Caesarstone Ltd. (CSTE) Q2 2020 Earnings Report, Transcript and Summary

Greetings and welcome to the Caesarstone Limited Second Quarter 2020 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, Brad Cray. Thank you, Brad Cray. You may begin.

Thank you, operator, and good morning to everyone. I am 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 SEC. In addition, on this call, the company will make reference to certain non-GAAP financial measures, including adjusted net income, loss, adjusted net income loss per share, adjusted gross profit, adjusted EBITDA and constant currency. The reconciliation of these non-GAAP measures to the most directly comparable GAAP measures can be found in the company’s second quarter 2020 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. I’m incredibly proud of our entire team for the commitment to excellence and consistent improvement during the second quarter. Since our last earnings call in May, we’ve continued to work hard to manage through the far-reaching impact of COVID-19 to protect the health and well-being of our employees, trade partners and customers. While health and safety remains our top priority, the Caesarstone team has focused on operational performance and financial strength in this dynamic environment. By being adaptable, we were able to quickly right-size our resources and continue to safely deliver our premium contractor offerings across our global footprint. Protecting our strong financial position is a priority and we have taken steps to improve our working capital and maintain our liquidity. As we look back to those decisive actions, we believe we have so far effectively mitigated the impact of various economic limitations and shelter in place guidelines that were beyond our control. We were encouraged to see sequential demand improvements in June as more businesses are open and consumer adapt to the new social distancing reality. This led to second quarter results that were better than our expectations at the onset of the pandemic in all our four global regions. We will continue to focus on controllable factors such as managing cost, preserving our strong capital position and flexing our capacity as needed to appropriately address demand. While we work to maximize our market opportunity into the recovery, we are also keeping a sharp focus on executing many structural business enhancements as part of our Global Growth Acceleration Plan. Even as we reduced our CapEx as part of the mitigation to the situation, we are still allocating resources and executing against the plan to improve our business over the long term, primarily in areas of product innovation, go-to-market capabilities, technology and production processes. We continue to invest in innovation and we are very excited with our strong pipeline of new models we are launching this year and plan to introduce to the market in the coming months. In addition, the award-winning Solaris outdoor collection that we rolled out last quarter has opened new markets for us. We continue to make further progress on improvements to our go-to-market approach, including greater use of technology to leverage our virtual capabilities in this new environment. As we move into the balance of 2020, we are confident in our ability to continue improving our sequential revenue performance as the recovery takes hold. We believe our strong financial resources, talented workforce and transformative investments position us to deliver on our long-term approach to value creation. And 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. Before I begin, I would like to remind you that a significant portion of our business is tied to residential, repair and remodel. Recent months, the combination of shelter in place guidelines, social distancing practices and overall economic uncertainty have collectively pressured demand resulting in significant pressure to our top and bottom line. A positive note, these impacts were much more pronounced in April and our business momentum improved as we progressed in the second quarter. With that backdrop, for the second quarter of 2020 global revenues was $99 million compared to $141.1 million in the second quarter of last year. On a constant currency basis, second quarter revenue was lower by 28.3% compared to the same period last year. As Yuval mentioned, this was better than our initial expectations at the onset of shelter in place guidelines implemented across our global footprint. We experienced the majority of the adverse revenue impact in April and May, primarily in our Americas region. However, since that time, we are encouraged to see improved business activity as more of our customers opened for business and demand began to return. In July, global sales declined in the high-teens percent range year-over-year reflecting an improving trend in sales performance compared to the second quarter. Looking at our markets, we have seen various pandemic-related impacts. In the Americas, shelter-in-place guidelines remained in place through May and June in many cases but have now been lifted across most of the U.S. and Canada. The U.S. IKEA stores were closed for the majority of the second quarter, which naturally had an unfavorable impact. This was partially offset by increased activity compared to last year in the big box channel at Home Depot stores, where we have a new and expanding presence. Canada performance also remains affected by soft housing and remodeling markets combined with intense price competition, primarily from China. In the APAC region, we have seen various pandemic-related impacts. In Australia, we saw relatively better performance than other countries due to the government’s effective response in controlling the virus at the onset of the pandemic. That said, the soft market conditions that existed prior to the pandemic, coupled with more intense competition, were still unfavorable factors impacting the market. In the EMEA region, both our indirect and core sales were impacted by government lockdowns due to COVID-19, although we have seen some improvement starting June. In Israel, the COVID-19 impact on our business in the second quarter has been relatively less severe as very strong sales in June grow mid-single-digit top line growth in the second quarter. Looking at our second quarter P&L performance, our margin performance and bottom line results were better than our initial expectations at the onset of the pandemic, particularly driven by our swift actions to control costs. Adjusted gross margin was 20.5% compared to 27.3% in the prior-year quarter. The lower year-over-year adjusted gross margin mainly reflects lower sales volume and less favorable regional and product mix as well as currency exchange headwinds that were partially offset by lower raw material prices. Excluding legal settlements and loss contingencies, operating expenses for the quarter benefited primarily from previous efforts of our Global Growth Acceleration Plan to improve efficiencies, combined with tight cost control from our business continuity measures driving lower marketing and sales expenses as well as lower general and administrative expenses. Last quarter, we discussed some of the actions we have taken to improve our financial position during COVID-19. As part of that, we limited capital expenditure and delayed investment related to our Global Growth Acceleration Plan. As demand level normalized, impacted by our strong balance sheet, we plan to accelerate our actions to improve our position by deploying more resources into our Global Growth Acceleration Plan. We continue to evaluate our levels of production capacity to meet expected demand. To date, we are pleased with our ability to flex capacity and control inventory, which has helped us to carefully manage our working capital. For the third quarter, we expect the sequential improvement in volume to have favorable impact on gross margin compared to the second quarter. Furthermore, last quarter, we took necessary actions to improve our cost structure including moving portion of our workforce to part time or reduce shifts, as well as furthering portion of our employees and freezing hiring. We have now begun to bring some employees back to full time. We are also beginning to bring marketing and promotional spend budgets gradually back to more normal levels, particularly in areas where demand is returning, although we continue to enact strict controls over nonessential expenditures. We believe we have a strong financial position and the flexibility required to support our global operations into the coming quarters. Our prudent efforts to control costs, manage our working capital, improve our operational structure and manage production capacity have collectively allowed us to preserve substantial cash position of $130 million as of June 30, 2020. As we move forward, we are confident that the strength of our balance sheet will allow us to continue executing against our plan to improve our business and market position. With that, let me turn the call back to Yuval for closing comments.

