Greetings, and welcome to the Caesarstone Second Quarter 2018 Earnings Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms.
Sarah Bicknell with ICR. Thank you. You may begin.
Thank you, operator, and good morning to everyone. I am joined by Yair Everbuch, Caesarstone's Interim Chief Executive Officer and 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. 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 Q2 2018 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 Yair. Please go ahead.
Thank you, Sarah, and good morning to everyone. Before I get into our performance, I will comment on our recent my planned departure and transition from Caesarstone. In July this year, the Board announced the appointment of Yuval Dagim as the company's new CEO, and he will assume the position on August 12. Yuval brings decades of experience in global businesses and leadership across multiple industries. This includes management of branded products on several continents.
Combined with Rafir, who joined us as CFO earlier this year, and the other members of the management team, I'm confident that Yuval will be able to lead the company to renewed growth and improved profitability by effectively leveraging our global operating platform, powerful brand and innovative products. With Yuval coming on board, I'm now in final stages of completing my transition process. Over the past 8 years with Caesar Stone and in recent months serving as Interim CEO, it has been an absolute pleasure helping the company to navigate through an evolving industry landscape, while also getting a chance to meet many of you on the line today. I am very grateful for this experience. During the Q2, our results showed considerable improvement compared to our performance in the Q1 of 2018.
This included a significant expansion in gross margin, which we will work hard to carry forward as Vafir will explain further. At the same time, the competitive environment remains challenging in several key markets, especially in the U. S. We continue to make necessary changes to better position ourselves in order to more effectively capitalize on the strong global market opportunity for quartz. While manufacturing saw co challenges in Israel associated mainly with the increased complexity of our product, raw material cost inflation and FX are likely to remain headwinds, we are making progress to improve our U.
S. Sales operation and global manufacturing to achieve better performance in 2019. Now I will refer to the Q2 financial highlights. Our 2nd quarter revenue of $149,200,000 was stable compared to last year. On a constant currency basis, our revenue declined by 1.5%.
Sales improvement in Canada, Europe and Rest of the World were offset by pressures in the United States and Israel. Our adjusted EBITDA in the quarter was $24,600,000 representing margin of 16.5%. This compares to $29,600,000 or margin of 19.9% in the Q2 of last year. This decline was anticipated and primarily reflect the lower gross margin compared to the prior year. Our adjusted net income in the 2nd quarter was $14,900,000 and adjusted EPS was $0.43 Now I would like to provide update on each of the region for the 2nd quarter.
In the U. S, sales were down 6.9 percent to $60,400,000 compared to $64,800,000 last year. Weakness in sales to IKEA due to changes in its promotional structure compared to last year was part of the reason for the decline. That said, we have also experienced softness in our core business since the beginning of 2018. In response, we are making changes to enhance our go to market strategy and strengthen the distribution capabilities.
We are confident in our ability to resume growth in this market as we realign our execution and progress with our business plans. In terms of filling the permanent role for the President of the U. S. Sales and Distribution Operation, the search is progressing and we will keep you updated as appropriate. In the interim, our Chief Commercial Officer is adding this role and working hard to reposition the U.
S. Business. Australia sales were $34,700,000 up 1.4% compared to $34,300,000 last year. On a constant currency basis, Australia was up 0.6%. We are pleased with our performance in Australia, considering the soft housing market condition, mainly remodeling.
In Canada, sales grew by 8.1 percent to $27,300,000 On a constant currency basis, Canada was up 3.8%. The sequential growth improvement was related to IKEA sales resuming growth as expected following the decline in Q1. This is a market where we believe that there is a meaningful growth potential for us going forward. Sales in Israel were down 15.9 percent to $9,100,000 On a constant currency basis, sales were down by 16.2%, reflecting intense competition and challenging housing market conditions. Europe was a bright spot with sales up 31.1% to $9,100,000 On a constant currency basis, growth was 22% year over year, reflecting better product availability and leveraging the growth in the United Kingdom from our direct distribution operation.
Revenue in the rest of the world during the quarter also benefited from better product availability and was up 27.2 percent to $8,500,000 On a constant currency basis, revenue was up 19.8%. I would like now to turn the call over to Ophir, who will provide more detailed view of our consolidated results and full year outlook. Thank you, Yair, and good morning, everyone. Global revenue in the Q2 of 2018 was $149,200,000 an increase of 0.2% compared to $148,900,000 in the Q2 of last year. On a constant currency basis, revenue declined by 1.5% versus last year.
