Caesarstone Ltd. (CSTE) Q3 2019 Earnings Report, Transcript and Summary

Greetings, welcome to the Caesarstone Third Quarter 2019 Earnings Conference Call. [Operator Instructions] A brief question-and-answer session will follow the formal presentation. [Operator Instructions] It is now my pleasure to introduce your host, Brad Cray of ICR. Thank you. You may begin.

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 third 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.

Thank you, Brad and good morning everyone. Our third quarter 2018 results reflect our focused efforts to execute the various aspects of our Global Growth Acceleration Plan that we introduced earlier this year. Execution against this plan, combined with tight cost control were the primary drivers in helping us grow adjusted EBITDA and achieve higher adjusted EBITDA margin compared to the prior year quarter. In addition, I'm encouraged with our execution in the U.S. where we drove 8% growth in our core business. This was largely due to the solid execution of our North American leadership team following the realignment of our operation in that region earlier this year. While many of our markets outside the U.S., continue to experience intense competition from low price manufacturers, I'm confident in the steps we are taking to improve our performance and enhance our position. Our new leadership team is now fully in place, executing our strategies to a variety of projects to better leverage our strong brand, more effectively control cost, increase efficiencies and streamline processes. To date we have started 90% out of an initial 30 identified projects under the Growth Acceleration Plan. Now I would like to provide several updates on our progress so far. First, on the production side, we have already begun to develop improved sourcing strategies and initiated projects to enhance productivity and stability of our manufacturing process. Our initial reduction early this year to less than 50% of our full capacity in our Richmond Hill manufacturing facility has provided us the opportunity to further improve productivity and quality. Working of these new efficient base, we now believe we are in a position to increase effective capacity to 60% while maintaining improved level of performance. Within our supply chain we are implementing new processes and technologies to improve our focusing, planning, distribution and inventory management that will provide efficiencies and better service to our customers. On the technology front, we have initiated a new IT strategy that will transform our Company into a data-driven organization as well as automate processes. Overall, we are confident that these strategic initiatives along with our strong balance sheet will better position us to generate additional value for our shareholders over the long-term. With that let me turn the call over to Ophir who will provide details on our results and outlook.

Thank you, Yuval and good morning everyone. I will start by discussing our third quarter results. For the third quarter 2019, global revenue was $142.8 million compared to $147.7 million in the third quarter of last year. More than half of the decline was attributable to adverse FX impact of $2.7 million. On a constant currency basis, revenue declined by 1.5% compared to last year, due to softer market condition in most of the regions outside the U.S. combined with more competitive markets mainly in Australia and Canada, along with lower performance in IKEA U.S. This was partially offset by improved performance in our core U.S. business and strong demand in the UK. In the United States, third quarter sales increased by 5% compared to the third quarter of 2018. Our core U.S. business grew 8% year-over-year, this marked the fifth consecutive quarter of revenue growth in our core U.S. business and is mainly attributable to the success of our North America region realignment earlier this year, including the instalment of new regional leadership team. As mentioned on our last earnings call, intense competition from Chinese manufacturer at low price point continue to pressure our global footprint outside the U.S. In Australia, constant currency sales were down 10.1% as a result of the factor I just discussed. Coupled with soft housing and remodeling markets in a more challenging lending environment. In Canada, constant currency sales were down 12.1%. Our performance was affected by softer housing and remodeling markets, combined with more intense competition from Chinese imports. In Europe, constant currency sales grew 16.3%, primarily reflecting continued strong performance in the UK. Sales in Israel, on a constant currency basis were up 7.5% as we experienced benefits from a higher number of selling days compared to the prior year quarter due to the timing of the Jewish holidays. Revenue in the rest of the world continue to experience unfavorable impact related to the Chinese competition discussed earlier and on a constant currency basis was down 10.7%. Looking at our third quarter P&L performance, adjusted gross margin was 29.9% compared to 29.7% in the prior year quarter and 27.3% in the second quarter of 2019. The modest year-over-year improvement in adjusted gross margin mainly reflects lower raw material cost and more favorable regional mix, partially offset by increased manufacturing unit costs due to lower fixed cost absorption, resulting from lower capacity utilization in addition to lower average selling prices and foreign exchange headwinds. Excluding legal settlement and loss contingencies, operating expenses for the third quarter benefited primarily from the execution of our Global Growth Acceleration Plan, combined with tight cost control, driving lower marketing and sales expenses, as well as lower general and administrative expenses. Adjusted EBITDA in the third quarter was $22.5 million, a margin of 15.8% compared to $21.6 million, a margin of 14.6% in the prior year quarter. This solid performance primarily reflects the higher gross margin compared to last year, in addition to lower operating expenses excluding legal settlement and loss contingencies. Adjusted diluted earnings per share in the quarter were $0.29 compared to $0.31 in the same period last year on a similar share count. Adjusted net income for the third quarter and first nine months of 2019 excludes also non-cash exchange rate differences as a result of the implementation of the new lease accounting standard. We ended the third quarter of 2019 with a strong balance sheet, including cash, cash equivalent and short-term bank deposits of $116.8 million with no financial debt. Moving to our outlook. As we discuss today, we expect soft global market condition and the competitive environment to persist in many of our regions outside the U.S. through year end. We continue to expect the most significant impact of these pressure in Australia and Canada, as well as in most of our indirect markets. In addition, since the last update to our outlook, currency headwinds have continued as the US dollar continue to appreciate against our other main currencies, with an estimated impact of approximately $2 million on the second half of 2019 expected revenue. Accordingly, we now expect our full year 2019 results to be at the low end of our previously communicated outlook ranges for both revenue and adjusted EBITDA. For the fourth quarter, we anticipate higher adjusted EBITDA margin year-over-year mainly attributable to operational efficiencies and cost control despite a continuation of market pressures on revenue outside the U.S. and less favorable currency exchange rates. As a reminder, the financial impact of our global growth acceleration plan is included in our outlook for 2019 and is intended to support additional growth in revenue and adjusted EBITDA over the long-term. To formulate our outlook, we have used current FX rates and raw material price. Changes to FX or raw material prices may impact our outlook. In summary, we are encouraged with the improvement in gross margin and adjusted EBITDA in a challenging environment during the third quarter. The execution of our Global Growth Acceleration Plan allowed us to generate additional efficiencies throughout the organization, helping create a strong base to achieve our long-term objectives. Now I would like to turn the call back to Yuval for closing remarks.