Thank you, Ophir. We remain committed to our strategy to accelerate our growth as a premium countertop market leader. As we look to the balance of 2020, we are cautiously optimistic for the recovery to continue steadily strengthening the demand environment. We continue to see promising market opportunities in North America as economies recover and we believe the underlying consumer interest remain strong to our best-in-class cutting-edge designs. As we look to the coming quarters and years ahead, we remain confident in our ability to leverage our strengths to become a better performing business and to generate further value for our shareholders. Look forward to update you further on our progress next quarter. Thank you and we are now ready to open the call for questions.

Thank you very much. [Operator Instructions] The first question is from the line of Reuben Garner from Benchmark Company. Please go ahead.

Thank you. Good morning, everybody.

Hi, Reuben.

So maybe we can start with the demand that you’re seeing here recently. You mentioned a couple of times improvements. You mentioned improvements in the month of June and then you gave a global number in the month of July. Can you maybe narrow it down a little bit more? What are you seeing specifically in the Americas? And then are there other areas of maybe pressure that are offsetting some improvement in certain markets? And what does that all translate to as far as expectations for demand overall in the third quarter?

Yes, Reuben. Thank you very much for the question. I think as – if I have to start with the more like a global view, we do see – we do – we are experiencing the markets being slowly open according to the changes of the lockdowns and the shelter in place guidelines market by market. Overall, we do see our revenues and volumes being improved from month to month. As for July, we have mentioned that we are still behind last year in the high teens as we expressed in July, but we are seeing a gradual improvement from quarter-to-quarter. So all in all globally, we are experiencing improvement from quarter-to-quarter. If it comes to the U.S. business, it’s relatively similar situation, although there are some differences between the different markets in the U.S.

Okay. And then within the U.S., are there any particular markets that you’re exposed to geographically that maybe you were hurt more by the shutdown? And if so, is there a situation where you’ve got some pent-up demand potentially as we move into ‘21, if there is a vaccine or a reopening of the economy where maybe you have more of a snapback than some other building products because you’ve been impacted more?

