Caesarstone Ltd.

Good day and welcome to the ScissorStone Second Quarter 2023 conference call. All participants will be in a listen-only mode. Should you need assistance, please press star 1 to reach the operator. After today's presentation, there will be an opportunity to ask a question. To ask a question, you may press star then 1. To withdraw your question, please press star then 2. Please note, this event is being recorded. I would now like to turn the conference over to Mr. Brad Gray, Investor Relations. Please go ahead, sir.

Thank you, Operator, and good morning to everyone on the line. I am joined by Yos Charan, Caesarstone's Chief Executive Officer, and Nahum Trost, Caesarstone's Chief Financial Officer. Certain statements in today's conference call in response 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, adjusted net income 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 2023 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 Yos. Please go ahead.

Thank you, Brad. Good day. And thank you, everyone, for joining us to discuss our second quarter. I will discuss our business activity and Nahum will then cover additional details regarding our financial results before we open the call for questions. Looking at our performance, we were pleased to produce a second straight quarter of strong operating cash flow and increase our net cash position, both of which remain significant focus areas for Caesarstone. We are working hard to restructure the business and reignite profitable growth with a goal to offset ongoing headwinds from challenging global economic conditions and the competitive landscape, which have resulted in lower demand. During the quarter, we devoted significant operational investments behind new products as well as reengineering existing collections using alternative and varying blends of materials aimed to address expected Australian regulations previously mentioned on recent calls. We are in the final stage of completing this costly project of re-engineering the full Australian portfolio in only a few months. Separately, in our core quartz products, we are investing significantly in our R&D efforts to create an exciting array of innovative collections in the second half of 2023 to be launched next year. Additionally, we are focused on investing further in sales and marketing, which we believe that combined with improvements in our pricing strategy will drive improved revenue performance in future periods, particularly in the U.S. We are moving swiftly with the implementation of our comprehensive restructuring plan and are taking many important steps as part of our strategic cost reduction efforts to improve our results, which we believe will become increasingly evident in the coming quarters. The closure of Sdotya manufacturing facility marked a pivotal step for Seasonstone, laying the groundwork for improved efficiencies and streamlined production within our manufacturing infrastructure. We are also working simultaneously to shift an increasing mix of production to our strategic network of third-party manufacturers in the Far East. This is expected to further reduce our costs and better align production to meet demand. In regards to other strategic cost-saving actions, we have enacted several changes within our organizational structure, including the consolidation of several senior management positions. We will also transition the work that was being done at our smaller samples and book plant to our network of third-party manufacturers in the Far East. These actions are expected to further improve our cost structure commencing in 2024. Looking ahead, we are on track to improve the financial position, including our cash flow, and we expect to significantly improve our profitability in Q3 and Q4 gradually. We are grateful for the hard work of all our team members who are executing our strategy to create a more agile, innovative, and profitable company as we strive to deliver growth in our top line and solid results for our shareholders as we move forward. Thank you, and I will now turn the call over to Nahum to walk through the details of our financial performance.

