Quartz surface specialist Caesarstone (NASDAQ:CSTE) posted earnings results this week that paired record sales with a sharp drop in profitability. The trends put the company on track to meet its revenue target for the year while falling just below earnings expectations.

More on that profit shortfall in a moment. First, here's how the headline results stacked up against the prior-year period:

 Metric

Q2 2017

Q2 2016

Year-Over-Year Change

Revenue

$149 million

$142 million

5%

Net Income

$14.9 million

$26.3 million

(43%)

EPS

$0.42

$0.73

(43%)

EPS = earnings per share. Data source: Caesarstone's financial filings.

What happened this quarter?

Revenue touched a quarterly record of just under $150 million thanks to continued growth in the key U.S. market. Profit margin declined, though, as Caesarstone's costs shot higher.

A white countertop produced by Caesarstone.

Image source: Caesarstone.

Highlights of the quarter include:

  • The 5% overall sales gain was powered by 8% growth in the U.S., which marked a deceleration from the prior quarter's 17% spike. Canada and Australia also contributed to gains, while the Israel market ticked lower.
  • Gross profit margin plunged to 35% of sales from 42%, which management blamed on a mix of spiking material prices and manufacturing stumbles.
  • Operating expenses rose to 22% of sales from 20% as Caesarstone continued to ramp up investments in its marketing and sales infrastructure to support growth in the U.S. segment. The increase sent operating income down to $19 million from $31 million a year ago as operating margin dove to 13% from 22%.
  • Operating cash flow improved slightly, rising to $34 million through the first two quarters of the year from $33 million in the prior-year period.

What management had to say

Executives highlighted the steady sales growth trends, but admitted they weren't pleased with their execution around costs. "Our sales performance this quarter was in line with our expectations," CEO Raanan Zilberman said in a press release, "but we need to continue to work hard in order to capture our full opportunity for profitability."

Zilberman explained that a shift toward more sophisticated products lowered manufacturing throughput during the quarter. Yet management believes the issues won't disrupt momentum. "We are confident we can mitigate challenges and, based on our achievements in the first half, we remain comfortable with our goals for 2017," he said.

Looking forward

Caesarstone affirmed its full-year target that predicts revenue of between $580 million and $595 million, equating to growth of between 8% and 11%. The company lowered earnings expectations for the second time this year, predicting adjusted profits to be around $119 million. That would be a 6% decline and would mark a painful turnaround from the prior year's 8% increase.  Still, management believes the step back is necessary to lay the groundwork for robust future growth.

That's why investors will be looking for operating costs to drop over the next few quarters as manufacturing efficiencies improve. At the same time, gross profit will ideally be heading higher now that the company's product mix is tilting toward more premium products.

Demitrios Kalogeropoulos has no position in any stocks mentioned. The Motley Fool recommends Caesarstone. The Motley Fool has a disclosure policy.