Good day, welcome to the Caesarstone Q3 2018 earnings conference call. All participants will be in a listen-only mode. Following today's presentation, we will open the lines for Q&A. Please press star one for questions. Today's conference is being recorded. At this time, I would like to turn the conference over to Sarah Bignell, ICR. Please go ahead, ma'am.
Thank you, operator, good morning to everyone. I am joined by Yuval Dagim, Caesarstone's Chief Executive Officer, Ophir Yakovian, our 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, and adjusted EBITDA. The reconciliation of these non-GAAP measures to the most directly comparable GAAP measures can be found in the company's Q3 2018 earnings release, which is posted on the company's investor relations website.
Thank you, I would like to now turn the call over to Yuval. Please go ahead.
Thank you, Sarah, good morning, everyone. Having joined the company in August of this year, I'm excited to realize the significant upside in the powerful Caesarstone brand and the potential of our global market leading position. Along with the management team, we are working on updating our strategy and crafting the direction for our company vision and mission statement. We have a deep emphasis on health, safety, and execution with excellence at all levels of our organization. I'm confident that this focus will bring better efficiency and stronger performance everywhere in our company. In regards to our people and structure, we are working to create a more seamless global operating model and bring the right talent at all levels. We are enhancing the management team and simplifying our hierarchy to allow faster decision-making process while empowering our people to be fully accountable for their business.
In our U.S. business unit, we are in advanced stage of fill the permanent role for President of Sales, Marketing, and Distribution. I look forward to provide an update on that front. In our manufacturing operation, we are working to implement best practices prioritizing health and safety, improve discipline, and bring the right talent where we need it. The Richmond Hill facility in the U.S. is experiencing better throughput and yield, which has contributed positively to margins compared to prior year. We recently appointed a new manager to the Richmond Hill plant who brings more than 30 years of operating experience from Alcoa. While we expect to continue to face pressures in most markets, mainly due to softer market conditions, we are focused on getting Caesarstone in better position to capture shares and improve profitability.
The actions we are already taking, along with many additional initiatives, are driven by our focus to drive better results and pivot our company to increasingly focus on growing EBITDA margins. I look forward to updating you in our progress in coming months. I will now turn the call to Ophir, who will provide details on our results and outlook. Please, Ophir.
Thank you, Yuval, and good morning, everyone. In the Q3 of 2018, global revenue was $147.7 million, a decrease of 4.5% compared to $154.7 million in the third quarter of last year. This was mostly attributable to an adverse FX impact of $4 million. On a constant currency basis, revenue declined by 1.9% versus last year, with lower volume more than offsetting more favorable pricing. I will now review our performance by region on a constant currency basis. In the U.S., sales were essentially flat compared to last year. We experienced volume improvement in our core business, which benefited from ongoing changes to enhance our go-to market strategy. These positive developments were offset by continued weakness in IKEA due to previously discussed changes in IKEA's promotional structure. Australia's sales were down 1.2% on a constant currency basis, with weaker performance than forecasted.
The decline was primarily due to increased competition, coupled with continued softness in the housing and remodeling markets, which were affected by more rigid lending standards and increased mortgage rates. In Canada, sales increased 2.6% on a constant currency basis, primarily attributable to our core business, where we were able to improve pricing on lower volume. The overall performance in Canada was softer than anticipated. Sales in Israel on a constant currency basis were 18.2% down. The timing of Jewish holidays adversely affected results in addition to challenging housing market conditions. In Europe, sales grew 3.1% on a constant currency basis, reflecting improved performance in the U.K. that was partially offset by slower performance in our indirect distribution operations. Revenue in the rest of the world on a constant currency basis was down 14.7%.
In the U.S., since August, there have been several announcements from U.S. government agencies in the interest of promoting fair trade in response to Chinese imports. Regarding quartz countertop, there are three applicable tariffs in various stages, which have so far placed a collective 44% of tariffs on most of the Chinese imports to the U.S. since September. The first is a tariff of 10% on broad basket of Chinese imports, including quartz countertop. This tariff is expected to go up to 25% at the beginning of next year. Second, in September, a preliminary countervailing duty of effectively 34% on imports of quartz surfaces product from China was announced. The third tariff relates to antidumping claim against import quartz surfaces from China that is currently under review, and preliminary determination is expected later this month.
We are encouraged by the long-term benefit of recent tariff on U.S. imports of quartz countertop from China, and anticipate a positive impact on our U.S. results in coming years. In the near term, we are cautious, given there has been a surge in 2018 pre-buy activity ahead of the tariffs. Quartz countertop import volume from China increased roughly 80% year-to-date through August, as indicated by the import data published by the U.S. International Trade Commission. For the period from June - August, import volume from China has more than doubled year-over-year. That pre-buy will likely keep U.S. inventory level elevated for the near term. Beyond that, we are watching closely to assess the collateral impact to international markets as Chinese producers seek to ship their products to other developed markets. These dynamics are reflected in our moderated sales expectation for the full year 2018.
