Greetings, and welcome to the Caesarstone 4th Quarter and Full Year 2017 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. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Allison Kane of ICR.
Thank you. You may 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 Q4 2017 earnings release, which is posted on the company's Investor Relations website. With that, I'd like to now turn the call over to Renan Zilberman, Chief Executive Officer of Caesarstone. Renan, please go ahead.
Thank you, Alison. Good day and welcome to our conference call to discuss our Q4 and full year results as well as our outlook for 2018. I will start by providing some financial highlights from our 4th quarter. We grew our 4th quarter revenue by 9.8 percent to a new 4th quarter record of 100 and $48,000,000 On a constant currency basis, our growth was 7%. We continue to experience gross margin pressure in the quarter.
This was primarily from lower throughput in Israel due to an increased portion of differentiated high products. We also saw some pressure from the increased polyester prices. On the positive side, while we still have much work to do at Richmond Hill, our organizational and operational improvement have begun to deliver benefits and I will speak about it more later. The 4th quarter adjusted EBITDA was $21,000,000 a margin of 14.2%. This was within our guidance range, but in the lower end despite the sustained stronger pace of sales growth.
The adjusted net income was $8,000,000 and our adjusted diluted EPS was $0.22 To be clear, these highlights and the annual numbers I will give exclude the impact of the $17,000,000 legal expense we incurred in the quarter. This is mainly the result of an arbitration commenced back in 2011. I'd like now to discuss the full year of 2017. We grew sales by 9.2 percent to a record of $588,000,000 dollars with constant currency growth of 7.4%. Our 2017 adjusted EBITDA was 100,400,000 dollars Adjusted net income was $50,000,000 and our adjusted diluted EPS was $1.45 This has been a challenging year.
We were pleased with our top line increase, especially with our 10% growth in the U. S. After a flat year in 2016. We are also pleased with our 1st year of direct K, which brought significant double digit growth and we believe it represents a solid growth opportunity going forward. At the same time, our growing quartz category has continued to evolve with increased competition for manufacturers in low cost countries.
Our intention is to accelerate the innovative stream of new products and to continue leading the global market with our premium brand. And in addition we have accelerated our efforts to diversify our production sourcing of basic design and colors to improve our competitive position. With respect to our manufacturing challenges, in Richmond Hill, the organizational changes that we have implemented in September have had a considerable positive impact. We saw a significant improvement from the 3rd quarter in all the aspects, throughput, yield rates and cost management. In Israel, we continue to experience lower throughput as a result of the increased portion of our differentiated products as well as their complexity level.
While we expect some of the pressure to continue, we are working hard to implement the identified opportunities for improvement. In order to maximize revenue capture, we are building better level of inventories availability across all the regions. I would like now to provide an update on each of our regions for the Q4 and the full year. In the United States, we grew our 4th quarter sales by 10.3% to $60,600,000 compared to $55,000,000 of last year. We believe that the United States hold a tremendous future potential for growth.
For the full year, our sales growth in the United States was 10.2%, a significant improvement from last year's flat performance. We are determined to keep our growth at a healthy rate in the year ahead. Australia sales in the 4th quarter were 36,700,000 dollars up by 1.7% compared to $36,100,000 of last year. On a constant currency basis, Australia was down 0.5% in the Q4. This is primarily reflects the continued weakens that the overall housing market is experiencing.
As you know, we are quite well penetrated in Australia and so we feel the macro pressure in our business. For the full year, Australia sales were up by 5.1 percent to 137,600,000 dollars and on a constant currency basis the full year growth rate was 2.1%. In Canada, a consistently strong contributor to our growth, we grew the revenue by 15% to $24,700,000 in the quarter. On a constant currency basis, growth in Canada was 9.5%. For the full year, Canada sales grew 14.1% to $97,800,000 and on a constant currency basis full year growth was 12 percent.
