Earnings Call Transcript - XPEL Q1 2024

Operator, Operator

Good morning, everyone, and welcome to the XPEL Inc. First Quarter 2024 Earnings Call. I will now turn the conference over to your host, John Nesbett, IMS Investor Relations. John, you may begin.

John Nesbett, Investor Relations

Good morning, and welcome to our conference call to discuss XPEL's financial results for the first quarter of 2024. 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'll take questions from our call participants. Now I'll take a moment to read the safe harbor statement. During the course of this call, we'll make certain forward-looking statements regarding XPEL, Inc. and its business, which may include, but not be limited to, anticipated use of proceeds from capital transactions, expansion into new markets and execution of the company's growth strategy. Such statements are based on our current expectations and assumptions, which are subject to known and unknown risk factors and uncertainties that could cause our actual results to be materially different from those expressed in these statements. Some of these factors are discussed in detail in our most recent Form 10-K, including under item 1A Risk Factors filed with the SEC. XPEL undertakes no obligation to publicly update or revise any forward-looking statements, whether a result of new information, future events or otherwise. Okay, with that, I'll now turn the call over to Ryan. Go ahead, Ryan.

Ryan Pape, CEO

Thank you, John. Good morning, everyone, and welcome to the first quarter 2024 conference call. Clearly, Q1 was a challenging quarter for us. Revenue increased by 5% to $90 million, with U.S. revenue growing 1.9% year-over-year to $52 million. We experienced weakness in the aftermarket at the beginning of the year, continuing a trend that started in late summer, which we have previously discussed. We are also now comparing against a stronger period from the first half of 2023. Our aftermarket customers are quite diverse, making it difficult to generalize, but it's worth noting that some dealers experienced declines of 10% to 15% in the first quarter compared to the same period last year. Comparatively, our internal company-owned locations, which serve as a good indicator for the aftermarket, reported similar weaknesses on a year-over-year basis. Some customers were down more than others while some saw growth, based on their business models and customer dynamics, but a common theme was a slow start in January and February across various regions. There seems to be a growing consensus about overall consumer weakness, which significantly impacts our aftermarket business. The adoption of electric vehicles (EVs) in recent years has likely benefitted our business for two reasons. Our core enthusiast customers are beginning to adopt EVs, and the EV revolution is creating a new class of enthusiasts who traditionally were not our customers. However, as the market for EVs cools and buyers attracted by discounts may not fit in our aftermarket customer base, declines in EV sales could negatively impact us in terms of volume and the overall composition of consumers. This further emphasizes our need to engage with diverse customer types, particularly those typically not involved in the aftermarket. Our initiatives, such as partnerships with OEMs and dealership activation programs, are aimed at addressing this challenge. Moreover, port delays in the U.S. have led to a significant reduction in sales for Porsche and Audi, two of our key brands for traditional paint protection film. These delays may have contributed to the strong performance we observed in April, an anomaly for us since April usually doesn't exceed March in revenue. Our attach rates are influenced by various factors, including the enthusiast nature of the brand, vehicle price points, production volumes, and the effectiveness of dealerships in marketing our products. Although U.S. port delays were a significant issue this quarter, the trends we observed are not unique to the U.S. Our dealership services business continues to perform well, with growth in both car counts and average selling prices. In April, we reached an agreement with Tint World, a prominent vehicle accessory and window tinting franchise, to supply their franchisees with co-branded products. This partnership primarily focuses on window tint products but also includes some paint protection film. We anticipate fruitful collaboration going forward. Outside the U.S., our performance in China was below expectations, contributing to lower than anticipated revenue growth. The dynamics in China, particularly the sell-in versus sell-through challenges, made for a lumpy business environment. We are committed to refining our go-to-market strategy in China and enhancing our product portfolio, inventory management, and overall distribution model. Despite difficulties in the U.S. and China, other regions experienced remarkable growth, particularly Europe and the Asia-Pacific areas, with our operations in India also progressing well. Additionally, our OEM business saw a year-over-year revenue increase of about 58%. In light of the current market environment and our preliminary forecasting, we are reducing our revenue guidance for the year to an organic growth range of 8% to 10%, with expected Q2 revenue in the range of $105 million to $108 million. While we face incremental challenges, we are focused on long-term growth and maintaining our cost structure to support our ongoing business aspirations. We also experienced improved gross margin performance of 42%, which reflects positively against our strategic objectives surrounding inventory management. Enhancing cash flow through improved inventory management remains a priority, and we have seen reductions in our raw materials inventory, contributing to our overall plans. Looking ahead, we will continue to prioritize mergers and acquisitions in alignment with our core operations. Our strategy includes pursuing international distributor acquisitions and investing further in the dealership business to facilitate growth. Finally, we have plans for product expansion, including new colored film options, while maintaining discipline in our approach to product additions, given our focus on improving our free cash flow. Although we experienced a challenging quarter, we remain enthusiastic about the future and the potential of our products. With that, I will turn it over to Barry before we move into the Q&A session.