Gross margin in the quarter was 32.4% compared to 34.9% last year. The decrease in margin reflects the following: inventory and logistical inefficiencies along with higher raw material costs impacted margin unfavorably by approximately 300 basis points Lower production throughput at our Israeli facilities impacted margin by roughly 200 basis points. These factors were partially offset by significant improvement in throughput and yield at our Richmond Hill facility in the U. S, which continues to ramp up and contributed about 2 50 basis points. With the volatility in our gross margin during the first half, we are also providing additional color on our 2nd quarter performance compared to the Q1 to enhance visibility in our margin moving forward.
On a sequential basis, gross margin improved by approximately 700 basis points compared to the Q1 of 2018. The main factors that drove the sequential improvement were as follows: higher average selling prices and volume benefited our margin by 300 basis points. Approximately 100 basis points of the sequential gross margin improvement came from reduced inefficiencies related to inventory and logistics, mainly in our U. S. Distribution operation.
Finally, roughly 300 basis points of the sequential gross margin improvements primarily reflect better operating performance in our manufacturing in Israel and the U. S. Compared to the Q1 of 2018, we view the combined 400 basis points from better operating performance and the improvement in inefficiencies related to inventory and logistics as good proxy for sustainable gains through year end. Operating expenses in the 2nd quarter were $35,100,000 or 23.5 percent of revenue versus $32,600,000 last year, which was 21.9%. Excluding legal settlement and loss contingencies, operating expenses increased to 21.7% of revenue compared to 20.9% in the prior year quarter, mainly due to higher marketing and sales expenses, in addition to non recurring expenses of approximately $1,200,000 mainly related to the relocation of our U.
S. Headquarter. Our 2nd quarter operating income was $13,300,000 compared to $19,300,000 in the Q2 of last year. Adjusted EBITDA in the Q2 was $24,600,000 a margin of 16.5% compared to $29,600,000 a margin of 19.9 percent in the prior year quarter. The decline in adjusted EBITDA margin primarily reflects the lower gross margin.
Finance expenses in the 2nd quarter were approximately compared to $1,400,000 in the last year. This swing was mainly related to FX fluctuations. Our tax rate on adjusted income was 13.4% compared to 17% in the prior year quarter due to lower non deductible expenses as well as the lower tax rate in the U. S. Adjusted diluted earnings per share in the quarter were $0.43 compared to $0.49 in the same period last year, reflecting lower adjusted net income and stable share count.
Turning to our June 30 balance sheet. We had cash, cash equivalent and short term bank deposits of $104,600,000 and net cash position of $95,600,000 Based on our profit performance during the Q2 and the first half of twenty eighteen, our Board of Directors declared a dividend of $0.15 per share with a record date of August 22nd and payment date of September 12, 2018. Moving to our outlook for 2018. Since we provided our sales outlook last quarter, currency rates have moved unfavorably. More specifically, the U.
S. Dollar appreciated in comparison to our main other currencies. As a result, this has created an adverse currency exchange impact of roughly $10,000,000 to our 2018 sales outlook. Therefore, we expect revenue to be at the low end to midpoint of the previously announced range of 5 $90,000,000 to $610,000,000 With respect to adjusted EBITDA, we continue to anticipate full year to be at the range of $74,000,000 to $82,000,000 Thank you. And we are now ready to open the call for questions.
Our first question comes from the line of Michael Rehaut with JPMorgan. Please proceed with your
question. Thanks. Good morning, everyone. And Yair, best of luck in the future.
Thank you. Good morning. First
question, I just wanted to get make sure I understood the comments around gross margin in terms of what was sustainable and what was not. I believe you said that of the 700 basis points sequential improvement that the 300 and the 100, I believe, both related to better operating performance or reduced inefficiencies are what's viewed as sustainable? And am I to understand from that, that of the 32 type percent gross margin that you did in 2Q that of the 700 basis point performance that only 400 basis points is what's viewed as sustainable and we should be looking more like at a 29% type of gross margin in the second half? I just want to make sure I'm understanding that correctly.
You got it right. That's correct.
Okay. The 29% in the back half. And I guess the second question kind of relating to that. So the 300 basis points that wasn't viewed as sustainable relating to was that relating to the higher ASP in volumes? And why is that view is that kind of a temporary why is that viewed as more of a temporary benefit, I guess?
Well, it's not I think that the way we see there was also headwind going forward on a sequential basis. FX is a headwind for us, as we mentioned. The polyester price impact is increasing actually in its impact relative to sequentially. So there are different pressures that lead us to believe that gross margin level will be a little bit below the 32% level.
Okay. And in terms of the U. S. Sales decline, you mentioned 2 main drivers of that, first being weakness to IKEA and second being softness in your core business. I was hoping to get a sense of the 7% decline.
