Earnings Call Transcript - XPEL Q1 2022

Operator, Operator

Good day, everyone, and welcome to XPEL Inc.'s First Quarter 2022 Earnings Call. It is now my pleasure to hand it over to your host, John Nesbett, Investor Relations for XPEL. The floor is yours.

John Nesbett, Investor Relations

Good morning, and welcome to our conference call to discuss XPEL's financial results for the first quarter 2022. 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. I'd like to take a moment to read the safe harbor statement. During the course of this call, we'll make certain forward-looking statements regarding XPEL 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, 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. Although XPEL has attempted to identify important factors that could cause actual actions, events, or results to differ materially from those described in forward-looking statements, there may be other factors that could cause actions, events, or results to differ from those anticipated, estimated, or intended. No forward-looking statement can be guaranteed. Except as required by applicable securities law, forward-looking statements speak only as of the date in which they're made, and XPEL undertakes no obligation to publicly update or revise any forward-looking statements, whether as 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, President and CEO

Thanks, John. I appreciate it. Good morning, everyone. Welcome to the first quarter 2022 call. We are off to a good start in 2022; for the first quarter, it was a record quarter for revenue and gross margin. Revenue grew 38.6% to $71.9 million, and we had strong performance in most of our regions. Sequentially, revenue was up about 2.5% from Q4, which was good to see given a 29% sequential decline in China due to lockdowns. Many of you know Q1 is seasonally the weakest quarter for us, and we haven't in every year always exceeded Q4 revenue in Q1. So we're happy that we did this time. As you recall from our last year-end call, we weren't sure if that would happen this quarter. That was definitely positive, and we're happy to see that. The U.S. business grew 62.4% to $41.6 million, again, another record quarter for the U.S. region. The U.S. Q1 new vehicle SAAR was down about 16% versus Q1 2021, and relatively flat against Q4. We saw some modest volume improvements in our dealership services business at the end of the quarter; this was encouraging. However, the inventory rebuild that we hoped for is still a work in progress for the industry and probably pushed beyond Q2 as we originally thought. It's obviously a moving target. But despite the anemic SAAR for reasons we know—primarily related to new car inventory shortage—we saw good growth, which suggests we're continuing to see tax rates grow for our products and take market share. So all in all, there is a lot to be happy about with the U.S. business against the broader backdrop. Our company-owned installation facilities in the U.S. really act as surrogates for what our customers are seeing generally; they saw record sales in March—in fact, almost all of them did. Given this, we expect continued strong performance in the U.S. in Q2. The results we see in those locations are really proxies for many of our aftermarket customers, so we expect the same from them. We remain in a really unique environment where these retail aftermarket sales continue to do great as indicated by the company-owned sales I just mentioned, and what we're seeing from our customers. The dealerships, however, are a mixed bag; where our revenue is more inventory coupled at dealerships, we have more pain, which we know. As we've been mentioning when we're discussing the performance of our acquired businesses over the past few quarters, some dealerships have been able to use the shortage of inventory to increase the attach rate of our products into their vehicles sold, but this is mostly for dealerships that were already carrying our products but had room to increase the attach rate. So that's been a positive to counter the other negative. However, we're also competing with an invisible accessory at these dealerships, which is the ability for the dealerships to place market adjustments on top of the MSRP, which brings the dealerships record profit without doing anything. So it's a complicated time to get a full read on the market with these competing inputs. But as you see, the results have been good either way and in many respects, the good and the bad are balancing each other out to yield decent results for us. So we feel good about that for the U.S. business. Outside the U.S., we saw solid growth in most of our regions, including record revenue for Europe, UK, and Latin America. Continental Europe was up sequentially and both were up; the UK was up quite a bit from Q4, so all good numbers there. Europe has been doing better than we thought, really, with the war in Ukraine and its knock-on effects. We're happy with that. Additionally, Canada was down a little from Q4, which is certainly normal for the seasonality in that market. Lockdowns have returned to parts of China due to COVID, reducing revenue in China for the quarter to $8.9 million. We had already discussed how we thought China would be a bit back-end loaded for the year, and obviously took this turn of events with the lockdowns. Unlike the 2020 lockdowns, however, this is not grounding business to a halt around the entire country. The lockdowns and the ensuing port congestion will reduce China sales in Q2 by at least $5 million from our original plan and may reduce them from Q1 levels. It's a very fluid situation, so we don't know fully what to expect as we see how the markets react to the news out of China every day. Hopefully, we can move beyond that quickly after this. In the case of the previous lockdowns in 2020, if things resumed very rapidly coming out of lockdown in China, the markets affected this time may not do the same, but we will continue to watch. As we talked about in the last quarter, we launched one small OEM program in March; this is for a new manufacturer in Europe, which is great. However, our larger planned OEM program, which was the second that we were launching, has been delayed several months due to supply chain issues with the OEM—kind of no surprise there—and that's a drag on us a little bit until we start to see revenue from that in Q2 or Q3, depending on the exact timing. So a few-month