Earnings Call Transcript - XPEL Q2 2023

Operator, Operator

Greetings, and welcome to the XPEL, Inc. Second Quarter 2023 Earnings Call. Please note, this conference is being recorded. I will now turn the conference over to your host, Mr. John Nesbett of IMS Investor Relations. Sir, you may begin.

John Nesbett, Investor Relations

Good morning, and welcome to our conference call to discuss XPEL’s financial results for the second quarter of 2023. 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 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, 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. Such statements are based on our current expectations and assumptions which are subject to known and unknown risk factors and uncertainties that could cause actual results to differ materially 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 Securities and Exchange Commission. XPEL undertakes no obligation to publicly update or revise any forward-looking statement whether as a result of new information, future events or otherwise. Okay. With that, I will now turn the call over to Ryan Pape. Go ahead, Ryan.

Ryan Pape, CEO

Thank you, John, and good morning, everyone. Welcome to the second quarter 2023 call. Q2 was another outstanding quarter for us, with record revenue, gross profit, EBITDA, and net income. Revenue for the quarter increased by 21.9% to $102.2 million. This marks our first quarter surpassing $100 million in revenue, which is a significant milestone, especially for those of us who remember a time when we had only $3 million in revenue. The U.S. region also had a strong performance with revenue up 20.3% compared to Q2 2022, reaching $59.1 million. This was an increase of nearly 16% sequentially and about 15% over our previous record quarter in Q3 of last year. Improvements in new car inventories have benefited our dealership services business, and OEM production has seen gains with our partners, aiding our OEM business. Additionally, new car sales have been solid despite interest rates, indicating a resurgence in demand from the past few years. July continued this positive trend for new car sales, allowing us to maintain momentum. While we might have stepped back from last year’s highs in the aftermarket, our results do not reflect a decline. Looking back, earlier estimates would suggest even better results, but we remain pleased. All our regions, except for China, achieved record or nearly record quarters, particularly Latin America. Most of these record revenues exceeded prior highs. Continental Europe, for example, reached $9.7 million for the quarter, which was nearly 22% above its previous best. China met our expectations for the quarter, with revenue rising 2.5% compared to Q2 2022, slightly better than our initial forecasts. Sequentially, China grew by 22% to $8.1 million, consistent with our expectations. The overall macroeconomic outlook for China remains mixed, and our projections for the region in the upcoming quarters are unchanged, forecasting sequential growth in Q3 and Q4, with total revenue for the year expected to remain flat compared to last year but gradually improving in the second half. As previously mentioned, we are in the process of establishing a corporate team in China for better visibility and to assist our distributor, which should enhance our focus in Asia, including China. The timing of orders versus deliveries in China will be crucial for the performance in the final two quarters. We anticipate that new car sales in the U.S. for the remainder of the year will be mixed, and adopting a cautious outlook, our projection for Q3 revenue will likely match or slightly exceed Q2. However, if the business sustains the momentum of the first half and China deliveries are timed favorably, we expect Q3 revenue could surpass Q2 by several million dollars. Therefore, there is some uncertainty regarding timing moving forward, but we anticipate a solid outcome. We estimate total annual growth for the year to be around 22%, staying within the 20% to 25% range, with variances likely influenced by China dynamics. Our international expansion is a key focus area, and we are reinvesting the cash we generate. We've seen significant success in Australia since acquiring our distributor, and our business there has grown two to three times in under a year. We plan to introduce our labor programs to Australia within the next year. Our strategies are relevant across all geographic regions, and while the labor market has been a priority in the U.S. and Canada, we also see opportunities in other regions such as Asia, Latin America, and India. These markets are top priorities for deeper investment and engagement. We expect to reorganize the company significantly around these priority markets in the next six months. We see tremendous opportunities, and in many of these markets, a foundational presence leads to business growth. We performed well on gross margins this quarter, achieving a gross margin of 43%. I’m very pleased with our gross margin initiatives and the results we’ve achieved. Our bill of material costs have decreased for some products, positively affecting gross margins, alongside a favorable channel and product mix. Our strong partnership with suppliers has also helped us negotiate discounts, benefiting our gross margins as the global supply chain stabilizes. There's potential for us to finish the year slightly above our forecast of 42%. We aim to gradually improve gross margins over the next several years, influenced by an increasingly complex revenue mix. We continue to leverage our business, with EBITDA increasing by 30.5% to $22.4 million, and net income rising by 32.3% to $15.7 million, both setting new records for the company. Our EPS was $0.57 for the quarter. Excluding costs tied to our dealer conference, which was costly but very successful, EPS would have reached $0.61 for Q2. This year, we have heavily invested in our team, particularly in software, technology, product development, and marketing within SG&A, to facilitate new product and service delivery in the years to come. We're seeing growth in our cost structure, more than offset by gross margin improvements, and some of these SG&A increases are advancing our gross margin profile. Overall, this year is pivotal for our investments in areas that will fortify our future, and we have maintained our plans regardless of macro trends. Much of this investment has shifted towards the latter part of the year. We generated nearly $27 million in operating cash for the quarter, with inventory levels stabilizing and modest reductions in days on hand throughout the year. We’ve seen a reversal in working capital dynamics, addressing past concerns regarding inventory levels. We prefer inventory to remain stable or decrease slightly while reducing days on hand. We've successfully managed to generate cash without significantly cutting inventory. Avoiding running out of inventory is crucial for us. We anticipate this trend will continue. Our acquisition pipeline remains robust, and we expect to utilize our cash for reinvestment primarily in acquisitions and, to a smaller degree, in capital expenditures to enhance gross margins. Given that most of our potential acquisitions are smaller and carry minimal risk to the company, we evaluate them alongside internal investments. A strategy hinging on larger acquisitions would entail different considerations. Regardless, we expect to utilize our available cash effectively over the next 18 to 24 months. On a related note, we've been investing in our DAPNext, our updated DAP platform, which will complete migration to the new system by the end of Q3. All new features pertaining to business operations, pricing, and marketing will launch on this platform. Customer feedback has been very positive, and we believe this platform will enhance our customers' profitability and confidence to grow and reinvest in their businesses, while also improving how we serve them. It’s been a fantastic quarter for us, thanks to our dedicated team who work tirelessly to deliver remarkable results. I appreciate everyone's contributions. Now, I’ll turn it over to Barry, and we will take questions.

