Earnings Call Transcript - XPEL Q2 2022

Operator, Operator

Good morning, everyone, and welcome to the XPEL Incorporated Second Quarter 2022 Earnings Call. I am pleased to hand the call over to your host, Mr. John Nesbett, from Investor Relations for XPEL. John, the floor is yours.

John Nesbett, Investor Relations

Good morning, and welcome to our conference call to discuss XPEL's financial results for the 2022 second quarter. On the call today, Ryan Pape, XPEL's President and Chief Executive Officer; and Barry Wood, XPEL's Senior Vice President and Chief Financial Officer, will provide an overview of the business operations and review the company's financial results. Immediately after the prepared comments, we will take questions from our call participants. Let me take a moment to read the safe harbor statement. During the course of this call, we will make certain forward-looking statements regarding XPEL, Inc. and its business, which may include, but are not limited to, anticipated use of proceeds from capital transactions, expansion into new markets and execution of the company's growth strategy. Often, but not always, forward-looking statements can be identified by the use of words such as plans, is expected, expects, scheduled, intends, contemplates, anticipates, believes, proposes or variations, including negative variations of such words and phrases or state that certain actions, events or results may, could, would, might or will be taken, occur or be achieved. Such statements are based on the current expectations of management of XPEL. The forward-looking events and circumstances discussed in this call may not occur by certain specified dates or at all and could differ materially as a result of known and unknown risk factors and uncertainties affecting the company, performance and acceptance of the company's products, economic factors, competition, the equity markets generally and many other factors beyond the control of XPEL.

