption and higher margin.
In addition to Ophir, our new CFO, we have now involved Moran [ph] as our new VP of Operations. Moran [ph] brings within deep experience background and proven track record.
We are confident Moran [ph] will lead our global operation team to improved results. More recently, we parted ways with Dan Clifford, our President of U.S.
Sales and Distribution Operation. Our Chief Commercial Officer, Israel Sandler, is taking this role in the interim while we look to fill the position permanently.
In my interim role as CEO, my partnership with Ariel Halperin, our Chairman is very helpful and we are walking diligently to reposition the business and our strategy as they Board complete the search for a permanent CEO. Third, while we consider the first quarter results and the reduced guidance we are reporting today to be clearly unacceptable, we are doing what is necessary to leverage our strong blend, innovation capabilities and position in the market to grow the business and navigate to success in the competitive environment we are in.
While we endeavor to improve our near-term financial performance, we also consider other benefits. This will be realized over a longer time period to be just as important.
Now, I will refer to the first quarter financial highlights. Our first quarter revenue of $136 million was similar to last year and on a constant currency basis, our revenue declined by 3.7%.
We saw a decline in revenue mainly in the United States and in Australia. The decline in the U.S.
was mainly the result of a more competitive environment including price pressure and execution challenges. Our adjusted EBITDA in the quarter was $11.2 million and margin of 8.2%, compared to $24.3 million, a margin of 17.8% in the first quarter of last year.
This was well below our expectation and reflects the lower gross margin and the loss from scale-related benefit because of softer than anticipated revenue performance in the quarter. Our adjusted net income in the first quarter was $3.4 million and adjusted EPS was $0.10.
Now, I would like to provide an update on each of our regions for the first quarter. In the United States, sales were down 2.2% to $56.8 million, compared to $58 million last year.
Although these results were below our expectation, we are confident in our ability to capture growth in this market as we re-align our execution and progress with our business plan. Australia sales were $28.9 million, down 2.1% compared to $29.5 million last year.
On a constant currency basis, Australia was down 5.2%. The overall housing market in Australia remains soft including a modeling activity and to some extent, we also suffer from inventory availability.
In Canada, sales grew by 4.7% to $23.4 million. On a constant currency basis, our business in Canada was flat to last year.
Our core business performance was reasonably well, but was offset by a decline in our IKEA business due to changing promotional event timing, which we expect to gain back later in the year. Sales in Israel were up 0.8% to $11.8 million for the quarter.
On a constant currency basis however, sales were down by 6%, a reflection of challenging market condition. Europe sales were up 16.6% to $7.4 million from $6.4 million last year.
On a constant currency basis, growth was 1.7% year-over-year. We have very strong growth in the UK, offset by decline in some of our indirect markets.
The revenue in the rest of the world during the quarter was down 7.8% to $7.8 million. On a constant currency basis, revenue was down 19%.
In this region, we experience supply issues and we were unable to fulfill demand for our product. Before I turn the call to Ophir, I want to say again that we are dedicated to improving our results and our effectiveness in every aspect of the business.
At the top of our list is to quickly improve our ability to grow revenue and to create sustainable gains in our production efficiencies. These challenges are operational as well as strategic.
We are working diligently to refine our strategy and our view of the future. I believe that over time, improved execution, combined with good strategic decisions will lead strong business results.
I would like now to introduce and welcome Ophir Yakovian, our new CFO, who will provide more detailed review of our consolidated results and of our guidance.
Ophir Yakovian
Thank you, Yair, and good morning, everyone. Global revenue in the first quarter of 2018 was $136.1 million, a decrease of 0.3% compared to $136.4 million in the first quarter of last year.
On a constant currency basis, revenue declined by 3.7% versus last year. Gross margin in the quarter was 25.2%, compared with 36.1% last year.
