Welcome to the Caesarstone third 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. 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 of ICR. Thank you. You may begin.
Thank you operator, 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 third 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. The benefits of our team's collective efforts are emerging with visible progress evident in our third quarter results. During the quarter, we were encouraged with the sequential improvement in year-over-year sales trends compared to the second quarter 2020. We also effectively controlled costs to accomplish our highest adjusted EBITDA and margin in over two years. Furthermore, we generated substantial cash from operation of $28.2 million, further strengthening our available financial resources. Our strong working capital management has provided us with significant flexibility to continue executing against our strategic plan. In addition, following the improvement performance of our business, we have resumed several initiatives that were postponed following the onset of COVID-19 pandemic. With a mission to be the first global brand of choice for countertops, Caesarstone's strategy includes three pillars: premium multi-material offering, customer experience and engagement, and global footprint expansion.
These three strategic pillars are integral to unlocking Caesarstone potential and are all managed under our Global Growth Acceleration Plan. The majority stake acquisition of Lioli, a producer of cutting-edge porcelain countertop slabs, represents a major milestone in our objective to become a leading global multi-material premium countertops brand of choice. Porcelain is one of the fastest-growing countertop categories, and this acquisition provides an attractive opportunity to complement Caesarstone established presence in the engineered quartz surfaces. Lioli is located in the center of India's porcelain hub, equipped with top-of-the-line Italian manufacturing technology and the cost-effective, vertically integrated operation to efficiently supply porcelain countertop products. Lioli is directly aligned with our strategy to leverage our brand, distribution, sales, and global scale to efficiently enlarge our addressable market and to further advance Caesarstone as the brand of choice for countertop around the world.
We will provide premium multi-material countertop offerings as we move through 2021, with porcelain being marketed alongside quartz in all regions under our leading global Caesarstone brand. In addition, we are investing in technology and new engagement tools that we expect to launch in several markets in the coming months to significantly strengthen our sales and marketing capabilities, which we believe will enhance our customers' experience. Overall, our plan is progressing, our performance is improving. We have brilliant talent in place to further execute our strategy, and we remain confident in the prospect of our business as the recovery continues. With that, let me turn the call over to Ophir, who will provide details on our results and outlook.
Thank you, Yuval. Good morning, everyone. I will start by discussing our third quarter results. For the third quarter of 2020, global revenue was $123.9 million, compared to $142.8 million in the third quarter of last year. On a constant currency basis, third quarter revenue was lower by 14.4% compared to the same period last year. The majority of the adverse revenue impacts were primarily business disruption related to COVID-19 in our Americas region, which I will further detail shortly. We are encouraged to see business activity improving in the third quarter compared to the second quarter, and expect further improvement in the year-over-year trend in the fourth quarter. Looking at our markets. In the Americas, our largest region, inconsistent state and local shelter-in-place guidelines continue to have an ongoing impact on business activity.
In the U.S. and Canada, the fact that IKEA stores were closed for the majority of the second quarter significantly reduced our order backlog, which naturally had an unfavorable impact, and accounted for approximately half of our North American sales decline in the quarter. This impact to our big box channel was partially offset by increased activity at U.S. Home Depot stores, where we have an expanding presence. Core sales were down due to shelter-in-place guidelines and social distancing practices, limiting installations at some residential job sites. In the APAC region, Australia accounts for the majority of our sales. Performance has been better than our expectations. That said, the soft market conditions that existed prior to the pandemic continue to be unfavorable factors impacting that market. In the EMEA region, both our indirect and direct sales were impacted by the aftermath of the first lockdown.
Recent government restrictions are also reemerging in certain parts of Europe and may slow the recovery. In Israel, a second pandemic shelter-in-place order was issued in the second half of September and resulted in slight year-over-year decline in revenues. This order was partially lifted during the second half of October, but is expected to impact Q4 performance in the region. Looking at our third quarter P&L performance. Our improved third quarter margin performance and bottom line results benefited from our focused execution of initiatives to improve efficiencies across our business. Adjusted gross margin was 31.4% compared to 29.9% in the prior year quarter. The higher year-over-year adjusted gross margin mainly reflects improved product mix, lower raw material costs, and improved efficiency, partially offset by the impact of lower sales volume, lower selling prices, and less favorable regional mix.
We continue to evaluate our level 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. However, it is important to note that the effective capacity utilization of our plants is currently running at less than 70%. As we ramp up production in future quarters, this will likely have a favorable impact on our gross margin. To that point, we expect our fourth quarter gross margin to be lower quarter-over-quarter, but slightly higher year-over-year.