The sales in Israel were $9,900,000 for the quarter, up by 1.2% compared to last year. On a constant currency basis, sales were down by 7.4 percent and for the full year, Israel sales were up by 4.6% to $44,500,000 but down 2.1% on a constant currency basis. This trend reflects the challenging market condition and as you know this is a highly mature market. Europe sales in the 4th quarter were $6,400,000 up by 22.7% compared to last year. On a constant currency basis, sales were up by 17.5%.
For the full year, Europe sales were $28,700,000 up by 12% and up by 11.2% on a constant currency basis. The increase in the quarter and the full year primarily relates to our successful transition to direct distribution in the United Kingdom. Revenue in the rest of the world during the quarter was up by 31.8 percent to 9,900,000 dollars On a constant currency basis, revenue was up by 23.1%. For the full year, sales in the rest of the world were $34,200,000 up by 9.9% and up by 7.6% on a constant currency basis. I'd like to discuss now our decision on dividend distribution.
As we announced today, we have decided to distribute a special cash dividend of $0.29 per share enabled by our strong cash balance, our positive cash flow from operation, as well as our confident outlook for the future. This is a return of excess cash that we believe is beyond what is required to fund our growth, either in terms of capital expenditure or working capital needs. We also announced a new dividend policy where we intend to pay $0.10 to $0.15 per share on a quarterly basis subject to a certain condition and at the discretion of the Board of Directors. We believe that this is a very appropriate way to return value to our shareholders without sacrificing our strategic options. As we announced today, we've appointed a new Chief Financial Officer, Ophir Yakovian.
Ophir has a strong background in industrial and public companies traded in the U. S. And I believe he is a natural cultural fit for the company. I would like once again to thank Yair for his many years of excellent service to the company in which he was an important contributor to our success. Yair,
thank you
very much and go ahead. Thank you for
the kind words, Ryan Ann, and good morning to everyone. I will now refer to our income statement for the Q4. Global revenue in the 4th quarter increased by 9.8 percent to $148,100,000 compared to $135,000,000 in the Q4 of last year. On a constant currency basis, revenue grew by 7%. Gross margin in the quarter was 31.3% compared to 38.1% last year.
Relative to last year, the primary factors for the decrease in margin were lower production throughput in Israel, as Ranan described, higher material costs related mainly to polyester prices, lower average prices in some regions and increased component of fabrication and installation revenue, which comes with lower margin, mainly related to our growth with IKEA. Operating expenses in the Q1 were $51,300,000 or 31.6 percent of revenue versus $32,300,000 last year, which was 23.9 percent of revenue. This increase was mainly attributable to a $13,900,000 increase in legal settlement and loss contingency expenses related mainly to the arbitration results with Fargilladie as previously disclosed. I would note that following the publication of the award by the arbitrator, Fargilladie submitted a motion to correct the damage amount by approximately $3,700,000 which we objected and is pending the arbitrator decision. Excluding legal settlement and loss contingency expenses, operating expenses in the 4th quarter would have been $34,300,000 or 23.1 percent of revenue, compared to $29,200,000 which was 21.6 percent of revenue in the same quarter last year.
This increase primarily reflects higher marketing and sales effort in the U. S. And the start up of direct distribution operation in the U. K. Our Q1 GAAP operating loss was $4,900,000 compared to operating income of $19,100,000 in the Q4 of last year.
Adjusted EBITDA in the Q4, which eliminates share based compensation and legal settlements and loss contingencies was $21,000,000 a margin of 14.2% compared to $30,000,000 a margin of 22.2 percent last year. This reflects the changes in gross margin and SG and A items just discussed. Finance expenses in the Q1 were $1,100,000 up slightly from $1,000,000 last year. Expenses related to exchange rate fluctuations were up by $600,000 but the increase was offset with higher interest income from our bank deposits and reduced bank fees. Taxes in the 4th quarter were $35,000 compared to $2,800,000 last year.
We recorded a small tax expense this quarter despite a consolidated loss before taxes, given a higher portion of taxable income generated outside of Israel, where tax rates are higher. I want to note that we recorded a one time credit of approximately $1,000,000 related to the recent U. S. Tax reform given our net deferred tax liability balance in this region. Adjusted net income attributable to controlling interest in the 4th quarter was $7,700,000 compared to $18,100,000 last year.