Thank you, Yos, and good morning, everyone. Looking at our second quarter results, global revenue in the second quarter was $143.7 million compared to $180.3 million in the second quarter of last year, a decrease of 20.3%. On a constant currency basis, second quarter revenue was down 18.4%, mainly due to lower volume partially offset by the benefit of previously enacted pricing actions. The 1.9% difference between U.S. dollar revenue and constant currency revenues reflects the impact of the stronger U.S. dollar against our generated revenues in all markets outside of the U.S. I will note that our second quarter 2023 revenues reflect two factors. is the impact of the challenging prior year comparisons, during which we realized the number of price increases in a period of strong market activity. The other factor is the impact of the residential sales activity, which slowed down commencing in the second half of 2022. The result of that slowdown is now more pronounced in our results. Therefore, second-quarter revenues were impacted by softer global market conditions and the competitive landscape of our products. Market pressure was most severe in the residential renovation and remodeling channels in North America and with destocking activity at many third-party distributors. In the U.S., sales were down 25.4%, mainly tied to softer residential and markets, particularly through third-party distributors. Higher sales with big-box customers and better performance in our commercial business were positive for the quarter. In our other large markets, Canada, sales were off about 15.3% on a constant currency basis, experiencing similar dynamics as the U.S. Australia fared relatively better with sales down roughly 5.3% on a constant currency basis, owing to less severe market pressure. Looking at our second quarter P&L performance, I will start with gross margin, where we saw a significant drop-off in the second quarter, largely related to several factors, many of which are temporary factors, as I will discuss. Our gross margin was 8.3% for the quarter. Adjusted gross margin was 9.6% compared to 26.4% in the prior year quarter and 19.7% in the first quarter of 2023. While lower revenues were certainly a pain point in our margin for the quarter, when factoring out a number of other non-typical and we believe transitory impacts during the quarter, we estimate our gross margin was around 15%. As reported, the year-over-year difference in gross margin reflects several factors. The first factor is the activity at our plant, including those mentioned by us, accounting for roughly 510 basis points for the margin decline. We experienced lower fixed cost absorption, resulting in higher manufacturing unit costs. Lower productivity related to closing of the Zdot Yam plant was also a factor. In addition, as Yoss also mentioned, we invested heavily in re-engineering existing collections which consumed a significant amount of resources and resulted in our throughput and margins coming under pressure in Israel. Our teams worked tirelessly to develop, engineer, test, refine, and attain the capability to manufacture those products previously produced in the Zdot Yam plant, as well as those aimed to meet evolving Australian regulation at our Bar-Leh facility in Israel. We saw reduced throughput and higher manufacturing unit costs due to this mixed shift. Second factor is concerning inventories. We were impacted on two fronts. First, a large portion of the units sold during the quarter were from our higher-cost inventory on hand at the beginning of the year, combined with an inventory write-down during the quarter. These two factors represented 11% of the gross margin difference. These factors were partially offset by previously enacted pricing actions and the benefits from lower shipping costs. We are confident that many of these margin challenges are addressable and our gross margin should improve during the second half of 2023 as we gain additional efficiencies from our restructuring efforts and the wind down of higher cost inventory. We also expect to benefit from lower raw material and sea freight expenses compared to last year. Operating expenses in the second quarter were $58.8 million, compared to $41.2 million in the prior year quarter, and included an impairment and restructuring expense of $23.6 million related to the Sdot Yam plant closure. Excluding the legal settlements and loss contingencies and the expenses related to the plant closure, adjusted operating expenses were 24.3% of revenue, compared to 22.1% in the prior year quarter. Adjusted EBITDA in the second quarter was a loss of $13.4 million, compared to adjusted EBITDA of $17.1 million in the prior year quarter. The difference primarily reflects lower operating income. Turning to our balance sheet. This is some balance sheet as of June 30, 2023, included cash, cash equivalents, and shorten bank deposits and shorten marketable securities of $57.3 million, with a total debt to financial institutions of $8.3 million. We generated during the quarter positive cash flow from operations of $17.2 million, mainly driven by our inventory reduction efforts. This compared to cash used in the amount of $4.5 million in the second quarter of 2022. During the quarter, we paid down our lines of credit from Israeli banks and ended the quarter with full availability on our lines of credit. Our net cash position as of June 30, 2023, was $49 million, compared to $33.3 million as of March 31, 2023, and $28.2 million as of December 31, 2022. Before turning to our outlook, the Sdot Yam plant closure has gone as planned overall. The plant closed in May, and costs associated with the closure totaled to $23.6 million during the quarter. The majority of that was related to the write-down on a long-term non-cancellable lease agreement related to the facility, with the term ending in 2032. We also incurred cash costs of $2.6 million. We now expect the total cash cost related to operations to come within a narrower band of $5 to $7 million, which we estimate to incur by mid-2024. As a result of the facility closure, as mentioned also in the previous call, we expect to realize the annualized savings of approximately $10 to $15 million. Above and beyond those savings, we are in the process of accepting bids to sublet portions of the non-cancellable lease agreement that I've mentioned earlier. The one-time buy-down on the lease is in part based on our estimates of our ability to sub-lease parts of this dot-yam property. We expect that the remaining cost associated with the lease will be increasingly offset by sub-leases over time. I will mention again that cash received from executing sub-lists would represent cash savings above and beyond our anticipated 10 to 15 million of analyzed cost savings. In regards to our outlook, we are reiterating our outlook for the full year of 2023 to generate positive cash flow from operations and to end the year with an improved net cash position. This is based on inventory reductions and other working capital improvements, along with cost optimization efforts. Additionally, we anticipate significant improvement in adjusted EBITDA in the second half of 2023 compared to the first half of the year. Adjusted EBITDA should step up sequentially through year-end, resulting in third quarter better than the second quarter, and the fourth quarter adjusted EBITDA to show additional improvement. While revenues are likely to remain pressured through year-end, we base our assumption for significant sequential improvement in the second half adjusted EBITDA and adjusted EBITDA margin on several factors. We have already sold through most of our higher-cost inventory. The operational investments that we have made to develop and re-engineer products are largely behind us. The closure of the SDOT-YAM facility in May will give us a full quarter of higher asset utilization on remaining assets. Increasing portion of our products will be produced at our third-party manufacturers in Fahri. And finally, we will start benefiting from lower shipping costs and raw material prices that have eased over the last few months, expected to have a positive impact in the third quarter and more evident in the fourth quarter of 2023. In summary, we are prioritizing our focus on taking actions that will make Caesarstone a more agile company that produces stronger cash flow as we look to drive long-term value for our shareholders.