As Yair mentioned, there are a number of factors that contributed to the 10.9% point decline. During the first quarter, the company recorded charges related to inventory and logistical inefficiencies, primarily related to the U.S.
distribution activity, the majority of which we do not expect will continue in the remainder of the year, accounting for approximately 300 basis points of the decline. The other major factors that led to the decrease in margin year-over-year were lower production throughput in Israel, impacting the margins by 500 basis points, higher raw material prices impacting margin by approximately 150 basis points and lower volume and average selling prices in certain regions, partially offset by regional mix, impacting margins by approximately 100 basis points.
Operating expense in the first quarter were $32.8 million for 24.1% of revenue versus $34.1 million last year, which was 25% of revenue. The year-over-year reduction in expenses were mainly due to timing of marketing and selling expenses offset by increased expenses for legal settlement and loss contingencies.
Excluding legal settlement and loss contingency expenses, operating expenses in the first quarter were $30.3 million or 22.3% of revenue compared to $33.4 million or 24.5% of revenue in the first quarter last year. This primarily reflects more moderate marketing and sales expenses in the U.S.
Our first quarter GAAP operating income was $1.4 million, compared to operating income of $15.1 million in the first quarter of last year. Adjusted EBITDA in the first quarter, which eliminates share-based compensation and legal settlement and loss contingencies was $11.2 million, a margin of 8.2%, compared to $24.3 million and margin of 17.8% last year.
The decline in adjusted EBITDA margin primarily reflects the factors that pressured our gross margin in the quarter. We have finance income in the first quarter of $0.5 million, compared to finance expenses of $1.5 million last year.
This swing is due to the favorable impact of currencies, including its impact on our hedging influence. Taxes in the first quarter were $0.5 million, compared to $2.3 million last year.
Adjusted net income attributable to controlling interests in the first quarter was $3.4 million, compared to $12.5 million last year. Adjusted diluted earnings per share in the quarter were $0.10 compared to $0.36 in the same period last year.
Those figure are on 34.4 million shares. Turning to March 31 balance sheet, we have cash, cash equivalent and short term bank deposits of $112.1 million.
I would note that during the quarter, we reduced $14.2 million of cash to settle previously announced microbial [ph] arbitration and $10.5 million for payment of the dividend we announced at the end of the year. I will note that considering the quarter's result, we will not distribute dividend this quarter.
With respect to our revised outlook and guidance for 2018, our current assumption for full year revenue is between $590 million to $610 million, compared to our prior guidance for a range between $612 million to $632 million. With respect to adjusted EBITDA given the variety of factors we experience in the first quarter, more significantly the lower than anticipated gross margin, we now believe that the adjusted EBITDA is expected to be in the range of $74 million to $82 million, compared to our product guidance range of $102 million to $110 million.
Thank you and I will now turn the call back to Yair for closing remarks.
Yair Averbuch
Thank you, Ophir. Thank you for your attention this morning.
We have some challenges in front of us for sure. Fortunately, we continue to have powerful advantages in strength.
Our brand occupies the premier position at the top of our category. Our products and our reputation are excellent and we are known for quality and innovation.
We have a very capable global platform, thus we will be able to leverage for better results. Finally, we have a strong balance sheet, even approximately $100 million net cash balance, which provide us a wide variety of range of option as we determine our next step towards driving value to our shareholder.
Thank you and we are now ready to open the call for questions.
Operator
Thank you. [Operator Instructions] Our first question is from Susan Maklari with Credit Suisse.
Please proceed.
Susan Maklari
Thank you. Good morning.
Yair Averbuch
Hi, good morning.
Susan Maklari
Good morning. My first question is around the inventory and the logistical inefficiencies, Yair, that you talked about.
Can you just give us a little bit more color on that and I guess with it, can you discuss the U.S. plant, how the new management team there is doing how the progress is coming along and how we should be thinking about it coming up to speed over 2018?
Yair Averbuch
With regards to the change of leadership in the U.S., the change is very well recent. Susan, are you talking about the plans or the distribution operation?
Susan Maklari
Well, both. I mean in your comments, Yair, you said that there were inventory and some inefficiencies on the logistics side there.
Are those related to the plant?