Ryan Pape, CEO

Thanks, John, and good morning, everyone. Welcome to the second quarter 2022 call as well. We had a very strong quarter, highlighted by our record revenue, gross margin and EBITDA performance. Revenue for the quarter grew 22% to $83.9 million. It was an outstanding result when you consider the poor but not unexpected Q2 new car SAAR in the U.S., the lockdowns in China that occurred in Shanghai area. And then more broadly speaking, FX impact to the business from the strengthening dollar. We had strong performance across most of our regions, certainly evident in our U.S. region, which grew 43.4% to a record $49.2 million in the quarter. We did see some volume pickup in our dealership services business, so that's off of lows that we've seen on modestly higher new car inventory, but we're still operating at less than 2/3 capacity, as has been the case for the past several quarters. Most of our company-owned facilities continue to experience strong demand, which generally means our aftermarket customers are also continuing to see strong demand in their shops. Looking outside the U.S., record revenue in Canada, Europe, U.K. and Latin America still see strong demand in Canada in one of our most mature markets, but proving there's still room to grow there. Europe continues to perform even in the face of the negative FX impact to revenue and margin, resulting from the strengthening U.S. dollar, particularly against the euro and the pound, not so much against the Canadian dollar unlike in the past. So that's helped us there. Looking at our results on a constant currency basis, measuring rates as of Q2 2021, revenue was negatively impacted by approximately $1.7 million, and margin was negatively impacted by approximately $400,000 for the quarter. We expect worse FX impact to revenue and gross margin in Q3 for sure, just with the way rates have moved, and then one would assume in Q4 as well. As we discussed on last quarter's call, we were expecting our Q2 China sales to be reduced by approximately $5 million due to the COVID-related lockdown situation in the region and in Shanghai in particular. We saw just right around that, just under $5 million actual reduction from the original plan. China new car sales were down in the first part of the quarter and then began to rebound in June. Unfortunately, our performance in other regions, particularly in the U.S. offset the shortfall relative to our plan. We think Q2 should be the bottom for China and expect run rates in Q3 and Q4 to start to trend back up to higher levels. But overall, I think China is a weak spot in the demand picture at the moment, just as it continues to have uncertainty going forward regarding the unpredictable impact of the COVID mitigation strategy. With the impact of China and then the currency, U.S. dollar strength, we saw almost $6.5 million worth of negative impact to our overall revenue plan. Absent those impacts, revenue growth would have been a little over 31% year-over-year. We had good gross margin performance for the quarter, and we continue to make great progress on our initiatives in this area, finishing the quarter at 39.3%, which is a great result. It's even more impressive when you consider what we just talked about—strengthening U.S. dollar puts pressure on gross margin with U.S. dollar-denominated product cost everywhere we sell. The quarter's gross margin was negatively impacted by about $400,000. We do get a slight mix benefit to our gross margin percentage when China represents a lower percentage of revenue as it did in the quarter. That helped us a little bit, but with the distribution market like China, we get no help from an operating standpoint, no SG&A cost savings. Overall, it's certainly a net negative any time your revenue is down. Overall, improvements to gross margin are consistent with the strategy we've been talking about. Even with all of the noise there, we remain very confident in our ability to reach a 40% gross margin run rate exiting the year. Obviously, you see we're very close there for Q2, but we get the mix benefit with China. China should represent an increased percentage of sales, but we still should be able to make that up in the second half of the year. We had no material pricing changes in the first half of the year, so margin and revenue performance is not being driven by pricing, which is a very common question in the current environment. However, we are currently evaluating the second half with respect to pricing, looking at how costs are trending. Obviously, we're not— even with a good gross margin improvement program we have, we're not immune to the trajectory of cost that everyone is seeing overall, and we will be making decisions on that in the second half of the year. Another big highlight for the quarter reached the highest EBITDA margin in our history, at 20.5%, the first quarter that we've ever exceeded 20% EBITDA margin. We achieved this result despite encountering approximately $2 million in EBITDA headwinds related to the China lockdowns and the strength of the U.S. dollar over the prior year. If those two things hadn't occurred, our EBITDA margin for the quarter would have approached 22%. So all the way around, I think it's consistent with what we've been saying—the business continues to grow revenue. We work our gross margin plan to completion and manage expenses, which are still trending a little higher on a percentage of revenue basis than we'd like, but you put it together and you can drive operating performance in this business, and we are and expect to continue to do so. We're estimating 2022 annual revenue growth to be in the 25% to 28% range. This is a little less than our previous guidance of 30%, mainly due to the China impact in the first half, slower recovery of China in the second, and then strengthening U.S. dollar, as we've talked about. But it will be a good result, and demand has remained strong. July was an exceptional month, and August is proving to be no exception so far, so we feel very good about that. That said, manufacturers have been more bullish in their expectations for new car production recovery in the second half. This is a potential upside benefit for us. We've heard that before, but there seems to be room for some optimism that we believe we’re set to benefit from this change. If you look at the comments from the manufacturers, I'd say they've incrementally become more positive about the production recovery and the concept that there’s pent-up demand among new car buyers in the channel, which we believe. We expect revenue for Q3 in the $85 million range, plus or minus, which represents an improvement in China and increased headwinds from the continuing strong U.S. dollar. Last year, we saw our highest EBITDA in Q2 and then sequential declines in Q3 and Q4. We discussed quarterly impacts during Q3 and Q4 last year, but absent those types of things happening or other one-offs, there's nothing structurally different about Q3 or Q4 versus Q2. So in other words, there's no reason that Q2 should year after year outperform Q3 from an operating standpoint or even outperform Q4. It really just depends on what happens in the quarter. From the product side, our window film business continues to do great, growing 42% for the quarter up to $60 million, sequentially was up just about 37%, so almost 19% of revenue for the quarter. The architectural film business makes up about 10% of that. We’re about 2% of total sales, so it's still small but growing, and we're seeing really good year-over-year growth each month this year as we continue to execute the strategy there and expect that to continue to grow as a percentage of sales and a percentage of the window film business overall. Last month, we announced our partnership with Rivian, an electric vehicle manufacturer, to be the exclusive supplier of their factory direct paint protection film program. It's obviously a great addition to our overall OEM program development and a great way to increase awareness of paint protection film in general. The program will begin by the end of the year. Rivian is really excited to promote paint protection film, and we just completed a joint marketing campaign to raise awareness of paint protection film among those who have already taken possession of their Rivian vehicles, driving them to our local installers to have installations done on those vehicles that have been delivered. It's been quite successful, with a very high interest rate when looking at the number of vehicles delivered. I think it's an example of what’s possible with some of the go-to-market strategies from these new manufacturers who have an even more direct connection to their customers, so it should be a good program there. I want to give a quick update on inventory. We've talked about this for a few quarters. We finished the quarter with approximately $74 million in inventory, which is relatively flat to Q1. We expect inventory to peak within a few million dollars of where we are, plus or minus, between now and early Q4, which is probably a little bit later than our previous estimate. Regardless, we remain well positioned to mitigate any of the supply chain risks, and we've really seen the bulk of that inventory build. This is a substantial departure from the first half of this year where we used almost $23 million in cash to build inventory. The inventory build has effectively stopped, and then we will begin to release some cash from inventory, but that's probably pushed back a little further into the year. We still intend to use our cash flow on acquisitions. We took the first part of this year to finalize the integration of everything that we had done last year and reassess our strategy and program going forward. We did complete a small acquisition of the software business at the beginning of Q3, which we will integrate into our DAP platform. We have a desire, an ongoing program to really invest in the software offering and build the best platform we can for our customers to use to run their business, and this will be part of that. We're active in the acquisition pipeline overall, as I mentioned. This is both domestic and international, including international distribution, where we want to get closer to the customer. With the dislocation in terms of currency, there are opportunities in currencies that weakened relative to the dollar. So, overall, a great quarter. I couldn't be more proud of the team, really executing exceptionally well. With that, we'll turn it over to Barry and take some questions.