If you could kind of give us a sense of which of those two factors, how much did each contribute to that decline? And how should we be thinking about I assume that's something that is not going to be easily turned around in the next quarter if we should be expecting further declines in the back half?
So I would say without getting into too much details that the impact of IKEA was significant, but even without it, we would have been down. So it's, I would say, similar impact, maybe IKEA slightly lower impact than the core decline. I think that the market in the U. S. Is now currently very, very competitive for us.
We ourselves, as we mentioned before, we are amid many changes in our organization to get better sales execution and better distribution capabilities and improve our supply chain. So we believe that we will see some improvement on a year over year basis compared to the first half in the second half.
And when you say improvement, Yair, you're talking about dollars sequentially
Do Do you
expect year over year growth in the back half in U. S?
Yes, we are. Yes.
Great. Thanks so much. And again, best of luck.
Thank you.
Thank you. Our next question comes from the line of Susan Maklari with Credit
Suisse. My first question is, you mentioned enhancing some of your U. S. Strategy in terms of how you distribute and maybe market or sell the product. Can you just give us a little bit more color on what you're planning there and how we should think about that coming together?
Yes. So I think there are 2 3 elements, I would say, to the planned improvement in our U. S. Top line growth. 1 is, as we mentioned before, we needed to strengthen our sales execution capabilities.
There was a leadership change announced in Q1, and this has followed up by additional changes that have been made or are continuing to be happening now in the U. S, all of which I believe will down the road contribute to a better performance on our part. So A, there is organizational capabilities, especially on the sales side, and we bought some important talents in recently. I believe that, again, it will take it will bring its result down the road. The second thing is we have a major focus on trying to penetrate into the big boxes.
We have been discussing it for quite a while. There is some positive things happening, and I hope that it will result in something that we can announce sometime soon. But it's definitely a major focus on our part in the U. S. And we believe that the big boxes are a big channel across the overall demand.
So it's important for us to be there. The 3rd matter is the distribution the operational distribution performance. And this has two sides for it. 1 is the ability to have the right product at the right place at the right time, which means not losing revenue on logistical elements. And the second one is just to reduce the cost structure because it's too costly as relative to the benchmark that we have experienced before and relative to what we believe should be the benchmark.
On those things, we have few initiatives that are now started to be on the pipeline. I prefer not to provide it's too competitive to provide information somewhere else. So I prefer not to get into details on that part.
Got you. Okay. That's helpful though.
There are there are clear things on the pipe.
There's what?
There are clear things on the pipe being happening and developed.
Got you. Okay. And then I guess can you also give us an update on the U. S. Facility?
It sounds like things are definitely improving there in terms of your volume and your throughput. Can you just give us a little more color on that?
Yes. I think that Richmond in performance was the most the brightest side of this quarter except from us meeting what we have planned to do in Q2 and recovering from Q1 performance. Richmond deal was by far the shining star. The improvement sequentially was just unbelievable. And it's converging to the Israeli plant performance very rapidly.
Soon enough, I believe, we'll just stop talking about it. But in throughput, basically, in throughput, they are in par now with Israel on per line capacity, on per line productivity. On the yield side, which is how many good slabs out of the total that we produce, how many of them ended being good versus not good, there is still some room for improvement despite the major leapfrog that they did. And on the cost per square meter, which is what matters to them the most, they converge very rapidly. So we believe there will be still some gaps because labor costs in primarily because labor cost in the U.
S. Is much more expensive than in Israel. But it's converging very nicely into what we know.
Got you. Okay. That's very helpful. Good luck.
Thank you.
Thank you. Mr. Averbuk, there are no further questions at this time. I'll turn the floor back to you for final comments.
Thank you. Overall, we made good progress during the Q2, but there are still many challenging to challenges to resolve. Fortunately, we have a strong global platform, a powerful brand, leading products and the financial strength to generate stronger returns over time. It has been a pleasure serving Caesarstone and I am proud to be leaving the place to be leaving in place a strong team, which is highly aligned with implementing the targeted goals to resume growth and achieve higher margin. Additionally, we look forward to Yuval working diligently with the team to further refine our strategy and strengthen our brand premium position at the top of our category.
Thank you for your attention this morning.
Thank you. Mr. O'Bourke, we do have one more question from the line of John Baugh with Stifel. Please proceed with your question.
Thank you. Don't know what happened there, Yair and Ophir, but thanks for taking the quick question and good luck in your future endeavors. I guess I wanted to ask quickly about 2 things. The mention of competition in Israel, you have a very large share there. I'm curious as to what precisely you're seeing there.
I'm sorry for the confusion. This does end our call. Thank you for your participation.