delay there, but we are still focused on that line of business as an additional way to grow awareness of paint protection and bring paint protection film to consumers who have never seen it before. At this point, we would affirm even with the China situation, our previous guidance of revenue growth in the 30% range for the year, and we expect Q2 to be in the $80 million range, plus or minus, which is definitely lower than we would have expected in Q1 after we adjust for the China COVID impacts I mentioned earlier. I was pleased with our gross margin performance in the quarter; we finished with a gross margin of $27.7 million, which is a quarterly high for us, and the gross margin percentage was 38.6%. As we discussed in prior calls, a combination of product and channel mix has been benefiting us, alongside some price increases that were region-specific, and improvements in build material costs of goods for some of our products. All of this comes together and contributes to our improving gross margin profile that we have been discussing. We still expect to see continued improvement in Q2 and beyond this year, and we still expect to hit 40% gross margin in the second half of the year, and that's not changed. While we grapple with pressure on gross margin and costs in general, we have seen some improvement in that. When you add that as a negative along with the other work, we are very pleased with the progress in gross margins that we are making and that we expect to reach 40% in the second half of the year. Our new product initiatives have also been advancing quite nicely. We released the ULTIMATE FUSION, which is a hydrophobic film, and it has been very well received. Initially, we started in the U.S., and in the past 30 days we are now releasing that globally. This is a specialty film that has a super hydrophobic coating, which combines the benefits of our ultimate XPEL paint protection film with our Fusion Ceramic Coating. This is a component of our future product portfolio. It may ultimately be 10% to 20% of the mix, so it won't dominate that business, but it is a nice addition. Additionally, we have focused significantly over the past few quarters on launching our architectural film business and expanding the product line; it has been very skew intensive with a very wide product line, and it's really coming together. Q1 revenue doubled from Q4, so we are really starting to pick up momentum there. Some of you may know that this business has two distinct sets of customers. We have customers in the automotive space who started their business with window film and now operate in both automotive and architectural films. It's a common misconception that they are entirely distinct customer sets, but that's not always the case. Then there are customers who focus solely on the architectural products, and we have been winning some of those accounts. These tend to be higher volume, more prestigious accounts. With the product line expansion we have been undertaking, we are now a viable partner for those businesses and are starting to see some success with them. We are very encouraged by that, and it will continue to develop throughout the year. Our inventory level for Q1 ended a little under $75 million in inventory. For those keeping an eye on the balance sheet, this has seen increases over the past two years, from around $25 million to $50 million, and now $75 million over the past 18 to 24 months. We have been particularly concerned about TPU resin availability, which goes into producing the extruded TPU film used in paint protection film. Prior to 2022, production of some of this resin was forecast to remain flat throughout the year compared to 2021 for various reasons. As a growing market, it has certainly been a concern. Recently, there were worries that actual production capacity would see a decline compared to the previous year, due to shortages in the broader chemical market and other factors. Additionally, we have been building inventory while others have been building inventory. There’s an overall dynamic in the economy where we've witnessed massive inventory builds that have likely contributed to some of the pricing dynamics we have seen, alongside shipping expenses, and now everyone’s sorting through this. Due to concerns about the TPU resin shortage, we planned aggressively to build inventory to mitigate that impact; this has been occurring over the past six to nine months. We expect inventory to peak in Q2; although the timing is slightly less certain given the lockdowns in China, we generally expect to release cash from inventory in the second half of the year. At that point, we will either have built sufficient reserve inventory to counter any supply shortages, or the feared shortages will not have materialized because they were exacerbated by others building inventory that perhaps they didn’t need. In either case, we’ll be in good shape for our customers in terms of ensuring we have ample supply; the only difference will be the rate at which we release cash from inventory. In the second half of the year, that could be a reduction of approximately $20 million, plus or minus, depending on how that actually plays out. So that's the strategy there. From an EBITDA standpoint, it grew 29.6% to $11.9 million, yielding an EBITDA margin of 16.5%. As we mentioned earlier, we held our Annual Dealer Conference in February, where we had about 510 employees, up from 350 at the last conference in 2020. We didn’t hold a conference in 2021, so that resulted in a net cost of about $800,000 in Q1 that wasn't present in Q1 2021, in addition to a $400,000 project we completed. That was $400,000 in professional fees that won't reoccur in the quarter. Normalizing for those, our EBITDA would have been—our EBITDA margin would have been approximately 18%, and EBITDA would have grown by about 42%. So those are really good numbers. We continue to make good progress towards our goal of a 20% EBITDA margin by the end of the year, driven largely through the anticipated revenue growth and the gross margin objectives we outlined earlier. All in all, it was a very solid quarter under the circumstances, and I am very pleased with the effort by our broader team. Everyone is very creative and working hard to navigate all of the challenges we see in the market and are doing a fantastic job. With that, I'll turn it over to Barry, and then we’ll take some questions. Barry, go ahead.