With that, we are now ready to open the call for questions.

Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you are using a speakerphone, please pick up your handset before crushing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question comes from Ruben Gardner, the Benchmark Company.

Thank you. Good afternoon, guys.

Hi, good morning.

Hi, Ruben. Maybe to start, Nahum, you kind of gave some pieces on what's going on with the gross margin, but can you help me with a bridge? sequentially from Q1 to Q2, revenue went down about $7 million and gross profit fell about $16 million. There's several pieces you called out. Can you quantify how much is competitive pricing dynamic, how much is you know, the inefficiencies from closing the plants and anything else that's causing the write-down, anything else that's causing that kind of 10-point decline that we saw?

Yeah. So Q2 reflected several temporary items that we recorded during this quarter. You said it accurately. One of them is the inventory items. So during the second quarter, we recorded a slow-moving provision on our inventory items that had an impact of almost 600 basis points, a negative impact of almost 600 basis points. And in addition, as we mentioned also, Q2 reflected a significant investment in reengineering a large portion of our portfolio, and this reduced the utilization in our plants, resulted in additional expenses which increased the overhead, and those factors had a negative impact of around 500 basis points. So if you... Take those two factors, main factors, into consideration. You have around 11% of decline, which is the main items from the 19.7% gross margin that we generated in Q1.

Okay, so those items should not recur in the back half of the year. So does that mean that if revenue is, if your volume or revenue is in the kind of mid-140s, range that your actual baseline for gross profit is north of 20%, and any improvements in efficiencies or volume growth from there would take you above 20?

Q3, you're right in part. Q3 will still reflect some investments, especially in July and in August. In the last portion of our project to re-engineer products. So it will still be an impact on Q3 results. In addition to that, our higher cost of products is expected to be completed and washed out again during the beginning of Q3. So taking those two factors into consideration, I think our Q3 should look much more like the first quarter.

Q3 should look more like the first quarter, so closer to 20. Yes.

There are positive indicators, you know, like a reduction in the sea freight expenses that we are paying. We will start benefit from lower raw material prices. This will become more evident as we are progressing in the second half of 2023. Okay. And then these...

The restructuring or however you frame it, are there any G&A savings that are on the come from that? You know, it looks like G&A was down a touch sequentially from Q2 to Q3, but it's still kind of near the highest levels it's been. Is that a number that we'll see come down to kind of offset some of the top line headwinds?