Looking at our P&L performance, we delivered Q3 gross margin and adjusted EBITDA better than our expectation on lower revenue. Gross margin in the quarter was 29.6% compared to 32.1% last year. The decrease in margin reflects the following. Adverse currency exchange impact of roughly 200 basis points. Inventory and logistical inefficiencies, along with higher raw material costs impacted margin unfavorably by approximately 200 basis points. Lower production throughput at our Israeli facilities impacted margin by roughly 70 basis points. These factors were partially offset by significant improvement in throughput and yield at our Richmond Hill facility in the U.S. and contributed about 150 basis points. Other factor accounted for the remaining 70 basis points. Operating expenses in the Q3 were $29.7 million, or 20.1% of revenue versus $38.7 million last year, which was 25% of revenue.
Excluding legal settlements and loss contingencies, operating expenses decreased to 20.3% of revenue, compared to 21.3% in the prior year Q3 . This was mainly due to lower marketing and sales expenses. Adjusted EBITDA in the Q3 was $21.6 million, a margin of 14.6%, compared to $25.6 million, a margin of 16.5% in the prior year quarter. While adjusted EBITDA performance was better than our expectation, the decline primarily reflects the lower gross margin, partially offset by lower operating expenses. Our tax rate was 15.2% compared to 20.9% in the prior year, mainly due to lower nondeductible expenses as well as the lower tax rates in the U.S. Adjusted diluted earning per share in the quarter were $0.31 compared to $0.37 in the same period last year, reflecting lower adjusted net income on a stable share count.
Based on our profit performance during the Q3 and nine months of 2018, our board declared a dividend of $0.15 per share with a record date of November 21st and payment date of December 12th, 2018. Moving to our outlook. Since we provided our 2018 sales outlook in May, currency rates have moved unfavorably as the U.S. dollar has appreciated in comparison to our main other currencies, with roughly $11 million effect on revenue. In addition to the previously discussed impact of recent tariffs on U.S. imports of quartz countertop from China, more intense competition and other dynamics in our major markets, conditions are expected to remain challenging in Q4. We are moderating our expectation for the full year 2018 and now expect revenue to be in the range of $572 million-$578 million.
With respect to adjusted EBITDA, our full-year range of $74 million-$82 million is unchanged, but we now expect it to be at the low end of the range. We expect moderated revenue assumption to be partially offset by cost-saving actions. We are in process of realigning our strategy and working hard on a range of operational improvements. We are excited to capture additional market share and benefit from stronger pricing in the U.S. as tariff come into play in 2019. Overall, we are confident that our company is better positioned for success in 2019. Thank you. We are now ready to open the call for questions.
Thank you. Ladies and gentlemen, if you would like to ask a question, please press star one on your telephone keypad. Please ensure that the mute function on your telephone is switched off to allow your signal to reach our equipment. Once again, to ask a question, please press star one. We will take now our first question from Susan Maklari from Credit Suisse.
Hi, this is actually Chris on for Susan. My first question is just on the specific cost-saving actions you highlighted for the remainder of the year. It looks like it's expected to offset a decent amount of the revenue weakness and imply over 100 basis points of improvement in four Q. I just want to provide some specific color on what those actions are and what the run rate for that will be for looking into 2019.
Hi, Chris. Thanks for the question. I guess it's just a great opportunity when we're joining the company, and we now need to change a bit of the trajectory for the year to approach our teams, our leaders all over the world, and advise them with a master plan, or we need to look again on the remaining of the year, what kind of course we want to spend and what we can avoid off. Of course, while doing that, we are kind of building our annual operating plan for 2019. It should probably be in line with this kind of lens of bringing greater efficiencies to our company.
Got it. It sounds like it's more on the production efficiency side of things. Okay.
It's just about everywhere. We're talking about G&A costs and S&M costs. It's all our day-to-day costs that we're trying to see what is the must-do this year and what is not. We're looking at each and every recruitment and each and every spend now all over the world.
Got it. Just my second question is on the impact of tariffs in the U.S. I know you said there's a significant amount of pre-buying going on. Is there any way you guys have a sense of how long it'll take for that pre-buy inventory to get worked through and when you'll start seeing the benefits of increased pricing power and just general better performance coming out of Richmond? Thanks.
With regard to the tariffs, we've seen the import from China data, and we see that in the past three months before the tariffs came into effect, we saw the import is more than doubling. We see that for the coming few months, it will have the effect. I think it will be reasonable for us to assume that during Q1 of next year, we will see a better market for us.
Okay, thanks for that.
Thank you. We now move on and take our next question from Michael Rehaut from J.P. Morgan.
Hi, thanks. Good morning, everyone, or good afternoon in Israel. First question, I apologize, you might have answered this before, but I had trouble hearing, maybe from the background noise or whatnot from the speakers. In the outlook, you talked about reducing the EBITDA range due to the moderated revenue expectations, but partially offset by cost-saving actions. I believe you were talking to this a little bit, so apologies if you have to repeat it. I didn't hear it that well. Could you kind of walk through what types of cost-saving actions you're taking and where, and if you can kind of quantify what dollar benefits you're expecting out of these for 2018 and 2019?