I think that we are experiencing the change in volumes and demand. According to development, the development of the pandemic in each of the regions, whether there is a second wave or they’re still running with the first wave, I think you do see a greater impact in the New York region than others. But I think it’s also the time to – maybe to mention IKEA that will probably close most of the – stores were closed most of the second quarter and just started to open in late June and July.

And so how would you – how should we think about your margin, maybe decremental margins if businesses continues to be down over the next couple of quarters? How do you think about decrementals in the back half of the year? It sounds like you’ve made a lot of moves to your cost structure. Can you just help us with the puts and takes there?

Indeed. First, I think we entered the COVID-19 environment in a relatively healthy position. On the back of the actions we took second half of last year, including some structural changes, streamlined some of our operations and taking significant cost out of the business, including reducing inventory. So the – where we entered the covenant in was relatively in healthy position. And you could see it in the amount of cash that we had at the end of fourth quarter last year and also in the end of the first quarter this year. Having said that, we very quickly took some decisions on changing our business according to this current environment, some of which was, of course, limiting our capital expenditure and making sure that we are investing only behind those essentials project, optimizing our working capital, whether it was with customers and suppliers. And I think more than anything else, and this is important also to – because it has impacted our gross margin, is looking out on being very flexible with our plants and production. And we – with the experience of 2019 where we reduced inventory to the level we wanted to be, we are taking the same exercise this year as well. Obviously, it comes in the account of gross margin as the plants are not fully utilized in order to preserve our cash position.

Got it. And then as far as for the baseball metaphor here, but what – the Global Growth Acceleration Plan, you mentioned it a couple of times. I know you started to see some progress before the virus unfolded. Can you just – can you talk about what inning you are in that plan? I know it’s tough to gauge your progress with the closures everywhere. But should we expect when things open back up that you will – well, I guess, is can you give us any update on where you are, what inning you are in that plan and just provide us with some updated thoughts?

Yes, by all means. The Global Growth Acceleration Plan was announced late second quarter last year. And I think it was another good build for entering the covenant in business environment because we already accompanied this program or this plan with structural changes and working on our company culture, especially putting up in safety at the top of our priority. So when we get into this pandemic time, when the business is more focused on health and safety, right structure, including the regional structure, and working in our culture, it was a good build to start with. And yet when we come to the specific programs or projects in the – under the Global Growth Acceleration Plan, we are allowing ourselves now when we see a bit of more – a bit of improvement in our revenues to come back to those projects that are supposed – that are will be improving our growth or helping us to grow in our company, acting as some growth engines in our business. And we source them back with our investment, so we can start or can finish this year and starting next year in a healthier position, if you like, with a better base to demonstrate our growth next year. Some of those projects will be around – looking on the right M&A efforts, especially around maybe materials or geographical spend. So we are working to see what kind of opportunities we find in the market at the moment. We are looking on tools to get – to have greater engagement with customers and consumers. We are launching a new product – new products, some of which not just different colors, but also new products that can be out of the house. And now when people are more – staying more at house looking at the backyard and having our slabs and full of quartz slabs in the backyard as well, in the gardens is a new initiative. So we are kind of touching the business in few areas and we are – we continue to invest behind those projects that will deliver growth in the short-term and the long-term.

Great. And one just final follow-up for me on that same note. So I’m hearing what sounds like to be some investment that you’re going to continue to make. Even with everything going on globally, is it fair to say that you’re comfortable making those investments even though the top line is clearly impacted by everything going on with the virus that maybe you’re willing to take some near-term pain because you see the opportunity longer term to grow the business?

Yes. I think it’s a very fair statement there. I think the way we are controlling cash now in the company is also demonstrating our hands-on approach and how close we are to operate the business in the – I think in quite effective way. We finished the second quarter with $100 million in our cash position, very similar to how we entered the COVID-19 environment, so good control around this issue. And I think we are feeling quite comfortable to look on a few opportunities that might be in the market to see if we can invest behind those.

Great. Thank you, guys, so much and best of luck going forward and stay safe.

Thank you very much, Reuben.

Thank you. [Operator Instructions] There are no further questions at this time. I would like to turn the floor back over to Mr. Yuval Dagim, CEO, for closing comments. Over to you, sir.

Thank you, Zahid. Thank you for your attention this morning. We look forward to updating you on our progress next quarter. Thank you.

Thank you very much. Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.