Excluding legal settlements and loss contingencies, operating expenses for the quarter were 18.8% and 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. As we see an improved business environment, we expect to increase our sales and marketing expenses to support our brand and future growth. Adjusted EBITDA in the third quarter was $23.7 million, representing a margin of 19.1%, compared to $22.5 million, a margin of 15.8% in the prior year quarter. This performance primarily reflects the higher gross margin compared to last year, in addition to lower operating expenses, excluding legal settlements and loss contingencies.
Adjusted diluted earnings per share in the quarter were $0.41 compared to $0.29 in the same period last year on a similar share count. Looking at our balance sheet. Our prudent effort to control cost, manage our production capacity and working capital, and improve our operational efficiency have collectively allowed us to generate strong cash flow from operations and preserve substantial cash position. This includes cash equivalents, and short-term bank deposits, and short and long-term marketable securities of $155.7 million at the end of the third quarter, with no debt from financial institutions. In accordance with the company's dividend policy and based on our net income performance during the third quarter and first nine months of 2020, our board declared a dividend of $0.14 per share with a record date of November 18th and payment date of December 9th, 2020.
As we move forward, we remain confident that the strength of our balance sheet provide us with sufficient flexibility to continue executing against our strategic plan. With that, let me turn the call back to Yuval for closing comments.
Thank you, Ophir. In closing, we remain encouraged by the ongoing disciplined execution of our Global Growth Acceleration Plan, and we are excited by the tremendous potential of our business. I am grateful for the significant contributions of all our team members across the globe and appreciate their dedication during these unique times. Looking ahead, as we integrate Lioli and make additional progress on other initiatives under our strategy, we are confident that we are on the right path to improve the long-term trajectory of the business. Look forward to updating you further on our progress next quarter. Thank you. We are now ready to open the call for questions.
At this time, we'll be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two 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 keys. One moment please, while we poll for questions. Our first question is from Reuben Garner with The Benchmark Company. Please proceed with your question.
Thank you. Good morning, or I guess, excuse me, good afternoon, guys.
Hi, Reuben. Good morning.
Maybe we could start with the top-line trend. You mentioned an expectation that it would continue to improve in Q4. I know there's a lot of puts and takes with different countries having COVID shutdowns and that sort of thing. Maybe could you help walk through the progression, the month-by-month progression in Q3? How did the year-over-year declines improve through the quarter, and what you saw in October and in the first part of the fourth quarter so far?
Yeah. Hi, Reuben. Good morning. Indeed, we're quite pleased with the sequential improvement from quarter-to-quarter on our sales. Although the global sales are improving, indeed, there is a change between the regions, all regions are improving from the, if you like, bottom level in April 2020 this year. We do see the improvement from quarter-to-quarter and from month-to-month, that is including the fourth quarter that we just started.
Is there any way to quantify that, Ophir? You cut the declines by more than half from Q2 to Q3. Can we expect a similar trajectory in Q4? Maybe you're down mid-single digits as we approach 2021, and then potentially next year you can return to growth?
We don't provide guidance for Q4. We just want to say that we are improving. We do see improvement in the trend. As you mentioned, there's a lot of uncertainty still in many parts of our global footprint. If you take Europe, where we see softer shutdowns in many major countries. We mentioned Israel, that we've been in lockdown since the mid-September, and it was not still fully lifted. We're going to be cautious about providing guidance in this uncertain environment at the moment, but we do expect to see improvement in the trend year-over-year.
Reuben, in line with this improvement in our strong financial results, we also resumed investment of some projects and resources to boost revenues even further for next year.
Okay. Understood. I want to ask a question about that before I get there. The margin turnaround in the third quarter was pretty remarkable. Can you maybe help us with kind of a bridge? It looks like the biggest change was on the gross margin front. Can you kind of bridge us from where you were in Q2 from a margin standpoint to Q3, or is it better to look at it on a year-over-year basis? You showed margin improvement year-over-year with a 13% revenue decline. Just help us walk through what the different pieces are to get there and how to think about those as we move forward.
We look at it compared to last year on a year-over-year basis, and I think first, we are very pleased with the performance and our achievement in the gross margin. It came from three, I think, main components. One is we had a better product mix. We sold more premium product where we command a higher premium and better margin. That was the main component here. There was better raw material prices coming from better sourcing and lower prices. We've seen improved efficiency in our operations. These were on the positive side. The main burden on the gross margin is coming from the lower sales volume. We are seeing a higher logistics cost per unit because of lower volume, where we cannot fully mitigate the volume decline.