Thank you, Ophir. While we expect our core U.S. business to remain strong and our ongoing operational initiatives to positively impact results, the competitive environment in most of the other regions is likely to persist into coming quarters. We recognize that we are shifting the fundamentals of our organization and it will take time to fully recognize the benefits that we are bringing into the organization beyond recent margin improvements. We are still in the early stages of this initiative and based on our progress also we are confident that our new leadership team is taking the right actions to deliver on our objectives and to improve our operating performance over the coming years. I look forward to updating you further on our progress next quarter. Thank you. And we are now ready to open the call for questions.

Thank you. [Operator Instructions] Our first question is from Dillard Watt with Stifel. Please proceed.

Thanks, good morning. Maybe wanted to talk a little bit about the core business in the U.S., so a somewhat measurable deceleration in terms of the year-over-year growth from the second quarter. But I don't - I'm not sure if there is some other - some year-over-year things that you guys are lapping or anything that might, explain that.

Hi, Dillard. Thank you for the question. I think all-in-all, we do see quite interesting increase of the quartz penetration in the U.S. And we are quite encouraged by the continuous penetration of this category in the U.S. in which we are continue to - with our efforts to have a bit of go-to-market platform, we continue to invest behind our sales team and actually all the initiatives that we put in our Global Growth Acceleration Plan, are implants regarding the U.S. I think all that has been kind of - I mean effected itself in this quarter increase in - sorry, growth in our revenue with 4.6% in our core business

Okay. And on the sales team, I know that that's sort of a process to get everyone hired in, ramped up. How far along are you in terms of either the number of people or the markets you're targeting or any of those type of metrics?

All-in-all, it's a few years journey, we are really building new foundations for our business in the U.S. We are in line with our expectations for and manpower and capacity this year. And I think we have quite a robust plan for next year. All our [Indecipherable] going quite well and we are - I think bringing quite a lot of new talent to our business.

Okay. And then I guess you know IKEA, I know it's tough to answer questions about specific customers to do headwinds from a year-over-year standpoint, start to ease, whether it'd be due to their changes in their promotions or their comps or anything like that? What should we expect over the next couple of quarters in terms of the stuff that you cannot control as it relates to IKEA?

So - just to repeat the numbers again our core business actually grew by 8% and all together with IKEA, it's only 4.6%. We are - we kind of have a very close relationship with IKEA, but we can't say if it's been flattened out or not, all-in-all, I think we continue with our relationship with IKEA, supporting them in their journey and I hope that numbers will come up again.

Okay. And then I guess internationally, sort of a similar story that you've seen in the past in the United States now playing out in Europe once the dumping duties have of course been put in place and therefore you need to go elsewhere. Is there anything you've learned from the U.S. that makes you feel like you can put together some sort of defensive strategy or protect yourselves or anything like that, that you basically have the benefit of some hindsight here that you can, you can use to your advantage, is this dynamic is playing out in other markets?

I think we referred, in the past, to the fact that I think most of the initiatives we should be taking are within our company to improve the way we do business. If there is a learning, this is the learning which upon that we are putting our plans going forward. It's the same to other regions as well. Competition, there will be no existing and will be in all our regions, then we mostly focus on what we can do better, how we can service our customers with newer innovative products and services. And just to make sure that we are - at our best in each and every market.

Okay. I'll defer to others.

[Operator Instructions] There are no more questions at this time, I would like to turn the call back to Yuval for closing remarks.

Okay. Thank you for your attention this morning. We look forward to updating you on our progress next quarter. Thank you very much.

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