Barry Wood, CFO

Thanks, Ryan, and good morning, everyone. I want to add a few comments about revenue. From a product line perspective, the combined revenue from paint protection film and cut bank grew 16.7% this quarter and rose sequentially by just over 14%. Our revenue from the window film product line increased by 28.7% quarter-over-quarter to $20.3 million, making up 19.9% of our total revenue, which is a record. The window film revenue is almost 29% higher than our previous peak. Within our window film line, our architectural window film product, branded as VISION, generated revenue that grew by just under 52% to $2.4 million, representing about 12% of total window film revenue and 2.4% of overall revenue, indicating strong performance. Our OEM business also had a good quarter, with revenue climbing over 62% compared to Q2 2022 to reach $4.3 million, up 22.5% sequentially from Q1. The revenue from our FUSION ceramic coating product, which is included in our other revenue line, grew by just over 81% quarter-over-quarter to $1.8 million, accounting for just under 2% of total revenue for the quarter. Our total installation revenue, which combines product and service, increased by 31.5% this quarter and represented 16.9% of total revenue. Year-to-date, total revenue has grown by 20.8%. Our SG&A expense for Q2 rose by just over 38% to $23.8 million, comprising 23.3% of total revenue. Included in this SG&A for Q2 were around $1.5 million in net costs from our annual dealer conference in April, which is out of the comparative period since our 2022 conference was held in Q1 2022. If we adjust for that, SG&A would have increased by approximately 29% for the quarter, making up around 22% of total revenue. Ryan mentioned the good leverage we experienced this quarter, even with the dealer conference costs counted. Our EPS for the quarter was $0.57, and year-to-date it was $0.98. Adjusting for the dealer conference costs, EBITDA would have risen by 39% quarter-over-quarter, and net income would have increased by about 42%. Year-to-date, EBITDA is up 36% to $39.5 million, while net income has grown 37.9% to $27.2 million. Cash flow from operations for the quarter was $26.7 million, showing a solid cash flow performance. As we noted in our previous call, we anticipated positive effects on our operating cash flows as our inventory levels normalize, and we saw that in Q2. Our cash conversion cycle improved this quarter primarily due to better inventory days on hand, and we ended the quarter in a net debt-zero position due to our strong cash flow. I should also mention that we are open to some modest leveraging, especially for attractive deals like we have pursued in the past. We will continue to optimize our capital structure moving forward, and we are in a very strong financial position to execute our strategy. Overall, it was another great quarter for us, and we're excited to finish the second half strong. Now, operator, we’ll open the call for questions.

