Caesarstone Ltd.

Greetings and welcome to the Caesarstone First Quarter 2021 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. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Brad Cray, Investor Relations. Thank you.

You may begin. Thank you, operator, and good morning to everyone. I am joined by Yuval Daguin, 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 20S and subsequent filings with the SDC. 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 first quarter 2021 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 first quarter result marked another consecutive quarter of growth as we continue to successfully execute our strategy to transform Silverstone into a leading premium multi-material countertop company. The collective actions we have taken since we announced our global growth acceleration plan two years ago have allowed us to establish an efficient global operating platform while using M&A, as an important tool to implement our strategy. This was demonstrated by 15% growth to a record first quarter revenue of $146 million, helped by our recent accretive acquisition of Omicron and Lioli Ceramica. We were also pleased to produce a third straight quarter of a year-on-year EBITDA margin expansion. Our results are encouraging and attributable to the superb execution of our entire team, for whom I am very grateful. As we have mentioned previously, we continue to view Accretive M&A as an important tool to drive sustainable long-term growth, and we are pleased to report that integrations of Omicron and Lioli acquisitions are progressing in line with our plan. We expect to begin leveraging our world-renowned Caesarton brand to execute on our multi-material strategy through the sale of ScissorStone porcelain slabs as we introduce our new premium porcelain collection in the second half of this year throughout select markets. The integration of Omicron is anticipated to be completed in the coming months and we see great potential in the combined business once fully integrated. We are pleased with the performance of Omicron's business in the first quarter with strong contribution to our revenue while augmenting ScissorStone's performance in the U.S. Another important growth leader is our continued penetration into the U.S. big box channel for ScissorStone branded products at Home Depot stores, and we are excited by our progress in this area as we nearly doubled ourselves compared to the first quarter last year. Separately, as we have discussed previously, a key focus area for ScissorStone is to leverage technology to simplify the consumer journey. A simplified and consistent approach to the countertop purchasing process is especially important to us as we further expand the global reach of our products with multi-material offerings. To that point, we are happy with the progress made during the CS Connect test launch in Australia. and we are on track to further expand the pilot program into several of our U.S. markets. We believe that CS Connect will increase our customers' sales conversion rates and fortify new and long-standing partnerships with our customers. While there are many projects still underway as part of our plan and some lingering impacts of the pandemic across our global footprint, we are highly encouraged by our positive momentum to start the year. We have a strong financial position, a more efficient operation, and a clear strategy in place to create additional value for our shareholders. I will now 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 first quarter's results. For the first quarter of 2021, global revenue increased to $146 million, representing 15.4% growth compared to the prior year period. The year-over-year increase included approximately $20 million in contribution from our acquisition of Omicron and Lioli Ceramica. On a constant currency basis, first quarter revenue was higher by 9.8% compared to the same period last year, primarily due to the contribution of acquisitions. Now looking at our regions. In the Americas, constant currency sales were up 11.8% as we began to see benefits from our Omicron acquisition. In the U.S. and Canada, our performance continues to be impacted by lower sales at IKEA stores. This impact to our big box channel was partially offset by increased activity at U.S. Home Depot stores where our first quarter performance was better than expected. In the US, we are happy with the sequential improvement in our business and see positive momentum into the second quarter of 2021. In Canada, rigid government restrictions related to COVID-19 continue to impact our sales. In the APAC region, constant currency sales were up 21.5%. In Australia, which accounts for the majority of our sales in the region, solid results were driven by improved demand and government stimulus actions. Contribution from LIOLI sales were also additive to the AIPAC region sales in the first quarter. In the EMEA region, constant currency sales grew 3.3%. We experienced strong performance in the UK, which was partially offset mainly by the impact of continued COVID-19 related restrictions on our indirect markets. In Israel, on a constant currency basis, sales were down 24.6% in the first quarter, primarily related to slow recovery from the country's third pandemic-related lockdown, which ended in late January, as well as the timing of Passover holiday. Looking at our first quarter P&L performance, We were pleased to improve our gross margin by 90 basis points on a year-over-year basis to 29.7% as we continue to benefit from our actions to improve efficiencies across our business. Adjusted gross margin improved 120 basis points to 30.1% compared to 28.9% in the prior year quarter. The year-over-year improvement in gross margin primarily reflected better product mix improved efficiencies, and more favorable currency exchange rates, partially offset by the impact of higher manufacturing unit costs due to lower fixed cost absorptions and lower selling prices. Operating expenses, excluding legal settlement and lost contingencies, were 22.3% of revenue compared to 24.7% in the prior year quarter. The decrease was mainly due to higher revenue. Going forward, we expect operating expenses to remain elevated as we return our investment in sales and marketing to a more normalized level to support our brand and future growth. Adjusted EBITDA in the first quarter increased 54.1% year-over-year to $20.3 million, percent in the prior year quarter. The 350 basis point improvement primarily reflects the higher gross margin compared to last year. Adjusted diluted earnings per share in the quarter were 42 cents compared to adjusted diluted earnings per share of 13 cents in the same period last year on a similar share count. Turning to our balance sheet. As of March 31st, 2021, Scissorstone had cash, cash equivalent, and short-term bank deposits, and short- and long-term marketable securities of $118.7 million, with total debt to financial institutions of $13.4 million, providing us with a solid net cash position of $105.3 million. The strength of our balance sheet continues to give us confidence that we can successfully execute on our strategic initiatives. In accordance with our dividend policy and based on our net income performance during the first quarter of 2021, our board declared a dividend of 21 cents per share with a record date of May 18th and a payment date of June 1st, 2021. Moving to our outlook. I would like to first take a moment to comment on the impact of raw material inflation to Caesarstone in light of the tight supply environment across the industry. While we did not experience a material impact from inflation in the first quarter of 2021, we anticipate that higher raw material and shipping costs will be a significant headwind to our margins in the coming quarters. In regards to timing, We anticipate that these headwinds will start to impact us in the second quarter and will continue throughout the remainder of the year. We expect to partially mitigate this impact through price increases and other cost-cutting initiatives. For some additional context on the breakdown of our raw materials, in 2020, raw materials accounted for approximately 34% of our cost of goods sold. including both the purchase price of the materials and the costs related to logistics and delivering of the materials to our facilities. This excludes the cost of OEM products sold, which accounted for less than 10% of our cost of goods sold in 2020. Quartz is the main raw material component used in our engineered quartz product. In 2020, quartz accounted for approximately 39% of our raw material cost, while polyester, which acts as a binding agent in our product, accounted for approximately 31% of our raw material cost in 2020. Historically, the price of quartz have been relatively stable, while polyester is more prone to a significant price fluctuation. Since 2020, we have been using dynamic hedging strategy to reduce our exposure to changes in polyester prices. However, Our hedging results are charged to finance expenses and therefore do not offset the impact of polyester prices on our operating income. We will continue to carefully monitor the impact of price fluctuation in our raw materials and will update you accordingly as the year progresses. With that said, we continue to anticipate 2021 revenue and adjusted EBITDA to be higher year over year with the expectation that revenue will grow faster than EBITDA in 2021. This outlook assumes similar growth margin compared to 2020 with higher revenue impact offset by higher shipping and raw material costs. In addition, we continue to increase our sales and marketing expenses to more normalized level to support our sales growth. As a reminder, we also temporarily reduced or delayed significant costs during 2020 due to pandemic-related impacts, which are now returning. Our outlook assumes that both pandemic-related business restrictions will fade and that the supply environment will improve as the year progresses. In the second quarter, we expect revenue growth to be driven by the contribution of acquisition, with a return to organic growth as well. With that, let me turn the call back to Yuval for closing comments.