Adjusted diluted earnings per share in the quarter were $0.22 compared to $0.53 in the same period last year. Both figures are on 34,400,000 shares. Now I would like to quickly review our full year financial performance. Revenue for the full year was up 9.2%, growth of 7.4% on a constant currency basis. Gross margin was 33.5% in 2017 compared to 39.5% last year.
Similar to the Q4, the annual change in margin was driven by a combination of lower manufacturing throughput in Israel, higher raw material costs related to polyester prices, increased portion of production in Richmond Hill and increased component of fabrication and installation revenue. Operating expenses in 2017 were $156,700,000 or 26.6 percent of revenue compared to $119,700,000 or 22.2 percent of revenue last year. I would point out that legal settlement and loss contingency expenses were $24,800,000 in 20.17 compared with $5,900,000 last year. Excluding legal settlement and loss contingency expenses, operating expenses would have been 22.4% of revenue compared to 21.1 percent of revenue in 2016. That reflects mainly That reflects
mainly the planned investment in marketing
and sales capabilities that are supporting better growth in the United States and the newly established direct distribution operations in the United Kingdom. GAAP operating income was $40,500,000 compared to $92,800,000 in 2016. Our adjusted EBITDA was $100,400,000 a 17.1 percent margin, down from $130,300,000 last year, a margin of 24.2%. This decrease primarily reflects the gross margin pressure and the investments made within our business this year in sales and marketing. Our taxes for the year were $7,400,000 compared to $13,000,000 last year.
As percent of income before taxes, the 2017 rate was 21.2% compared to 14.5% in 2016. The effective tax rate increase is related to a larger portion of our taxable income being generated outside of Israel, mainly in the United States, where tax rates are higher. In addition, the proportion of non deductible expenses out of the taxable income was significantly higher in 2017. Adjusted diluted earnings per share in 2017 were $1.45 compared to $2.33 in the prior year. Turning to our December 31 balance sheet.
We had cash, cash equivalents and short term bank deposits of $138,700,000 with $38,300,000 in free cash flow generated during the year. In addition to Ranan's comments on the decision regarding the dividend, which I certainly agree with, I will note that the dividend record date is February 21, 2018. The dividend is payable on March 14, 2018 subject to applicable withholding tax. With respect to our view of 2018 and our guidance, we are expecting revenue in the range of $612,000,000 to $632,000,000 With respect to adjusted EBITDA, we are guiding to a range of $102,000,000 to $110,000,000 In this respect, we would like to note that we expect Richmond deal overall year over year impact to be positive due to operating improvement, partially offset by its becoming a larger portion of our total production. In addition, we expect a continued negative impact from increasing polyester prices.
Given our strong performance in the Q1 of 2017, we expect the Q1 to be the most challenging year over year comparison on both revenue growth and adjusted EBITDA. Thank you and I will turn it back to Arnon for closing remarks.
Thank you, Yair. Looking ahead at our 2018 challenges and opportunity, I can see the following vectors. We will continue to experience headwinds from the following vectors. 1, as you mentioned and as I mentioned before evolving low cost competition in the USA. 2, its external factor is the increase of polyester prices.
And number 3, which I mentioned as well before, softer housing condition in few of our markets, including Australia, Canada and Israel. At the same time, we expect to benefit from tailwinds due to 1, the improvement in the manufacturing of Richmond Hill. This is going on a good direction. 2, our new and differentiated exciting product 3, the strong brand position and 4, the fundamental growth that exists in the category. We will remain focused on the high end of the quartz market.
However, with the developing and growing those segments. In terms of performance, as we just guided, we are planning to continue and grow the top line between 4% to 7.5% and increase our adjusted EBITDA between 2% 10%. Thank you. And we are now ready to open the call for any question.
Thank Our first question comes from the line of Michael Rehaut with JPMorgan. Please proceed with your question.