Barry Wood, CFO

Thanks, Ryan, and good morning, everyone. I'm going to dive a little deeper into our overall revenue performance. Product revenue in the quarter grew approximately 14.3% to $67 million and grew 20.8% to $125 million on a year-to-date basis. Our service revenue in the quarter grew 67.3% to $16.9 million and represented 20.1% of our total revenue. As in the prior quarter, this growth was driven by increased demand in our company-owned facilities that Ryan was talking about and acquisition-related labor revenue from our dealership services businesses. On a year-to-date basis, total service revenue grew 80.1% to $30.6 million. Keep in mind that sometimes our product revenue is converted to service revenue when we do these acquisitions, such as PermaPlate and Tint Net. What was pre-acquisition was product revenue; post-acquisition is now service revenue. So this certainly impacts the growth rate in the service category as well. Total installation revenue, combining product and labor, increased a little over 106% and represented 15.7% of total revenue. This increase was due again to both acquired dealership services businesses in 2021 and the continuing strong demand in our company-owned installation centers. Overall, our total revenue was up 16.7% sequentially versus Q1. We were pleased to see gross margin coming in at 39.3% for the quarter. Sequentially, gross margin was up 19% from Q1, and our year-to-date gross margin finished at 39%. Our Q2 SG&A expenses grew 37% versus Q2 2021 to $17.3 million and represented 20.5% of total revenue. For the first half of the year, total SG&A expenses were up a little over 56% and represented 22.4% of total revenue. Part of this quarter-over-quarter growth is due to increases in travel-related expenses, as our team has returned to conducting more in-person meetings, providing more outbound training, and holding more marketing events. We think this is important after the last two years of limited in-person contact, and we’re happy to see these expenses increase as we believe we get great returns on that investment. Sequentially, SG&A expenses were down approximately 2.5% versus Q1, but we did have some one-timers in Q1 related to our dealer conference. If you normalize for that, SG&A expenses would have been essentially flat sequentially. This nicely plays into our bottom line performance. Q2 2022 EBITDA increased 26.6% versus the prior year quarter to approximately $17.2 million, which again was a record for the company. On a sequential basis, EBITDA increased 44.9%. As noted earlier, our sequential revenue increase was 16%, so we had some great leverage quarter-to-quarter. Q2 EBITDA would have grown a little over 40% versus Q2 2021 if you normalize for all that. Year-to-date, our EBITDA grew 27.8%. Q2 2022 net income increased 16.8% versus Q2 2021 to $11.9 million, reflecting a net income margin of 14.2%. Net EPS for the quarter was $0.43 per share. Our EBITDA grew faster than net income in the quarter due to new amortization related to 2021 acquisitions that we still need to earn through and additional interest expense on our debt that we incurred to fund our inventory build. Normalizing just for the FX impact, net income would have grown a little over 21%. On a sequential basis, net income grew 52.5% versus Q1. On a year-to-date basis, net income grew 15.7%, and our year-to-date net income margin was 12.7%. Our year-to-date EPS is $0.21 per share. Cash flow from ops for the quarter was $1.8 million as we returned back to generating cash as our inventory build moderated. We expect this trend to continue as we monetize our built-up inventory in the coming quarters. Our debt level also moderated during the quarter. Our debt level could go up or down in future quarters, depending on the excess cash that we generate and the timing of any future acquisitions. Regardless, we are very well positioned financially to execute on our plan. We are very pleased with the quarter and excited about the rest of the year. With that, operator, we'll now open the call for questions.