Yair Averbuch
Okay. Let me clarify this.
First of all, nothing that we have discussed in the call related to the U.S. plant, let me put this one first out of the radio streaming [ph].
The U.S. plant, we experienced the significant improvement both year-over-year and also sequentially and the plants is really on-track based on our plans.
It didn't play any factor in this quarter results because on one end, there was an internal major improvement in the factory. On the other end, because the factory now is a bigger component of the total production and is still more expensive than in Israel, so those two drivers kind of offset each other and Richmond deal was not part of the gross margin drivers for the year.
So most of the inventory and logistics and inefficiencies and also the mix on the revenue side was related to our U.S. sales and marketing operation.
As I've said, they started to say our leadership changer is extremely recent and I believe that we aligned what we need to do now, how we should go about the market and I believe that we are off to a better performance.
Susan Maklari
Okay. All right, that's helpful.
And then Yair, one of your U.S. competitors has filed an anti-dumping suit in the U.S.
given all the imports that are coming in here. Can you just give us any thoughts on that and maybe any way that you can be involved in that case as a significant player in this market?
Yair Averbuch
Susan, we actually prefer -- not to refer to any specific allegation, but it would just edit in general, of course we support first-rate practices in our markets. More specifically, this petition was not initiated or submitted by us.
However, of course if regulatory agencies will approach us, we will provide any relevant information.
Susan Maklari
Okay, thank you.
Operator
[Operator Instructions] There are no more questions at this time. Actually, Susan Maklari has a follow-up question.
Please proceed, Susan.
Susan Maklari
Yair, if I'm the only one that's in the queue, I'm going to ask you another question. I guess with Dan Clifford gone, can you talk about the kind of person that you're looking to fill that role?
What will be different about their profile related to Dan, and how are you going about the process?
Yair Averbuch
Okay. Without referring to Dan at all, I would say that we are looking for somebody with some specific industry experience ideally with a very strong marketing and sales capabilities and background.
Somebody who is a strategic thinker and I would add to those three that we want somebody who can roll up his sleeves and move in quite a big organization with a lot of complexities, drive it to do strong execution. So in a nutshell, that's what -- that would be my ideal candidate.
Susan Maklari
Okay, all right. That's helpful.
And then just lastly on the dividend reinstatement, you're not going to pay the dividend in the second quarter, but then how should we think about it going forward?
Yair Averbuch
The board decided on a dividend policy at the end of last year and we believe that once we see a better performance in terms of the result, we will resume the distribution of dividends hopefully in the next quarter.
Susan Maklari
Okay, all right. That's perfect.
All right, thank you, guys.
Yair Averbuch
Thank you.
Operator
Our next question is from Michael Rehaut with JPMorgan. Please proceed.
Unidentified Analyst
Good morning. This is Neil [ph] for Mike.
I guess I just wanted to continue on the gross margin performance. Your comments on the inefficiency were helpful, but on the raw materials part, what are you doing with pricing or otherwise as an offset?
I guess as an add-on, sort of what do you see as your pricing power?
Yair Averbuch
I think that in the business of polyester prices and titanium oxide and those of the world; those are commodities that I'm not sure the season is [indiscernible] due respect to us as much power. This is a market that tends to fluctuate quite a bit, we of course try to bid between different suppliers and do the maximum and optimize our sales but our capabilities they are not exactly [indiscernible] industry.
I'm not sure that somebody has a buying power in oil industry.
Unidentified Analyst
Okay. That makes sense.
I meant more pricing on your end as far as rating prices and products.
Yair Averbuch
Yes. What I would say about our prices is that the dynamic -- as far as we see it, in the foreign, though we have generally increased competition in the quartz market especially in the U.S.
from lower end manufacturers mainly from China. For Caesarstone is a brand and a differentiator in the market.
We will continue to put a lot of weight and a lot of effort to try and introduce new product into the market and keep the gap between us and the competition. On the other end, to still optimize the top line growth, we are a bit more aggressive on the classical collection in general.
