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Caesarstone Ltd (CSTE) Q1 2019 Earnings Call Transcript

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Caesarstone Ltd  (NASDAQ: CSTE)
Q1 2019 Earnings Call
May. 01, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the Caesarstone First Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Brad Cray, Investor Relations.

Brad Cray -- Investor Relations.

Thank you, operator, and good morning to everyone. I'm joined by Yuval Dagim, Caesarstone's Chief Executive Officer; and Ophir Yakovian, Caesarstone's Chief Financial Officer.

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 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, adjusted gross profit and adjusted EBITDA.

The reconciliation of these non-GAAP measures to the most directly comparable GAAP measures can be found in the company's first quarter 2019 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 Yuval. Please go ahead.

Yuval Dagim -- CEO

Thank you, Brad, and good morning to everyone. We are excited to share with you today the news about our Global Growth Acceleration Plan. The intention of this plan is to oversee an improved allocation of our resources while positioning ourselves more efficiently for sustainable accelerated growth.

In the last decade, we have grown at a fast pace, thanks to passionate and energetic teams, this was a truly remarkable achievement for us. With much larger business today, we have set out to optimize our global structure to operate more efficiently and improve scalability for new growth opportunities.

We anticipate that the initiatives and actions taken through our Global Growth Acceleration Plan will empower us to achieve our 2019 goals, and we expect to see further contributions from this multiyear plan over time.

The actions include: expansion of our sales force in the U.S. while significantly improving our logistics, distribution network, technological infrastructure and processes; cost rationalizations, including headcount reduction announced today that will enable a redirection of resources to be invested back into the business; investments in product innovation to enhance our portfolio of premium product offerings; and more efficient management of our go-to-market supply chain and production processes.

Globally, we will reduce our headcount by approximately 7% or 110 employees across all business units and functions mostly in the U.S. Our headcount reduction measures are intended to move Caesarstone toward a more efficient, lean and agile organization.

Also, as start of these headcount reductions, we are temporarily reducing the effective capacity of our U.S. manufacturing facility by 50%, which should provide for increased production efficiency and reduced inventory levels. We are confident that this facility will have meaningful contribution to our business over the long term. In line with our focus to bring the best talents to our team, we have announced global leadership changes to strengthen our company's marketing efforts and drive technological transformation.

This include appointments of new Global Chief Marketing Officer and Chief Information Officer, who are both expected to join our company in the next couple of months. Technological and digital investments will be geared toward operational enhancements such as inventory management and production along with improvement of our go-to-market tools.

One of our forward initiatives will be to expand our U.S. sales force over the next months by approximately 15% to 20% or 20 to 30 people. The emphasis will primarily target large metropolitan areas where our presence has been underrepresented in the past. Beyond currently identified opportunities, we are actively pursuing additional avenues to accelerate growth and generate better results to this multiyear plan.

While some of these actions will contribute to our 2019 results, we recognize that majority of actions will benefit results over the long term. These changes and enhancements should allow us to generate greater value for our shareholders in the coming years.

I look forward to updating you further on our progress next quarter. With that, let me turn the call to Ophir, who will provide details on our results and outlook.

Thank you, Yuval, and good morning, everyone. I will start by discussing our first quarter results. For the first quarter 2019, global revenue was $128.2 million compared to $136.1 million in the first quarter of last year. This was mostly attributable to an adverse FX impact of $5.3 million.

On a constant currency basis, revenue declined by 1.9% compared to last year as soft market position in Canada, Australia and Israel combined with lower performance in IKEA U.S. more than offset sales improvement in Europe and the company's core business in the U.S. In the United States, first quarter sales were off by 0.6% compared to the first quarter of 2018.

This was primarily attributable to expected softer performance in the retailer IKEA that was partly offset by low single-digit revenue growth in our core U.S. business, which grew for the third consecutive quarter. We estimate that there are still elevated inventory levels of quartz countertop in the U.S. due to the previously discussed second half 2018 surge in pre-buy activity ahead of recently announced tariffs on U.S. imports of quartz countertop from China. The impact of these tariffs in the U.S. should be favorable over the long term.