Thank you Ophir. We started 2021 on a positive note, and the focused execution of our plan resulted in strong first quarter results. As vaccines roll out across the globe, we will continue to prioritize the health and safety of our employees and express our sincere gratitude to all of our global team members who work tirelessly to support our customers and achieve our growth objectives. Moving forward, we are focused on further enhancing our global operating platform we have built by leveraging our innovative go-to-market initiatives, world-class scissors from brand, and multi-material product offerings to drive additional value for our shareholders as the year unfolds. We 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. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. The confirmation tone will indicate that your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. One moment, please, while we poll for questions. Thank you. Our first question will come from Ruben Gardner with Benchmark Company. Please proceed with your question.

Thanks. Good morning. Well, good evening. Good afternoon, you guys. So maybe I'll start on the top line. Can you talk to me about what you're seeing in maybe the U.S., particularly about a recovery, maybe starting with, you know, I know you gave a constant currency number, but any way to tell us what, like, the organic revenue growth was like in the U.S.? And I think you mentioned an expectation that in the second quarter, organic volume growth returns. That's encouraging. It is an easy comp. What about as you move through the rest of the year? Are you seeing signs of a likely acceleration in your business?

Hi, Ruben. Good morning. First, I think I would like to start with really being optimistic on what we see as the momentum in the U.S. We do see the progress from quarter to quarter. And even in the first quarter, we see a great change between January, February to March. And some of that momentum continues with us to the second quarter as well. So all in all, we do see a very nice recovery in the U.S. organically and obviously unorganically as well. All in all, we believe that the first quarter, although the difficult comparison to the first quarter of last year, will be kind of organically is 7% down to the first quarter, something that completely recovers in March and later on in April as well.