And then in some of these all equation ends up in a more challenging environment in our plans because the newer product are more sophisticated, are more complex to introduce and take more cycle time in our plants.
Unidentified Analyst
Okay, that makes sense. I want to ask a little bit on channels.
Maybe if you could break down the results you're seeing, the big box versus retail whereas maybe trending better or worse than your expectations?
Yair Averbuch
Yes. Without getting into a lot of take in the big boxes, we are in IKEA.
IKEA as we said in Canada was a bit down due to the timing of the promotional event in the U.S. If I remember right, IKEA was a growth and in what we see for the remainder of the year in IKEA in the U.S., our outlook for IKEA is actually a bit negative, we see a decline because of the change of the structure of the promotional events in IKEA.
Basically it's less favorable of the promotional matter for the consumer in IKEA and because a lot of the demand comes in those promotional events, we are also impacted by that.
Unidentified Analyst
Okay, that makes sense. That's great.
Yair Averbuch
That's on the IKEA channel. I would say that in the more in the builder segment, we are doing quite well.
I think the challenges are mostly on the retail channel.
Operator
Our next question is from Dillard Watt with Stifel. Please proceed.
Dillard Watt
Thanks. Yair, good morning.
Maybe if you want to talk a little bit about Australia, your second biggest market, you said you had some inventory availability issues there. Is that something that gets better for the rest of the year or are you going to continue to face the headwind so long as I guess maybe the Israeli plant throughput is not where you want it to be?
Ophir Yakovian
We expect Australia to be better in terms of inventory availability because we shifted some production there to the juggle between all of our capacity challenges. And I would say that in Q1, this was the case because in the second half of 2017, we've put a lot of emphasis on build up inventory for North America.
So Australia was impacted in Q1 somewhat. We are now fixing those situation and I believe I hope that the revenue opportunities, these are going to be low due to inventory availabilities, will diminish dramatically.
Dillard Watt
Okay. Just back on the inventory and logistics issues in the U.S., maybe if you could just again give us a little more detail on what happened and what gives you confidence that that was a one-time charge, I assume I got sort of through the first five weeks of the quarter.
Maybe things are better, maybe that was just a first half of the first quarter issued. It was just a really big drag and then has since corrected itself.
But what happened?
Ophir Yakovian
Yes. As Yair mentioned, we built inventory in North America, both in the U.S.
and in Canada, the way that we built it was in a way that there was some peaks in the delivery of our products of the shipments to the location and that created some extra charges related to freights and storage and related expenses and then as a result, we suffered. We had some excess expenses that we don't expect now to return later in the year.
In addition to that, we have some inventory write-downs related to some finished goods that we also don't expect to return in the remainder of the year. This were the two main factors and that's why we don't think it's the majority of which will not reoccur during the year.
Dillard Watt
Okay. And raw material outlook for the rest of the year, I assume it gets better as we get through the year.
What shall we expect for the raw material impact on gross margins this year?
Yair Averbuch
Well, we are always as good as the last quote in the last buy and now I wish we had a crystal ball on guessing where this is going. In prices of both polyester and titanium oxide [indiscernible] on us sequentially.
So I'm not sure that the future is brighter and thus we'll have to wait and see.
Dillard Watt
Okay. You just assume maybe they were flat from here.
Is that a similar year-over-year pressure? Or does it get a little easier just on the year-over-year comparison?
Yair Averbuch
I think it may be a minor impact on the year-over-year because the prices of polyester trended up sequentially for quite a long time. So I guess just the impact is somewhat...
Ophir Yakovian
More moderate.
Yair Averbuch
More moderate as we go along. It's the prices will stay flat now.
Dillard Watt
Okay, thank you.
Operator
Ladies and gentlemen, we have reached the end of our question-and-answer session. I would like to turn the conference back over to Yair for closing remarks.
Yair Averbuch
Thank you, everybody for attending the call and we look forward to provide better results in the next quarter. Thank you.
Operator
Thank you. This concludes today's conference.
You may disconnect your lines at this time and thank you for your participation.