We do expect. Our restructuring is not only related to the DOTI-AM closure. Our restructuring is much more wider plan that includes several factors. Some of them also relate to GNA. For example, consolidation of several positions in the management. So, yeah, we do expect GNA to slightly come down in the second half.

Ruben, I would just like to maybe a little bit explain about the reengineering because all this work is associated with regulations in Australia. This is related to the Australian collection only. So we anticipated and anticipating a change in the regulation in Australia. And we had to change the combination of the raw materials of the product. And this is a very expensive process to transform all the Australian collection. We don't know yet. what will be the Australian decision. So in a way, it is something that we are doing according to our best estimation. But anyway, we have decided to take this step and incur the costs, but be in a better position for future development in Australia. So this is one thing that is important to understand. The second one is connected to the restructuring plan, which is in part also may be considered a strategic move. And this is multidimensional aspects. So it's not only, of course, the closure of Dotiam, but other stuff that Nahou mentioned, other marketing and sales improvements that we are doing. And, of course, other savings mainly because of the shift to the strategic partners in the Far East. So just this is, you know, a few clarifications.

Okay, great. Thanks for the detail, guys. I'll jump back to you.

Thank you.

Our next question comes from Mr. Stanley Elliott. It's twofold.

Morning, everyone. You talked about kind of improved profitability as the year progresses. You just kind of helped to kind of frame it out, kind of given the starting point where we are in the first half. You did about roughly maybe let's call it a 5% sort of margin last year in the second half. Do you think that you will be above that or below that?

Hi, Stanley. Good morning. I think we should look, we are starting the second half, as I mentioned earlier, and you should look at our first quarter margin, gross margin, as a more indicative number, as this quarter reflects several temporary items. And during the second half, we expect to see a gradual improvement in our gross margin from several factors. The restructuring plan, the lower raw material prices, the lower shipping costs that are currently baked in our inventory balance in the balance sheet but will become more significant as we will progress in Q3 and stronger during Q4. We expect a gradual improvement over there as well.

So it sounds like probably negative or kind of flattish sort of EBITDA for 23 and then kind of really focus more on 24 with some of the restructuring and some of the other initiatives you have underway to kind of return to profitability.

We are looking at it from quarter to quarter because we are in the middle of a very big restructuring plan And we are starting to see the benefits of what we have already done. And there is a lot more to do. So we expect a gradual improvement, as we said, between Q3 to Q4. And we will have to refine the internal projection. Of course, the external projection during the call on Q4 But we definitely see a gradual improvement. As Nahum said, bear in mind that we are suffering for a long period of time because of the high inventory levels that were produced during last year with very high costs of raw material prices and shipping prices. So this is almost washed out. So we'll see definitely an improvement in Q3 in addition to the other improvements that we will start to benefit from, like, you know, and the big cost cutting that we are doing. Gotcha.

And with the inventory work down, is there a way to kind of size what we should think about from a dollar basis? Yes. you know, through the balance, you know, kind of on a year-over-year basis reduction inventory or, you know, any ballpark on cash flow targets in either the second half or all of 23?

Yeah, so as you said, the cash flow from operating in the net cash position is still our focus for this year. And as we mentioned also in the outlook, we expect to continue and to generate a positive cash flow from operating, not only on the basis of lower inventory, which came down nicely during the first half from the starting point of around 180 days, almost 180 days, to the current level of 120 days. and we expect to continue and reduce the days of inventory as the year progresses and as we continue with our restructuring plan. But not only that, not only on the back of lower inventory, but also on tighter cost control, better prices on our raw material shipping costs. So we expect to continue and to generate a positive cash flow also in the second half.

Perfect, guys. That's it for me. Best of luck. Thanks.

Thank you.

Thanks. Thank you.

This concludes our question and answer session. I would like to turn the conference back over to Mr. El-Sharad for any closing remarks.

So thank you for your attention this morning, and we look forward to updating you on our progress next quarter. Goodbye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect. Thank you.