Barry Wood, CFO

Thanks Ryan, and good morning, everyone. I'll jump right into the revenue categories. Our product revenue in the quarter grew 29.3% to approximately $58.1 million. Within this category, paint protection film grew 22.8% to $44 million, and sequentially this was down about 3.7% from Q4, primarily due to the challenges in China discussed by Ryan. Our window film product line grew 61.1% to $11.5 million, which was a record for us and represented 16% of total revenue. We continued to gain share in the automotive window film segment. As Ryan noted, our architectural segment had a great quarter, doubling from Q4. Q1 2022 service revenue grew 98.5% for the quarter to $13.8 million, driven by increased demand in our company-owned installation facilities and acquisition-related labor revenue from our dealership services business. Our total installation revenue, combining product and labor, increased a little over 197% and represented 15.3% of our total revenue. This has certainly contributed to some of the favorable mix influencing the gross margin that Ryan referred to earlier. Our Q1 2022 SG&A expense grew 81.5% to $17.7 million, representing 24.6% of total revenue. Sequentially, Q1 SG&A expense was up just under 9.4% versus Q4 of 2021. If you normalize for the dealer conference and the earlier one-time expense for project-related professional fees, SG&A would have been essentially flat versus Q4. Sales and marketing expenses increased 86.3% during the quarter, and normalizing for the dealer conference, they would have increased about 63%. Sequentially, sales and marketing expenses are essentially flat versus Q4 again, normalizing for the dealer conference. Q1 2022 general and administrative expenses grew 79% to $11.4 million, primarily due to expenses associated with our new acquisitions, mainly the increased amortization costs from those acquisitions. Sequentially, G&A expenses were flat versus Q4 after normalizing for the one-time costs. While we've been managing gross margins well, we're not immune to inflationary pressures, and you see some of that shown in our SG&A, but we're doing our best to work through that. Q1 2022 EBITDA increased 29.6% to $11.99 million, reflecting a margin of 16.5%. Echoing Ryan's point, if we normalize for the dealer conference and the cost of professional services incurred, EBITDA would have increased 42.3% to $13 million, reflecting an EBITDA margin of 18.1%. Q1 2022 net income increased 14% versus Q1 2021 to $7.8 million, reflecting a 10.9% net margin. EPS for the quarter was $0.28 per share, and if you normalize for the dealer conference and the one-time professional services, then net income margin would have been approximately 12.2%, and EPS would have been $0.31 per share. As Ryan mentioned, we continue to use cash to maintain elevated inventory levels, primarily to hedge against future supply chain risks. As a result, we used operating cash for approximately $4.3 million for the quarter, and we do anticipate inventory levels dropping during the second half of the year. We closed the quarter with $33 million drawn on our line, and we remain well-capitalized to execute on our initiatives in the coming quarters. With that, operator, we'll now open the call for questions.