However, there are other developed markets that continued to be served by Chinese competitors at low price points. Therefore, outside of the U.S., some of the key -- of our key markets are expected to feel continued pressure from Chinese manufacturers.

In Australia, constant currency sales were down 3.8%. The decline was attributable to continued competition mainly from Chinese manufacturers coupled with continued softness in the housing and remodeling markets, which were affected by more rigid lending standards and increased mortgage rates.In Canada, constant currency sales were down 9.2%.

Our performance was affected by soft housing and remodeling markets with a decline in housing completions and continuous decline trend in the remodeling market. This was partially offset by slightly better results in our IKEA business. Sales in Israel on a constant currency basis were down 8.9%.

We experienced lower volume mainly due to challenging housing market conditions and increased competition. In Europe, constant currency sales grew 27.5% reflecting continuous strong momentum in the U.K. as well as in our indirect distribution operations in Europe. Revenue in the rest of the world on a constant currency basis was down 7.9%. Looking at our first quarter P&L performance.

Adjusted gross margin was 25.3% compared to 25.2% in the prior year quarter. A similar adjusted gross margin mainly reflects the following: increased unit manufacturing costs due to lower fixed cost absorption and foreign exchange headwinds.

These factors were offset by more favorable geographic and product mix, lower raw material costs and better supply chain efficiencies. The temporary 50% reduction in our U.S. manufacturing capacity should improve the fixed cost absorption as we optimize our production allocation globally and work down inventory. Adjusted EBITDA in the first quarter was $11.6 million, a margin of 9.1%, compared to $11.2 million, a margin of 8.2% in the prior year quarter.

This primarily reflects our efforts to control costs and improve our operational efficiency as we walk to overcome challenging global market conditions and increased competition. Adjusted diluted earnings per share in the quarter were $0.08 compared to $0.10 in the same period last year on a similar share count. Turning to our balance sheet and cash flow.

CapEx totaled $6 million for the first quarter representing approximately 5% of revenues. We ended the first quarter of 2019 with a strong balance sheet, including cash, cash equivalent and short-term bank deposits of $86.8 million with no financial debt to banks. Moving to our outlook. For the full year 2019, we continue to anticipate revenue to be in the range of $580 million to $600 million and adjusted EBITDA to be in the range of $72 million to $80 million.

As noted on our last earning call, we expected the first quarter to be most challenged from a year-over-year comparison, but as we moved through the year we expect to start to show improvement in key metrics with growth largely coming in the second half of 2019. Our outlook also factors in our expectation for soft global market conditions and for competitive environment to persist in many of our regions during 2019.

This outlooks assume a similar gross margin for 2019 compared to full year 2018. To formulate our outlook, we have used current foreign exchange rates, raw material prices and preliminary determination on U.S. tariffs on Chinese imports. The final determination on tariffs is still expected in the first half of 2019. Changes in tariffs, FX or raw materials prices may impact our outlook as we move through the year. In the U.S., we continue to expect stronger revenue growth in the second half of 2019 as we expect inventory levels return to normal. Furthermore, we continue to expect that the previously discussed enhancement in North America will start yielding results in the second half of 2019.

We expect our gross margin to improve gradually over the year with the full year gross margin to be similar to 2018. The improvement in the gross margin will cascade to the bottom line, which together with the revenue growth will increase EBITDA as the year progresses. As a reminder, the second quarter 2018 was our highest gross margin quarter in 2018, which will not recur in the second quarter 2019 primarily due to lower capacity utilization. As a result, we expect adjusted EBITDA to be lower year-over-year in the second quarter.

As we announced today and Yuval discussed in detail, over multiyear Global Growth Acceleration Plan will result in us taking a number of steps to improve our operations. The financial impact of this plan is included in our unchanged outlook for 2019 and intended to drive additional growth in revenue and adjusted EBITDA in the coming years. In connection with the action we intend to take as part of the Global Work Acceleration Plan, the company expects to incur a onetime charge of approximately $1 million in the second quarter of 2019.

Overall, we believe that we are on track to achieve our full year 2019 objectives. We are focused on improving our operations, our profitability and capturing market share as the year progresses. We are confident that the specific actions we are taking will bring stronger performance to our organization in the coming years.