This was something that we hopefully, once the volume picks up again, we see here a favorable improvement, and some lower selling price and regional mix, which was less favorable, of course, on the negative side. I would also mention here that we are still working under 70% capacity in our utilization of our factories, which is also an unfavorable impact on our gross margins. The gross margin, as you said, was the main contributor for the improvement in the EBITDA improvement and the EBITDA margin. In addition to that, we took a lot of steps to control costs and seen cost reduction that in effect, that was also helpful to our EBITDA margin. Having said that, looking at Q4, we are expecting a gross margin to be lower than what we've seen in this quarter, but slightly better than the performance we had in Q4 last year.
In terms of the EBITDA margin, we are going to see more normalized level of sales and marketing in G&A. As we are preparing and reinvesting in order to boost sales. It becomes critical then for me to put those investments. We are expecting EBITDA margin to be more similar to what we've seen in Q4 2019.
Reuben, before I may mention to our attempts. If you remember, I made a lot of attention to the gross margin and EBITDA in Q1, in quarter one of this year, that was relatively healthy as well against the same quarter the year before. What you see actually in Q3, is actually leaders all around the world in Caesarstone acting with speed and discipline to mitigate cost and spend to the current demand. I think it is been manifested in our results in Q3.
Got it. No, that all makes sense and it's helpful. Let's, I guess, talk about those investments to drive growth. Can you elaborate on maybe the amount of the investment? What exactly are you investing in? Is it more salespeople? Is it just marketing in general? What do you expect to be the outcome? Is it Europe and the U.S. increasing penetration primarily that you're focusing it on? Just help us understand what the investments are, maybe quantify if you could, and then what the benefits you expect from them.
Sure, Reuben. Maybe three areas of investments or adding resources to boost growth and revenues. First, we just closed the deal with or completed the deal with the Lioli Ceramica company. We just added another category to our business, addressing a bigger market now by offering porcelain and quartz to our customers in the coming years. In addition, we continue to invest behind our sales team, in the U.S., mainly when we are expanding our presence in many of the markets in the U.S., as we started to do the beginning of the year. That's a continuous effort that we continue to do.
Of course, the few or many projects that we have under the Global Growth Acceleration Plan, some of which are around new technologies that we are adding, probably to be launched in the coming months in several markets of ours to improve engagement and experience of our customers and consumers.
I'm going to sneak one more in, if that's all right. You just closed on that deal. Talk to me about what the pipeline looks from an M&A perspective. Do you anticipate more of those? How many a year? Is the size and scale of the acquisition you just made a reasonable expectation for others in the future, and that's kind of a playbook to build out your [King] of Countertops plan is to kind of pick off similar-sized different materials and roll them up into your distribution network?
Yeah. I may start with our mission, and our mission is for Caesarstone brand to become the first brand of choice in countertop all around the world. Under this mission, we have our strategy with three main pillars. One of the pillars is having a multi-material offering in premium countertop. The other pillar is, as I mentioned, to improve consumer and customer engagement and experience. Lastly, to expand our global footprint and to go direct in some other markets. Obviously, our efforts in terms of M&As are firstly, around the multi-material offering, which we completed by having this porcelain as part of offering going forward. The other focus of ours will be on covering our global presence in some other regions around the world where we are still working through distributors, and we would like to have our own presence in the market.
Great. Thanks, guys. Congrats on the results. Good luck through the rest of the year.
Thank you so much, Reuben.
Thank you.
Again, as a reminder, if you have any questions, you may press star one on your telephone keypad. Our next question is from Asaf Chandali with Oppenheimer. Please proceed with your question.
Hey, guys. First of all, just congratulations on a great quarter, despite the difficult conditions.
Thanks, Asaf.
I guess I'd also like to start on the margin front. Gross margins for the quarter were the highest since, I think, about 2Q 2018 when we looked back. With this being kind of depressed levels of revenues and you also mentioning that you also had some headwinds from lower volume, lower pricing, maybe some unfavorable geographic mix, do you think that the better product mix this quarter was totally one time? Because maybe it gives mixed signals because you're guiding for a lower margin sequentially, which is still solid, I guess, 26.5%+ for 4Q. How should we be thinking about a normalized run rate? Where should we be thinking about where the company is, where the goal is here for 2021, 2022 when sales normalize? Is it kind of high 20s% near-term, above 30% medium-term?
That's a good question. I think that it's quite a hectic period that is changing things, and I think that the product mix that we see, it's hard to say whether it's something that we should expect to see in the coming quarters as well. Our estimate is that things will normalize, and we'll see a more reasonable or normalized mix. Having said that, I think that we didn't change our long-term goal. I think that once we're back to our volume that is more normal, like we used to see in previous years, and not less important, even more important, to move back to full utilization of our facilities, the long-term goal that we've set of 32%-35% is something that we believe is reasonable and achievable.