Operator, Operator

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

Ryan Sigdahl, Analyst

Ryan on for Steve. I don't think I caught it, but so China sounds like sell into the country is a bit disrupted because of port issues and everything going on there, but can you comment on sell-through? I guess, how does sell-in compare to sell-through? And then secondly, how do your inventories look at the country level at your distributor?

Ryan Pape, President and CEO

Yeah, so I think you're seeing, and the dynamic there, as you correctly mentioned, is that when we're talking about large quantities going to China, you've got sell-in. You might have inventory on a boat, inventory on an airplane, and then there's inventory in country. Then there's the sell-through to the end customers. The sell-through is obviously disrupted in provinces that have been in lockdown, clearly, such as Shanghai and some other places. So, you've got disruption there. As a result, we have less product going in-country just in anticipation of needing less product in the immediate term due to those lockdowns. In that sense, it impacts both sell-in and sell-through with the lockdown scenario.

Ryan Sigdahl, Analyst

How do you feel about inventory in-country at the moment?

Ryan Pape, President and CEO

Well, I think we ended the year with a little higher inventory than we had in Q3, as the distribution there had, and I think we talked about that. That dynamic is really unchanged, not higher nor lower, given that we had already been reducing shipments even in Q1. So, I don't think the inventory dynamic has changed. The real change is just the sell-through as a result of the areas and provinces that have been locked down.

Ryan Sigdahl, Analyst

Switching over to the U.S., the industry challenges here are pretty obvious—you mentioned many of them—but our math implies XPEL is taking accelerated market share here. I guess, can you attribute that to anything specific recently? And then secondly, do you think that outperformance relative to new vehicle sales can continue as the volumes increase, or is there not necessarily a one-for-one type comparison to new industry vehicle sales?

Ryan Pape, President and CEO

Well, our thesis has been for a long time really twofold. One, if you look at paint protection film as a product category, it is an industry that's growing. The attach rate to new cars sold is increasing, and there are more cars with some amount of paint protection film. The amount of film per vehicle has also been increasing over time. Effectively, content per vehicle is increasing, and the attach rate is increasing. That’s what's led us to continuously outperform the underlying market because we're seeing that growth in attach rate. In terms of market share, we do take market share. We still believe in paint protection film, but we certainly take market share in the window film and automotive window tinting space. This growing attach rate for paint protection film runs counter to the cycle that we're in and allows that category to grow even when vehicle sales drop, and even in excess of those amounts. Both of those factors have remained true, and we think that trend continues no matter what the macro throws at you. From that standpoint, we feel pretty good.

Ryan Sigdahl, Analyst

Just following up on the window film, can you remind us what the approximate mixes of new versus used vehicle applications for window film? And how does that compare to paint protection film?

Ryan Pape, President and CEO

Yeah. For us, the vast majority is still new, even for window film. We've not put out any specific numbers, but the vast majority is new. The applicability of window film to the used car market is substantially greater than paint protection film, mainly because from the moment you apply window film on a vehicle, you receive full utility of the product even if it's applied later in the vehicle's life. With paint protection film, its effectiveness declines if it’s not applied while the vehicle is new, as it’s being damaged over time. There’s more potential for the used vehicle market with window film, but it’s still overwhelmingly new cars, primarily due to our route to market, which focuses on premium installers in the aftermarket and dealerships. Those are much more tied to new cars than used cars, which you might see in some lower-end aftermarket shops that aren't our primary customers. So, for us, that skews overwhelmingly toward new vehicles.