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

Questions and Answers:

Operator

(Operator Instructions) Our first question comes from the line of Susan Maklari with Credit Suisse.

Christopher Frank Kalata -- Credit Suisse -- Analyst

Hi. Actually Chris on for Susan. My first question is just on your announced Global Growth Initiative. Are there specific channels of distribution you're targeting?

And is there a way you could quantify the pace of growth acceleration you're expecting at the back half of this year and possibly into 2020 as well?

Ophir Yakovian -- Chief Financial Officer

Hi Chris thanks. Thanks a lot for the question. Actually, when we are looking on this Global Growth Acceleration Plan, we intend to continue our investment behind our U.S. operations. And we are coming with quite large investments also -- I mean, in headcount and sales force, but also creating some other momentums around technology by creating this new innovation group to help us to come with better technology services and approach in our consumer and customer journey.

So first and foremost will be the U.S. operations when we are becoming -- want to invest more behind our sales force. And then, I guess, around the consumer and customer journey of ours. For that, we are kind of coming with -- also with efficiency program with quite direct cost-cutting exercise in order for us to fund this future growth of ours and to fuel it.

And I think altogether, it's kind of a 3-years plan, which -- during these 3 years, we expect the company to acquire market shares in a few markets, continue to invest in our main markets and to become more efficient.

Christopher Frank Kalata -- Credit Suisse -- Analyst

Okay. And just as a follow-up. Could you just give us a sense of what your current capacity utilization is in the U.S.? And what your target run rate is for going forward after you execute on this plan?

Ophir Yakovian -- Chief Financial Officer

So again, what was the question, please? I didn't get it.

Christopher Frank Kalata -- Credit Suisse -- Analyst

Just what your current capacity utilization is in the U.S., given that you're going to be reducing it by 50%? And what's your room for expansion going forward after the reductions?

Ophir Yakovian -- Chief Financial Officer

So all in all, as we are a global company, we are supplying our demand from 3 different plants and 7 lines. I guess the total capacity, the one that we are putting a focus on, and I think we are now moving from 80% utilization to 85% by shutting down temporarily this line -- one line in Richmond Hill plant.

Altogether, I think we will be around 85% utilization. So we are going to have enough room for any growth increase or any more demand coming from the markets definitely for the next 2 to 3 years.

Operator

Our next question comes from the line of John Baugh with Stifel.

John Baugh -- Stifel Nicolaus & Company -- Analyst

Thank you for taking my question so I wondered if we could talk a bit of the Chinese impact, both in the United States as well as perhaps Australia. In the U.S., I would assume that inventories are coming down and that perhaps your business sequentially by month from January to

April is somewhat better or less pressured and I'm excluding IKEA from that. So is that right? And is that sort of expected to continue? Or has that not happened yet but you still expect it to happen in the second half?

Yuval Dagim -- CEO

Hi John. Great to hear you. I think if you remember in our last conversation, we kind of explained that we are not seeing the large amount of demand coming our direction from the new tariffs on products coming from China. And I think it's still the case, we are not seeing a huge amount of demand at the moment. I think all in all, if we look at it correctly, I guess, we will not be competing with the Chinese volume neck to neck. It was -- most of it -- 90% of it was to serve the low end of the market, and we are playing in the medium and premium end.

Having said that, I think what we should be experiencing is a bit of more -- or a bit of less pressure on prices. And I think that's something we should be expecting. Having said that, if we will have brighter views or better vibes on demand over the next few months, we will be more than happy to share it with the market.

Thank you for that.

John Baugh -- Stifel Nicolaus & Company -- Analyst

And what are you seeing specifically in Australia and/or other parts of the world as it relates to the Chinese competition?

Yuval Dagim -- CEO

So I think in both countries that we were kind of expecting to see some maybe increase in competition levels, Australia and Canada. At the moment, what we are not experiencing that harsh competition. I think it's maybe still to come or not.

I think what we are experiencing in those 2 countries is actually a bit of slowdown in the industry. And I think not too much of greater competition.

Ophir Yakovian -- Chief Financial Officer

I'd just say that -- to that in Australia, John, we do see a competition from China, but it didn't change to what we see in the market since the new tariffs implemented in the U.S. So we see this competition. They are there, but it's not -- it didn't change dramatically.