Wait, I'm sorry. Can you repeat that? What is down 7% sequentially? That's what Q2 will look like versus Q1? No, no.

What you said is that organically compared to last year in the U.S., we were down 7%. We see good momentum into Q2 and expect to see this improved performance in the U.S. as we progress through the year Of course, there are easy comps there compared to last year, but still I think the performance we expect will be much improved. Also, we are very happy with the integration of Omicron in the first quarter and the performance and the revenue delivered by Omicron in the first quarter in the U.S.

Got it. Okay. And then on the gross margin commentary, I think you said that this year, the full year will be similar to 2021. So can you talk to us, like the last three quarters now, your gross margins averaged about 30%. You've got a recovering, you know, end markets as we move through the rest of this year. I assume, you know, the revenue is only going to improve from where you've been the last few quarters. your guidance kind of implies that, you know, you're under 27% for gross margin the next few quarters. I guess one, am I looking at that the right way? And then secondly, what's kind of the difference between the 30% the last few quarters and the 27%? How much of that is price cost because of inflation you're seeing and how much is maybe other factors? Yeah.

I mean, most of it is of the difference. First, you're looking at it right. We are seeing a significant headwind coming from mainly raw material prices and also shipping. There's a very tight supply chain. We see polyester, which is an important material for us. price inflation of over 40%. That's what we see as a price today compared to what we've seen in the past few months. So it's a very significant increase. We do expect that as we progress in the year, there will be some improvement in the supply chain and prices will come back to a more normalized level. But looking at that, we do expect to see this headwind impacting our gross margin. We do plan to mitigate that at least partially by a price increase in a selected market where we think it's the right thing to do. And by managing our cost more tightly to mitigate. But yes, we do see these headwinds and it will be on a higher revenue base as you mentioned.

Okay. I guess same line of questioning on the EBITDA line. I don't think I heard you give specific EBITDA guidance, but the last three quarters have been north of of 14%, and obviously you've got some gross margin pressure, but you're also going to have a better top line. I mean, is 14%, you know, unsustainable? You know, I know your longer-term targets are above that, but how do we think about that 14% number that you've put up the last couple of quarters as we move through the rest of this year?

Definitely. First, we're very happy with the first quarter's results, but looking forward, mainly due to the fact that gross margin is going to be lower, we don't think that this is sustainable to this year, and we do expect both revenue and EBITDA to grow this year, but revenue will grow faster than EBITDA, and the profitability on the EBITDA will be lower due to the lower gross margin. Okay.

Thanks, guys. Congrats again, and I'll let someone else jump in here.

Thank you, Ruben.

As a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. The confirmation tone will indicate your line is in the question key. Thank you. Our next question comes from Ruben Gardner with the Benchmark Company. Please proceed with your question.

Hey, guys. Sorry, I figured I'd jump back in. So just a couple quick follow-ups. You know, we talked about the U.S. market. What about internationally? It was a nice recovery in Australia. Are you seeing that trend continuing? And then maybe, you know, Israel, I understand, had a tough dynamic going on in the first quarter. Do you expect that to sort of return to growth, you know, I've read and heard that the vaccine has taken very well over there and things are opening back up. Just any update you can give us on those two big markets of yours?

Yes, sure, Ruben. First, I think it's nice to see that in the first quarter of this year, we do see some of the fruits and the outcomes of the early buds of the execution of our strategy. And we do see it in a number of markets. We are launching a few growth engines this year and we are on the journey to introduce more and more of those growth engines as the year progresses. As for the two currencies you mentioned, we do see or we are experiencing some nice market recovery in Australia where you see growth on constant currency basis and local currency and we are performing quite well in Australia. As for Israel, we just ended the latest lockdown in January, and to the fact that Passover holiday was coming a bit earlier this year, we have experienced a bit softer Q1. We believe that some of it will be offset during the year.

Okay, and then last one for me is just a follow-up on the gross margin and the cost of goods. How much – so you told us how much polyester and quartz are as a percentage of your raw materials. How much are your raw materials as a percentage of cost of goods? And then how much is, you know, shipping and how much would that shipping element be up? You know, what kind of inflation are you seeing in that aspect of your business?

So raw material in 2020 was 34% of cost of goods sold, so 34% of cost of goods sold in 2020. And as for shipping costs, when you look at, say, finished goods, The estimation will be, say, $2 or $3 million of impact, assuming that shipping costs will remain at the current levels.

Okay, great. Thank you, guys, again, and congrats on the quarter, and good luck as you move through the year.

Thank you.

Thank you. There are no further questions at this time. I would like to turn the floor back over to Yuval Begim for closing comments.

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

This concludes today's conference. We may now disconnect your lines. Thank you for your participation. Have a wonderful day.