We are taking steps. Ran mentioned that earlier. It's across all functions. We are checking and trying to save and make sure that we are investing in the right places that will promote the business. I can say that it goes from manufacturing and production and logistics and goes to sales, marketing, and G&A. This is a general effort that is done by all functions. This is in that regard. I can say that I think that the
A level of operating expenses will be similar to this quarter, next quarter, maybe a little less, but this is the expectation. For 2019, we are yet to plan and complete the planning for next year, and we will share our expectation for next year once we decide to do that, and we will be ready to do that.
Okay. I guess just more broadly about the competitive backdrop in the U.S., how do you feel about your positioning? Obviously, in the last couple of years, your own organization has gone through a lot of change. How would you characterize, Yuval, given your assessment of the team in the U.S. and the strategies or the approaches to market that you have in place today, where would you say you are in terms of the evolution of the team and I assume, you mentioned in the press release that you'll be bringing different best practices to bear. Where are we in the process of the evolution of the U.S. operation and the go-to-market strategy?
All right. Thanks, Mike. I think we are quite well progressed in the development of our U.S. branch, I guess. I think the new coming president will enhance this process. We have quite a stable team already, and I think we are pushing quite hard on our go-to-market efforts to make sure we are capturing the antidumping opportunity coming early next year. I think we are kind of well-positioned to take this opportunity and to maximize the benefit to our company. Yet we are giving the right momentum for greater build of our U.S. business. I think all in all, I'm feeling very positive on the trajectory and definitely the momentum we are giving to our business in the U.S.
All right. Thank you.
Thank you.
Thank you.
Now we take the next question from John Baugh from Stifel.
Thank you. Good morning. It's nice afternoon, Yuval and Ophir. My question is, first on Australia. I think you referenced you all increased competition as well as the slowing housing market there. Could you tell us what's going on there? Is that already Chinese goods showing up, or is it something else?
Hi, John. It's Yuval, of course. I think what we're experiencing in Australia is probably the twofold. I think, on one hand, the housing markets has become softer over the last few months. I think we started to see the buds of new Chinese companies in the market with a different set of prices. I'm not sure we'll be competing in all tiers with them, as we are targeting the premium segment more than others. I think we have seen both dynamics. Yes, fierce competition in the market, and at the same time, a bit softer housing market in Australia.
Okay. Canada, you mentioned, I think volumes were down. Is that IKEA or competition or housing slowing there? What are the factors driving Canada volume down?
All in all, we did, and revenue went up, and I think you see good, better pricing, and you're right, the volume was down. Our core business did do better than the IKEA. IKEA performed less in this quarter than the core. All in all, the market in Canada is good. Maybe decelerating a little bit, but still growing. Our expectation is to capture more of this growth and grow more than we do today.
Just following up on Michael's question, but I guess on the sales and marketing spend in the U.S. being down, and it sounds like it'll be similar levels in the Q4 . Is this simply, are you just kind of one, reassessing your strategy, what to do with sales and marketing spend, but also just waiting for the inventories to clear and getting in a better price relative market once the Chinese imports slow dramatically?
It's a combination of things. I think that we are timing our investment in marketing to be at the right time, and we will not avoid the, of course, the marketing initiatives that we think that are beneficial and will contribute to the business.
What we are doing is optimizing the timing and doing the right thing. I think that it's fair to say that there are places that we think that we can reduce some of the costs without affecting the business.
I think, John, beyond the cost and our go-to-market model, I think we have quite a strong brand in the U.S., playing in the premium segment. I think what we're going to see over the next months and years is that we are probably going to be investing more behind our brand and innovation. I think we'll be probably boosting a bit the exercise in the U.S. and delighting our customers.
Great. My last question is on the complexity of product going through the Israeli facilities. You referenced that again. Where are we in terms of that issue abating, getting less bad, maybe back to a point. I know your volumes are down, but that affects throughput, I guess. I'm curious as to where we are with outsourcing product versus the complexities of what you're making inside, and that ceasing to be a drag on margin going forward.
I think, in general, the continuous improvement momentum is actually continuing and increasing. We are getting better from quarter to quarter. We are not suffering from any shortage of capacity. We have stock where we need it. I think the complexity is something is in hand, and we are not seeing this being reflected in our P&Ls too much, or less and less. I think going forward, we will probably continue to look and find for the right balance between purchasing some of our products through an OEM methodology, and continue to produce probably the more innovative models of ours in-house. I think in 2019, we will probably present a better balance of that, we'll be kind of serving the markets better with the right models being manufactured in the right places.
Great. Thank you. Good luck.
Thank you.
Thank you. As there are no further questions, I will now hand back to your speaker today for any additional or closing remarks. Thank you. Gentlemen, you may close your call. Thank you.
Thank you for your attention this morning. We look forward to updating you in our progress in the quarters to come. Thank you very much for your participation.
Thank you. Ladies and gentlemen, this will conclude today's conference call. Thank you for your participation. You may now disconnect.