Operator, Operator

Your first question is coming from Steve Dyer from Craig-Hallum.

Steve Dyer, Analyst

Thanks. Another great quarter, guys. Congratulations.

Ryan Pape, CEO

Thanks, Steve?

Steve Dyer, Analyst

When you look at how much you're outgrowing new car sales, particularly in the U.S., could you sort of break down the biggest drivers, whether it's sort of attach rates or the amount of film going on for vehicles? It doesn't sound like price increases have much to do with that, but sort of what would you attribute it to?

Ryan Pape, CEO

Yes. I think it's multiple factors. Clearly, attach rate for paint protection film is increasing, has been increasing, and we think will continue to increase. Within the paint protection film business, the trend over time has been more product per vehicle on average. You used to cover a smaller portion of the cars in aggregate, and that's grown over time and probably continues to grow. Then we have additional products that allow more opportunities for more content per vehicle, such as coatings and the window film products, where we're able to take market share in some of those cases, particularly in the window film business where it's a more established business. Taking market share into a larger established, slower-growing business allows us to out-earn and out-compete there. I think the extent we’re in the service business, increasingly through acquisition and other avenues, that also drives dollar content and dollar-denominated growth in excess of what you would get just from product sales simply because the service is priced so much higher than just the product. So, I think it's really all four of those things contributing to that.

Steve Dyer, Analyst

Got it. As you look at kind of the dealer base, could you remind us how many franchise dealers are selling your PPF? What do you think is the realistic opportunity there? Is there competitive share you can gain or other dealers that don’t sell anybody's PPF going forward?

Ryan Pape, CEO

Yes. It's a bit challenging to determine the number of new car dealerships we reach directly and then through our whole network. What does it mean to reach? Is it touching one car a month or touching 100% of the units sold monthly? We have some connectivity directly and indirectly into several thousand new car dealerships in the U.S. I think there's tremendous opportunity to grow the number of dealerships offering paint protection. That doesn't mean that we need to sell to them, but we will and we might, also through our aftermarket channel. There is a huge labor force for the new car dealerships, and I think you'll find many dealerships that don't offer paint protection. You'll also find many that offer it but do it only when asked or on occasion. The opportunity is to offer it if you're not, and then do so with greater conviction and much greater unit volume—greater attachment to units sold. There is a long way to go there. We've seen success doing that at many different price points. When you get the dealers involved, it’s not driven by the enthusiast buyer who is traditionally about the product in the aftermarket; you can get attachment into a much broader range of vehicles. We think that's really important to do.

Steve Dyer, Analyst

Yes, I purchased a vehicle this quarter, and interestingly, it came preloaded with XPEL. I'm curious if you are noticing this as a trend, if it's an incentive you're offering, or if it's mostly dealers looking for margin improvements and preloading it to the point where customers tend to opt out, which is uncommon. Is this kind of trend something you're seeing?

Ryan Pape, CEO

Yes. You are seeing more paint protection film preloaded on the lot. When you look at the environment we're in with the shortage of new car inventory, we talk a lot about the takes and puts that occur in that environment. One is that dealers are having an opportunity to do more preloading and do that sort of upfront accessorization, so that might be what you're seeing. We do see more of that occurring, and yes, it's typically motivated ultimately by the dealer's profit motive like anything that they would sell. Our job is to help educate the dealers that paint protection film is, in fact, a better alternative, in our view, than many of the other things that they sell or preload. There’s a lot of warranty and finance products that we don't think offer quite as much value to the consumer as paint protection film. And from a dealership standpoint, those are cancelable products—you can leave a lot and cancel it—and hard add like paint protection film that’s actually on the car, that stays. There’s a lot of opportunity there. A point that may not be obvious to everyone is that we’re not telling the dealerships anything they don't already know—that they can make money by doing other things and selling the car. They obviously know that. What we’re doing and will continue to do is to say, paint protection film is a product that customers love; those who buy it once are incredibly likely to buy it again. It’s a tangible product with demonstrable value, therefore, it’s a better thing to sell with these new cars than many other things you may be offering.