Barry Wood, CFO

Thanks, Ryan, and good morning, everyone. Just to start out, I wanted to provide a quick reminder on the seasonality of our business. In all regions, excluding China, Q1 is typically our lowest quarter of the year. Q2 and Q3 can trade off being the highest quarters and then Q4 is less in Q2, Q3, but higher than Q1. And this holds true in China, except that Q4 tends to be their largest quarter. So given all that, comparing revenue sequentially versus Q4 is really not near as meaningful as it is in other quarters. Looking at the product lines, combined paint protection film and cut bank revenue declined about 1% in the quarter, again, owing to the China performance and lower U.S. demand. Our window film product line revenue declined 2.9% quarter-over-quarter to $14.5 million, which represented 16.1% of our revenue. But excluding China, the total window film revenue grew 10.3%, which is still decent performance even in a seasonally lower quarter. Our Q1 vision product line revenue, which is included in our total window film revenue grew 33.1% to $1.8 million. So again, good growth in a low seasonal quarter. And as Ryan mentioned, our OEM business continued to post strong results, with revenue growing just under 58% versus Q1 2023 to $4.6 million. Our total installation revenue combining product and service grew 34.7% in the quarter and represented approximately 22% of total revenue. And as Ryan mentioned previously, many of our corporate store's revenue declined versus Q1 2023. So the total installation revenue was certainly buoyed by our dealership services business and OEM business. Our Q1 SG&A expense grew 36.2% to $28.6 million and represented 31.8% of revenue. Included in Q1 SG&A was approximately $1.6 million in net costs from our annual dealer conference that was held in February this year, but held in Q2 last year. And if you normalize for that, our SG&A would have grown approximately 28.6%. Sequentially, after factoring in the dealer conference costs in Q1, SG&A grew 1.3%. And certainly, our expense profile looks outsized in a down revenue quarter. But as Ryan alluded to, we're actively managing our costs where we can and really trying to thread the needle between the right trade-off of managing costs versus continuing to do right by our customers. And we've gotten and continue to get an ROI on our SG&A spend in the form of improved gross margins, and we want to continue that for sure. So we'll continue to monitor this, but our expectation is that our SG&A run rate will remain largely intact for the remainder of the year, especially in light of the improving revenue momentum. Our Q1 EBITDA declined 31.5% to $11.7 million, reflecting an EBITDA margin of 13%. And normalizing for the dealer conference costs again, EBITDA would have declined 22.1% and EBITDA margin would have been 14.8%. Our Q1 net income declined 41.7% to $6.7 million, reflecting net income margin of 7.4%, and our EPS was $0.24 a share. But again, normalizing for the dealer conference costs, net income margin would have been 8.8% and EPS would have been $0.29 per share. And Ryan talked about our inventory earlier, so I don't have much to add to that other than it did impact our cash flow from ops where we posted a use of cash of approximately $5 million. Again, our expectation is to return to positive operating cash beginning in Q2 as we work down our days on hand as we've discussed. So tough quarter for sure, but we're well-positioned to continue to work through these macro challenges and get back to solid double-digit growth. And with that, operator, we'll now open the call up for questions.

Operator, Operator

Thank you very much. At this time, we'll be conducting our question-and-answer session. Our first question is coming from Jeffrey Van Sinderen of B. Riley.

Jeff Van Sinderen, Analyst

I wonder if you could give us your expectations for gross margin. Your gross margin was, I think, one of the highlights of positivity in Q1, maybe for Q2 and for the rest of the year, anything we should be factoring in for that. And then operating expense expectations for Q2 and the remainder of the year, just maybe giving us a better sense of how to model those.

Ryan Pape, CEO

Sure, Jeff, thanks for the question. Yes, our goal last year was to end the year around a 42% gross margin, and we started the year there. That's where we aim to stay or improve. I believe we still have room for improvement in gross margin over time, as we've discussed. However, we have some fixed costs in the cost of goods that could limit our ability to increase that margin significantly in the near term. That said, there was nothing particularly unusual about Q1 that would stop us from maintaining that level. Regarding SG&A, as Barry mentioned, we don't intend to reduce our overall SG&A meaningfully from the current run rate. We're focused on efficiencies and making the right trade-offs to prevent it from growing, excluding any potential acquisition impacts or other factors that could influence it. We expect to see growth and accommodate that within our cost structure. However, if the environment worsens, we may reassess our approach. Our goal is to manage SG&A effectively and maximize our spending rather than simply aiming to reduce total dollar amounts.

Jeff Van Sinderen, Analyst

Okay. That's helpful. And then I just wanted to hit on one of your comments in the prepared remarks. I know you spoke to what you saw in your own dealer units and what you saw in folks that you sell a product to your partners out there, if you will. And I think you said 10% to 15% decline, order of magnitude was not unusual in Q1. And so just sort of just positioning that with the improvement you saw in April, maybe you could speak to your level of confidence in getting to the 8% to 10% growth in revenues for the year.