John Baugh -- Stifel Nicolaus & Company -- Analyst

Okay. And I'm trying to -- obviously, the U.S. facility has a lower margin than your Israeli lines. But I'm curious, is this decision in any way to temporarily close the U.S. line relating to either increased sourcing of product around the world? Or the view that a home seller won't come in with significant volume, which I would presume would make sense to service from the U.S., perhaps not.

I'm just trying to read if anything into the U.S. line closure as it relates to your sourcing strategy or your expectation for home center gain?

Yuval Dagim -- CEO

So John, we are following in terms of sourcing the original plan for the year, and we are kind of sourcing out of our own production facilities. And the amount we plan to do, I think, the temporary closure of the line in the U.S. will serve, I guess, 2 main drivers at the moment -- or regions. One is really to make sure that our utilization is becoming better and we're not building inventories anymore in our yards.

That's one element. And the other one is to allow us to focus on this one newly line -- relatively new line in Richmond Hill plant to make sure that we are kind of closing the gaps that -- ongoing gaps, I guess, of the KPI productions -- production KPIs against the other plants that we have in Israel. So it's actually a good opportunity for us to focus resources.

We are not coming too short on headcount with this specific plan and actually investing more human resource around this one line in order to become more professional. And when demand will increase to open the other line on a stronger base and professionalism of the plant.

John Baugh -- Stifel Nicolaus & Company -- Analyst

Ophir, what is the nonrecurring import-related expense of $1.1 million?

Ophir Yakovian -- Chief Financial Officer

It is -- actually, we had this charge in the previous quarter and this is kind of completion to that, it's related to some custom-related items, and we don't expect this to recur in the future. This is -- I can say in confidence that this is the last quarter that we should see this one-timer.

John Baugh -- Stifel Nicolaus & Company -- Analyst

Okay. Good. And then I noticed legal settlement and loss contingencies were down almost $1 million year-on-year. Is there anything to read into that?

Yuval Dagim -- CEO

Thank you I don't think so, john. It's -- we are recording the expenses as we get the claims. So it fluctuates a little bit. You can see it between the quarters. I wouldn't take anything for the future on that.

John Baugh -- Stifel Nicolaus & Company -- Analyst

Thank you very much. Good luck and here you.

Operator

Our next question comes from the line of Michael Rehaut with JPMorgan.

Analyst -- -- Analyst

This is actually Maggie (ph), on for Mike. First I wanted to ask kind of about your longer-term gross margin trajectory. I think you said that in 2019, you see gross margins gradually improving over the year and ending kind of at a similar level to 2018. But as you look a couple of years out, how are you thinking about margins?

Ophir Yakovian -- Chief Financial Officer

Maggie. Thank you. Thank you for the question. We do expect gross margin to improve in our -- I would say, that in the longer-term goal, not talking about the next 1 or 2 years. We do expect to be higher than maybe 30% to 35%, something in that area, but I would not specify the exact time that we really expect to get there.

Currently, we are working. We do think that we will see gradual improvement in the gross margin next year and years to come.

Analyst -- -- Analyst

Okay. Thanks. And second and I apologize if I missed this earlier, but I know sometimes you'll quantify the -- some of the tailwinds and headwinds that affected gross margin during the quarter. So I was wondering if you could do that for your 1Q results.

Ophir Yakovian -- Chief Financial Officer

Yes. We did that when we had some big fluctuations and we wanted to give more color, but we are not providing this information on a regular basis.

Operator

There are no further questions in the queue at this time. And I would like to turn the call back over to Yuval for closing remarks.

Yuval Dagim -- CEO

Thank you for your attention this morning. We look forward to updating you in the coming quarters. Thank you very much.

Operator

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.

Duration: 27 minutes

Call participants:

Brad Cray -- Investor Relations.

Yuval Dagim -- CEO

Christopher Frank Kalata -- Credit Suisse -- Analyst

Ophir Yakovian -- Chief Financial Officer

John Baugh -- Stifel Nicolaus & Company -- Analyst

Analyst -- -- Analyst

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