Hey, good morning. This is Nivasan Malik in for Mike. So I guess starting on gross margins, I appreciate your commentary there. But I guess given the result this quarter and your guidance implying roughly flat EBITDA margins, how do you think about gross margins in 2018? And then I guess, is a significant piece of that the shift to big box?
Or what do you see as improving? Or is it sort of a level you expect to persist for 2 to 3 quarters?
Thank you for the question. And so, I mean, if you take our mid range guidance, it implies basically same EBITDA margins of 2017. I prefer to not break the guidance by P and L item, but we do expect some operating expense leverage this year. And therefore, the conclusion is that there will be slightly lower gross margin taking into account polyester prices and increased fabrication and installation.
Just to make sure that we are all in line, total dollar of gross margins are going to go up, okay. And if you'll do the math, as Yair said, you will see that it will be around $10,000,000 The margins are going to stay more or less the same as Yair mentioned, okay. But total dollar are going to go up.
Okay. That's helpful. I guess just looking at marketing and selling and G and A, I mean, do you see that as kind of continuing to increase with further investments as you're continuing the U. S. Strategy or is that sort of fly lining?
So we made a big investment in 2016 2017 in the U. S. We also started our distribution operation in the U. K, which was another point of investment. We while we intend to grow the expenses, we believe that our top line growth will leverage this.
So in percentage, we believe that operating expenses should be lower than last year, excluding legal settlement and loss contingencies.
Okay. That's helpful.
Thank you. Our next question comes from the line of Susan Maklari with Credit Suisse. Please proceed with your question.
Hi, this is Chris on for Sue. Thanks for taking our questions. So I want to touch on some of the lower ASP you guys are seeing in some of your regions. I know you said it's driving some of the gross margin pressure. So I was wondering if you could touch on what regions you are seeing those pressures and whether or not what's driving the lower selling prices there?
Yes. Looking at the ASP, I'll first refer to your question on the region. Primarily, it's coming from the U. S. And Australia.
However, we see low cost competition coming also in China and other markets. But as I said, the main markets right now are U. S. And Australia. Now you have to look inside the price pressure because it's very interesting.
If you look at the same model, the like for like, there is clear erosion in prices. However, the way we protect ourselves to try and to cope with it is in 2 ways. First, what we do is that we are coming ongoing basis with new and exciting products that allow us to charge for higher pricing. So this is offsetting some of the mix, some of the like for like price erosion. And naturally, we are selling more and more in the states and less and less in countries like Israel or the rest of the world, and this is helping as well.
So if you look from the top, top, you don't see really price erosion. However, inside there is a price pressure and the way to cope with it again is those unique and differentiated product, which bring them the toll of more longer cycle times, more complicated production, higher cost and therefore longer cycle time and the pressure on the gross margin is coming in instead of from the top, it's coming from the bottom. So I hope that this was a good enough explanation.
Yes, thanks. That was very helpful. And then just my second question, I was hoping to touch on the UK growth strategy. I was wondering if you could explain if there's any differences in the competitive landscape versus the U. S.
Or Australia or some of the other regions and what's kind of driving success
there? Yes. U. S. Market is a pretty Virgin Island.
So we have only one major competitor and therefore we still see a fundamental demand that exists in the market. What works for us as well is that we moved from a distributor to a direct distribution. So we take more responsibility on the entire supply chain. And with that, we feel that we are enhancing the relationship with our value chain. We feel that there is a lot of work to gain in the market.
It's not a market of 100 of 100 of 1,000,000 of dollar, but it is a market of, let's say, around $100,000,000 that we can still continue and grow significantly. So we see it as a good opportunity and we've got a good outlook for the market.
Okay. Thanks for that.
Thank you. Our next question comes from the line of John Baugh with Stifel. Please proceed with your question.
Good luck in your future endeavors. And thank you for your support. I guess a question first on inventory. It's up 30% roughly year over year. Is that a good thing or a bad thing?
Is that planned? What's the composition of inventory finished versus work in process? Are you in a better stocking position? Any color on the inventory?