Steve Dyer, Analyst

Got it. Lastly for me, speaking of sort of preloading, do you anticipate your deal with Rivian to be one of the only OEM ones you do? Or do you feel there's a big opportunity there going forward?

Ryan Pape, CEO

Sure, Steve. Yes, there remains opportunity with OEMs. The OEM channel allows us to reach buyers today that we wouldn't reach in many cases any other way, either because the dealers aren't offering it or the customer isn't aware of it. In Rivian's case, they’ve been very forward in marketing it, branding it as XPEL, which they’ve done for themselves, and done the broader business of paint protection film a service by introducing it to many people that didn’t know about it. I think there's plenty of opportunity to expand upon that, looking at this still small attach rate in total new car sales and ways to grow that. This would not be the last one of those we look at doing.

Steve Dyer, Analyst

As a quick add-on to that, would you typically do that with a manufacturer that doesn't sell through the dealer channel, just given sort of the conflicts there?

Ryan Pape, CEO

No. There’s opportunity for both. When you look at Rivian with an alternative channel, it's allowed them to engage in marketing activities directly to the consumer because they're that much closer to them. However, we have other examples in the OEM channel where we have a product being installed and sold through the dealers. There’s, again, a benefit to the dealer too—it's another margin opportunity for them just as it is for OEMs, so it seems equally compatible, irrespective of the new car channel.

Operator, Operator

Next question is coming from Jeff Van Sinderen from B. Riley.

Jeff Van Sinderen, Analyst

Let me add my congratulations on the strong Q metrics. Sounds like there are some encouraging signs in OEM production rates. But can you speak a little bit more about what you're hearing from the dealers, from the OEMs around the inventory outlook and flow that they're expecting as we think about the second half?

Ryan Pape, CEO

Sure, Jeff. Yes, I think we have kind of a couple of data points—what do the OEMs talk about publicly and what does that mean in aggregate, and then the feedback we get from all the dealerships, down to when are the trucks delivered and do the cars show up. Those haven't necessarily run together in the past three quarters, but now it seems like they're coming into alignment. We have reports from dealerships getting increased fill rates and delivery rates, which seems to tie into what the manufacturers have mentioned. Last year, our expectation was that Q2 would see a meaningful improvement in the overall inventory situation. While the inventory ticked up from the lows for Q2, no one would probably call it a meaningful recovery. It seems there’s room for optimism for the rest of the year, both based on what we’re seeing at the dealership level and the OEM's public comments. We believe there will be improvements throughout the remainder of the year.

Jeff Van Sinderen, Analyst

Okay, good. But it seems like that's probably a multi-quarter thing, right? I mean, we're not going to get back to normalized inventory by the end of this calendar year.

Ryan Pape, CEO

Yes, absolutely.

Jeff Van Sinderen, Analyst

Okay, good. I’m curious on the software that you acquired that I think you said you are melding into the DAP software platform. Could you touch on what that is? And also, any other components you might want to layer in that you would acquire?

Ryan Pape, CEO

We're not quite ready to talk about what we bought and how it integrates into the DAP. We probably need a little more time to advance that. I do think that, that's something we are looking at, and open to, as a way to build out that platform. We look at our market and the customers we have as being technology-driven. We know this is true even when looking at our own operation and where our operation is strong and weak and where we need improvements. There’s a lot of benefit we can bring. Most of that will be from our internal efforts and the team we have and are growing here. But like we did with that little tuck-in, there are probably other opportunities we would consider going forward.

Operator, Operator

There appear to be no further questions in the queue. I will now hand back over to management for any closing remarks.

Ryan Pape, CEO

Thanks, everyone, and thanks to the XPEL team for doing a great job. Looking forward to speaking to everybody in the future. Have a great day.

Operator, Operator

Thank you, ladies and gentlemen. This concludes today's conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.