I think that what we also saw in this quarter is many improvements in our operational KPIs, coming from our project under the Global Growth Acceleration Plan that we believe contributed to improve our gross margin. Hence, we feel that we are on the right track to get this target or goals that we've set. The main thing is to see a higher volume of sales, and hopefully, once the economy recovers, we'll get there.
Just to support it, Asaf, with another dimension, the latest addition to our portfolio, which is porcelain, is accretive in gross margin and EBITDA margin. That will be contributing to our future growth of gross margin in the future.
Okay, great. I know that, I guess we could just move over to Lioli naturally here. We can start on the financials. It's a couple of percentage points of the top line now, if I recall correctly. Where do you guys want to get that? How should we be thinking about you guys growing the Lioli business? Should we be thinking about this a year ahead? Should I be looking forward to the 20-F to see what the situation is? Will I get any kind of segmentation breakdown between porcelain and quartz? Anything further that would be helpful.
Yeah, sure. Obviously, it's a bit premature to give a bit of more color at the moment on this new category in our business. Obviously, the porcelain category is expected to be growing in a 10% CAGR in the coming years. We are joining a category which is growing at the right time. We're going to be utilizing our current assets to address a bigger market size, namely our logistics, full supply chain, the distribution companies that we have. All that will be now we're serving a bigger market with this porcelain offering. The ramp-up of this category will be starting next year, as we are now integrating Lioli to our business. Obviously next year it will be easier for us to advise on the growth and the different launches of new product in our porcelain offering.
Okay. Any specific reason that you guys had chosen porcelain? Was it just that the target made sense, happened to be porcelain, and it's just your first in a multi-material approach?
In the multi-material approach, under this strategy, we are focusing on stone. In the stone area, you have quartz, which is primarily our main business, porcelain, and natural stone. Porcelain is a natural fit to our business as it's a manufactured stone as porcelain. Sorry, as a quartz. Different technology, though. We see it as a natural fit to our business. We'll continue to look on expanding our material offering in the years to come.
Okay, great. I guess just another question on Lioli, because I think, as we look forward, this is going to be thought of kind of as a countertop company and maybe less of as specifically a quartz company. Do you guys have a focus or any kind of direction as to if you want to manufacture increasingly in emerging markets? I really ask this because I think most people are aware that your core quartz business came under pressure at one point from low-cost manufacturers, and you now manufacture, having a facility in India, theoretically, you could move some of your manufacturing there, maybe not near term. Any color there on where future targets would be located or where your future facilities would be located?
We are kind of already utilizing capacity in the East in quartz, and about 15% of our business, or the slabs volume is being acquired in China. We're already balancing our manufacturing cost by utilizing some low-cost manufacturing sites to support our competitive position in the market. Obviously, the decision to look on a porcelain production or manufacturing in a place like India is with enough looking forward, if you like, to make sure that we will remain competitive in the coming years in producing porcelain.
Okay. That's helpful. I guess last question here is, when we look at the sales trends on a constant currency basis, for example, for Australia, the 3Q number is actually showing not much of a difference relative to where you guys were pre-COVID-19, even on a year-over-year basis. Is this sustainable? Are you guys even having any maybe positive impact from maybe less competition from China? Because I'm looking at Australia only down 7%. Those were levels we were even seeing double-digit declines in 2019, so - 7% isn't a terrible number. Any color there would be helpful.
Sure. I think I mentioned this to my answer, to our answer. Indeed, we are in a stronger competitive position this year than year before in countries like Australia and Canada and Israel by utilizing our OEM supply. We are in a better competitive position. At the same time, the business environment in COVID-19 is a bit different from country to country. At the beginning of the year, Israel and Australia were impacted less by that, and you could see that our revenues are relatively strong. With the lockdown in Victoria, which is a very long lockdown in Victoria, one of the states in Australia, there is a greater impact, and now it's been eased off. It's more on the market conditions and the activity in each and every country. Australia is having the same situation as others.
We see our demand and volumes up and down according to the market activity.
If I could actually just ask another question. Maybe the cadence of revenues through the quarter, how was July, August, September looking like? Was there a gradual improvement? How do you guys feel through now effectively, the beginning of November?
We addressed it earlier, and I think I'm very happy to report that we do see a gradual improvement from month to month and obviously from quarter to quarter, and we expect that to be continued.
Okay, great. Thank you.
Thank you, Asaf.
We have reached the end of the question and answer session, and I will now turn the call over to Yuval Dagim, CEO, for closing remarks.
Thank you for your attention this morning. We look forward to updating you on our progress next quarter.
We have reached the end of our conference. You may disconnect your line at this time. Thank you, and have a great day.