So generally speaking, we've taken a principal decision to increase our inventory. And the reason is that we are coming into days where people there is a much a lot of competition out there in the market. And people are consumer are expecting to a quick response. There were days when we were alone and people were willing to wait few weeks to get those lab, not anymore. So actually what you see is just the beginning.
We've taken the decision to increase the inventory in 2018 by a little bit more, let's say another half of a month in the USA in terms of inventory and here and there in some other places. So all in all, we see it as a positive thing and we believe that with better inventory, there will be better availability and better serving the needs. So it's absolutely not coming from lack of control. It's in a managerial decision it's going to continue.
Okay. And then there was commentary about diversifying sources and I would assume that this is the commodity quartz you're selling but not making. I guess I'm trying to get a sense of how much of your business currently is sourced? And then what, in terms of a cost benefit you see in 2018 or beyond in sourcing from other areas?
Well, John, let's start from first the principle. The principle is that with the low cost competition, there is a very interesting phenomenon. A new market is emerging, market that was not exist before. Historically, we were working, we were inventing and working in the high premium market. And that's where we pointed all the years and these were our consumer and customer.
And with low competition, it's more affordable and people that could not afford in the past quartz. Caesarstone need to decide if we want to take part in this market. We can stay where we are today serving the premium market or we can say, let's look at the mass market, maybe not compete in all the range, but let's take the premium part of it, the upper part of it and be relevant to people over there. A good example is the big box, but it's not just in the big box, it's happening in all the segments, It's happening in the K and B. It's happening in the with the contractor.
This is a strategic decision that we are now debating nowadays. One of the way to address that competitive market is to be relevant both with the cost of the product, but also with its supply chain. This is the motivation to try and diversify the sourcing of the commodities product. I think at this stage we don't want to reveal how much of it is done internally or externally. But I would say that it's not a major thing.
The majority of what we do, we do on our production line and with our full control. By the way, the entire OEM production is under our control and our specification, but not just theoretical one, including our people at the source, making sure that the quality is maintained as the level that we expect to have in season storm.
So, Renan, not to put words in your mouth, but are you trying to say that while Caesarstone will stay at the high end, whether it's K and B or possibly Big Box or Builder Channel that you need a product offering in a lower price point to be competitive or maybe win the high end business along with the growth in the middle or lower price points? Is that essentially the strategy or the shift here?
To some extent, I would say it's fair, but it is even more than that. Think about OEM as kind of a muscle that you want to have, a, to answer certain range of your demand, but also as a muscle that gives you flexibility to fluctuation of inventory need, of supply need, etcetera, etcetera. So I think most of the manufacturers today, definitely the big manufacturers today today try to maintain certain degree of flexibility with outsourcing. And it's a new era for us. It's the 2nd year.
1st year went pretty well. And we are considering to strengthen that muscle, absolutely.
Okay. And my last question relates to capital spending and the dividend decision and maybe production capacity. In theory, I think you have $100,000,000 of capacity per line. You have 7 lines. You gave us your revenue guidance, and I believe it takes 2 years, give or take, before production can begin from decision to commit capital.
So it would appear that paying a sizable dividend and no one else plans to add capacity that you plan on growing your revenue through a lot more sourced product? Or am I wrong and you have plans to expand capacity, just haven't announced it yet?
John, it's a fair observation. I would say a mixture of it, which means 1, we believe that we have sufficient money. By the way, the dividend is relatively not a big dividend. Now let's take it in proportion. We are talking about small numbers.
However, 1, we still believe that we have enough money to invest if we will decide to invest in capacity. Nevertheless, it's true as what you say in the short term, I believe, and it goes with what I said in the past that the company needs to step by step move the center of gravity from industrial company to a commercial company. I believe that building the muscle of OEM, allowing us to use capital and resources to the commercial side of the business or in the future to M and A if it's needed. I think it's a decision that is not in conflict with the decision to bring some value in a marginal way or in a reasonable way with the dividend. So to cut a long story short, there's no conflict.
And yes, the needs that we will have in the short term probably we will have sufficient resource to use or will be used by outsourcing.