Ryan Pape, CEO

Yes. Well, I think, frankly, we saw much better growth within that segment in April versus the aggregate we saw in the first quarter. So that's quite a change within that segment. Now April is one month. And if you've got some sort of hangover effects from the first quarter, maybe April outperforms May and June. I mean, frankly, we don't know. But we've seen more growth than we saw sort of declines in the first quarter. So I mean that's, you know, candidly, when you look at the data that we have, that's as far into the future as we can see. So I think that is a positive trend, but maybe one month doesn't a trend make.

Jeff Van Sinderen, Analyst

Okay. Fair enough. In terms of the order of magnitude, I understand that you are selling to various vehicle brands. Were there any vehicle brands that were 10% or larger in size in the first quarter? Additionally, could you provide some insights into the EV brands? You mentioned Rivian; how significant were those brands in terms of their impact on your business? Also, can you share any information regarding the concentration of those brands?

Ryan Pape, CEO

Yes, as we've discussed today and previously, the distribution of this business is likely much broader than many may assume. There's a perception that all revenue is centered around one or two brands, but that's not accurate. Last year, we mentioned that concentration related to specific makes was about 5% or less. It's important to convey that there are various trade-offs at play. For instance, you have high-volume brands like Toyota with significantly lower attachment rates, while brands such as Porsche may exhibit lower volume but much higher attachment rates. This pattern holds true for other brands as well. When you look at these factors together, different metrics of attachment can emerge, whether considering content per vehicle, some film per vehicle, or using bumpers as a reference. Although the leading brands may appear to have similar aggregate volumes based on various measures, their attachment rates differ substantially. It's crucial to emphasize that there is no single point concentration risk associated with any one vehicle in this business; they all interact with one another. With enthusiast vehicles, certain brands will show higher attachment rates that impact their overall results. For instance, the attachment rates for BMW, based on our metrics, are significantly higher than those for Mercedes. There is no single factor driving this, nor is there an overly dominant brand; each contributes to our overall performance. If there were an excessive concentration in a specific make or segment, we would openly address that.

Jeff Van Sinderen, Analyst

Okay. I'll jump back in the queue.

Operator, Operator

Thank you very much. I'm not seeing anyone else in the queue at this moment, so I will now hand it back to management. Apologies, we just had someone in the queue, and it's from Steve Dyer of Craig-Hallum.

Matthew Raab, Analyst

This is Matthew Raab on for Steve. I guess I'll just start with China in Q1. Obviously, it was much weaker under $2 million. Can you kind of talk about what you see in Q2, kind of thinking about the revenue guide? It seems like it's much more second half weighted. Is that kind of the right way to think about that?

Ryan Pape, CEO

Well, I think it is in the sense that we have this sell-in versus sell-through dynamic that we've talked about sort of ad nauseam. But our goal is to eliminate that this year and to then have the ability to recognize our revenue in China as it occurs. And that's part of what we're trying to accomplish there and part of what we're trying to change to actually enable us to see even more growth in China. And that could take a number of forms in terms of what we do, vendor-managed inventory type process or others. And so all of that is part of what we're working on in China. When you got the bulk of the product for China coming from the U.S., you've always got lots of material in transit. You've got lots of inventory held at different points. And so that creates this lumpiness until you can actually sell through it. And that's what we're going to change. So our quarter-to-quarter, our sales into China really have almost no relationship to actually what's happening on the ground.

Matthew Raab, Analyst

Okay. Yes, makes sense. And interesting commentary on the colored film. Can you kind of explain what sparked that move because you guys have been cautious in the past. Just curious why the change.

Ryan Pape, CEO

I think we're at a pivotal moment regarding the application of colored films and their alignment with our business model, especially if we can utilize a technology and installation profile that most of our customers are accustomed to. The traditional products, which are not based on TPU, have fundamentally different physical characteristics. This creates a bigger jump for technicians and installers, as the installation process is not the same. However, the shift towards using TPU-based color films brings us closer to the capabilities of our existing customer base and the trained workforce available in the market, which presents a new opportunity. Using TPU as a substrate can lead to products that are more durable, have better optical properties, and offer an improved appearance, which is appealing. However, I must candidly state that at the consumer level, this may not significantly increase the number of people looking to change their car's color. This option remains somewhat specialized and can be costly, likely attracting a limited segment of buyers. Yet, looking at other initiatives related to accessorization and customization at dealerships or OEMs, there could be more opportunities. The timing is ripe for further development in this area. From a product line perspective, it's important to be cautious about maintaining a wide range of colors, as it requires substantial inventory and color trends can shift, particularly in the aftermarket. This could explain our historically conservative approach. Over time, we may witness a restructuring in the aftermarket regarding colored films due to advancements in technology, which aligns with our strengths. Therefore, expanding our offerings beyond black is a worthwhile pursuit.

Matthew Raab, Analyst

That's it for me. Thank you very much.

Operator, Operator

We will now be handing back over to management for any closing comments.

Ryan Pape, CEO

I want to thank everybody for joining us on the call today and thank our team for working really hard to set the business up for success and look forward to speaking with everyone again.

Operator, Operator

Thank you very much. This does conclude today's conference. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.