Ryan Sigdahl, Analyst

Great. Just one clarification, then I'll turn it over to the others. But just to confirm, you said $80 million revenue for Q2, and 30% growth for the year on revenue?

Ryan Pape, President and CEO

I am still looking at 30% growth for the year, even with the China impact. If that situation deteriorated through the year, that might change, but I still feel good overall. Q2 will be around $80 million, which would drop from our initial expectations due to China. We mentioned China possibly causing a $5 million to $6 million cut, which would have placed revenue around $86 million or $87 million before adjustments due to China, so, yes, around $80 million.

Operator, Operator

Your next question is from Jeff Van Sinderen with B. Riley. Your line is live.

Jeff Van Sinderen, Analyst

Hi, good morning, everyone. First, congratulations on strong numbers, especially in the face of many general headwinds. Can you speak more about what you're seeing and hearing around car dealer inventory levels and your expectations? How do you see that developing? Also, how does that influence your outlook for ramping the Permaplate and Tint Net segments? Additionally, when do you expect those to run at levels where you can utilize capacity at a more acceptable level?

Ryan Pape, President and CEO

Sure. Yes. From the industry perspective, what the manufacturers discuss regarding their manufacturing output and our observations from what we see in the world we live in don’t overlay all makes and manufacturers equally. While many have a more bullish view of inventory last year, we've seen delays in expectations for inventory improvements due to wire harness shortages linked to Ukraine and other factors. The industry consensus is that we still expect improvement in inventory as the year progresses, whereby Q2 might have marked a turning point. That said, the industry outlook has shifted to pushing those expectations to Q3 or beyond. In our case, we are concentrated on specific vehicle makes and models. At times, this concentration can reveal pockets of improvement in inventory levels. For our dealership services, we saw the highest numbers since December, which is historically a high month. However, it’s challenging to indicate if that is a trend or merely a temporary situation. Realistically, we’re looking at this improving by Q3, with some regions fully utilizing our labor; we have even done some hiring. Such improvements could be attributable to increased vehicle deliveries to dealerships and our added new accounts. It seems attainable, but we expect to fully deploy installation capacity later in the year.

Jeff Van Sinderen, Analyst

I wanted to ask about the trends regarding full wraps versus partial wraps. If you have any insights into how full wraps might have evolved as you're growing?

Ryan Pape, President and CEO

The trend for paint protection film has been toward covering more of the vehicle over time. In the past, it was relatively common to use small pieces of film just on the leading edge of the vehicle or a partial hood on high-end cars like Porsches. Now, it's practically unheard of to cover only a partial hood; consumers increasingly cover entire front ends. More consumers are choosing full coverage for various reasons, and this trend continues to down-market, where we see mid-range vehicles showing more interest in paint protection film in the aftermarket. The trend remains positive for both the attach rate and content per vehicle, which benefits us.

Jeff Van Sinderen, Analyst

I know this may be tough to answer, but do you think that the partial versus full wrap mix might change in a US or global recession?

Ryan Pape, President and CEO

Our view is that it won't change significantly. If you are in a position to buy paint protection film, you're likely purchasing it alongside a new car. If you’re buying a new vehicle in a challenging economic climate, our belief is that you'll still purchase our product. In a scenario where you buy the car, it's likely you’re not going to adjust the coverage substantially to save a few dollars because, as a percentage of the new car value, paint protection film is a relatively small expense. While we may feel some impact from sales, the ongoing increasing attach rate serves as a buffer amidst fluctuating market conditions. Hence, that has been our experience based on previous downturns. Our performance has also reflected this since we have over-indexed into the luxury segment, which has done better with inventory shortages than the rest of the market. We anticipate continuity in that trend regardless of what the macroeconomic landscape looks like in the next few years.

Jeff Van Sinderen, Analyst

Thank you for taking my questions. I'll take the rest offline. Continued success.

Operator, Operator

Thank you. That concludes our Q&A session. I will now hand the conference back to management for closing remarks. Please go ahead.

Ryan Pape, President and CEO

I want to thank everyone for participating today, and I look forward to speaking with you again next quarter. Thank you.

Operator, Operator

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