Thank you.
Thank you. Our next question comes from the line of Lena Rogovin with Chardan Capital. Please proceed with your question.
Hello. Thank you for taking my questions. Actually, I have 2. The first is about revenue growth in the U. S.
In Q4. We see some acceleration compared to previous quarter. So the question is, what was the reason for that? Is that the market in general was stronger? Or is it because of the product mix?
And what should we expect in the next quarters? And my second question is about production issues in Israel. When you say that you expect pressure to continue, is that something you know how to manage in the foreseeable future or that's the new reality, the production of differentiated product? Thank you.
Okay. So Eileen, on the revenue growth side, indeed revenue we were pleased with the revenue results for the quarter. And it was above the growth rate that we demonstrated in the second and the third quarter, primarily because of the U. S. Growth rate and the growth rate in Europe and in the indirect market in general, partly because of U.
K. Growth. Yes. Which by the way, U. K.
Growth just it's an easy comp. I have to be fair and say that it's an easy comp because last year in the second half of the year when we had to terminate the distributor, it was very tough there. So just want to make a note.
Yes. Thank you. I was actually asking about excuse me, I was asking about the U. S. Growth specifically.
So U. S. Growth was again was the in Q1 was better 17% then it was 8% 6 percent and then back to 10%, we had a very good core growth this quarter compared to Q2 and Q3 and actually the growth rate of IKEA has accelerated a bit.
Yes. So just to echo on what Yair said, I do agree we had a very strong Q1 and a very good Q4. In the middle, it was a little bit softer. But I take the opportunity to stress what Yair already mentioned before that due to the fact that we had a very strong Q1 in 2017, we are expecting in terms of growth a little bit softer growth in Q1 this year. And as you know, our company is based on a lot of fixed cost.
And if Q1 is going to be a little bit softer in terms of growth, then it means that the margins will follow. So if you ask about the outlook of the or the development of the quarter during 2018, it will be fair to say that we will start a little bit slower than what we are expecting the year to end. In regards to your question about the Israeli plant, it's a good question. And I must admit that it's a little bit different case than the one in Richmond deal. So in Richmond deal, when I came, when I joined, I recognized that there is 2 main issues.
1 was leadership issue in the plant and the second was no out transfer. And therefore, we assembled the solution that was kicked off in August and immediately brought the result and I believe that we are on a good path. As Yair said, I believe that this is the last year that it was a negative contributor to the margin. In Israel, it's a different situation. I think I mentioned to you in the past that I've been traveling and I've seen quartz manufacturers all over the world.
Some of them we wanted to buy, some of them are our suppliers, etcetera, etcetera. The throughput, I can tell you the throughput in the Israeli plants are the best in the world. I don't know any quartz manufacturer in the world that have such a throughput as the throughput in Israel. However, it will be fair to say that we are amounting more and more complexity on those plants in order to differentiate from the rest of the market. And with that, we are suffering slower throughput.
Now the way to cope with it is not to change somebody or not to move transfer from the United States. Those are not going to help. What we need to do is what you do in industrial life. It's very, very detailed competent thorough work of operational excellence, Kaizen team, etcetera, etcetera to try and to improve it. I can say that we definitely rock the boat.
We hired an external company to work with the team on Kaizen events. We are putting a lot of efforts. We are changing the incentive system in the plants. We are focusing on a daily basis on the issues. But those kinds of things that you don't solve overnight.
In our assumption that was also translated to the guidance, we took a target in 2018 to stabilize the erosion that we've seen in the throughput during 2018. So I'm expecting a very slow stabilization and then step by step ramp up. I'll be smarter in quarter or 2 from now and we can discuss it further.
Thank you very much. That's very helpful.
You're welcome.
Thank you. There are no further questions at
this time. I would like turn the call back over to Mr. Zilberman for any closing remarks.
No, I just like to say thank you for your time and attention today. We look forward to update you on our business next quarter and talk to you soon again. Bye bye.
Thank you. This concludes today's teleconference. You may disconnect your lines at this time.