Operator, Operator

Certainly. The floor is now open for questions. Please remember to limit yourself to one question and a follow-up. The first question this morning is coming from Steve Dyer from Craig-Hallum.

Steve Dyer, Analyst

Thank you. Congrats guys. Another very good quarter. Clearly, over the last couple of years, your ability or the desire from dealers to pre-load inventory, I’m talking primarily about paint protection film but I suppose also window tint maybe in some instances, that was obviously a big driver. Are you seeing kind of with inventory sort of a little bit more normal? Are you still seeing the same appetite to do so, or any changes there?

Ryan Pape, CEO

Yes, Steve. We’re really not. And if you look at paint protection film, the vast majority of that for us has not been preloaded. It’s actually a relatively small percent owing to the level of aftermarket sales that drive that. The window tint business is slightly more pre-load focused in terms of what we’ve seen, but we’ve not seen that trend change. And in fact, we’ve seen an interest in pre-loading maybe continue or even accelerate, in some cases, as the market adjustments and sort of the free-wheeling nature of the business over the past two years with the short inventory has become more challenged and the margins just aren’t quite there like they were. So, we haven’t seen that change, but we’re not overly exposed to it. And I think our approach in terms of working with dealerships and our whole aftermarket network working with dealerships is we really want to meet them where they are. And for some, a pre-load option is good. For some, that’s not the right answer. And then they may want to sell it on the back end and then in some cases, they would do both. So, I don’t see that as a huge driver for us or a huge risk at this point.

Steve Dyer, Analyst

Got you. That’s great. Are you seeing just, I guess, over the last couple of years, call it inventory changes, etc. Are you seeing any change in how much of the vehicle clients or customers are wrapping? Sometimes it’s put into like a certain package with front of the hood and front bumper and back to the mirrors or something like that. But any sort of larger change in how much they’re wrapping?

Ryan Pape, CEO

We have definitely noticed an increase in average coverage. Initially, paint protection film was only applied to part of the hood of high-end vehicles, which often left an invisible line that became noticeable when the car was dirty. This has been a common concern regarding the product. Over time, we have seen a shift towards covering the entire hood and similar areas. Our goal is to find a balance between offering smaller coverage options to introduce more customers to paint protection film at a lower price, while also pushing for expanded coverage. We believe that by addressing the last objection regarding price, we can enhance customer adoption. So, we are pursuing both strategies simultaneously. Overall, the average amount of the vehicle covered has continued to rise, and we expect this trend to persist.

Steve Dyer, Analyst

Got it. Okay. And maybe I missed this. I don’t think so, but any sort of update on your progress on the OEM front?

Ryan Pape, CEO

Yes. We experienced significant growth in OEM. I believe Barry addressed this, with growth of around 60 percent compared to the previous year. This area remains a key focus for us, and all the programs we've implemented are currently successful. Our strategy is to ensure these programs complement the broader market by attracting new consumers to paint protection film. We aim to execute these initiatives successfully and avoid overly ambitious goals, which we've managed effectively. I can confidently say that all our efforts have been successful, and most programs are in discussions for expansion, aligning with our approach of starting small and growing from there. Additionally, we have a robust pipeline of further opportunities. The sales cycle for these initiatives is longer than our other business segments, often spanning 6, 12, or even 18 months. However, we anticipate this sector will grow and positively impact the overall business. The current attachment rates and awareness levels are low, indicating that we are not competing within market segments but instead enhancing attachment rates and, more critically, increasing awareness for future purchases in the channel.

Steve Dyer, Analyst

That’s great. That’s helpful explanation. That’s all I have.

Operator, Operator

Your next question is coming from Jeff Van Sinderen from B. Riley.

Jeff Van Sinderen, Analyst

I wanted to discuss gross margin briefly, as it is performing very well. Could you provide more insight into the long-term outlook for gross margin and the factors contributing to it? Additionally, it would be great to hear about the new products that are contributing to higher margins. I also have a question about the new dealer software and would appreciate more details on the service revenue aspect as well.

Ryan Pape, CEO

Certainly, Jeff. Regarding gross margin, it's divided into a couple of areas. For instance, our business in Australia is experiencing much faster growth since we acquired it, along with a significantly higher gross margin. We're observing growth in various regions and channel elements that have higher margins. Additionally, as we introduce new products, such as our ULTIMATE FUSION paint protection film and components of our architectural film and coatings lines, these contribute positively to gross margin. The more these products make up our revenue, the more benefit we see. Broadly speaking, service revenue also tends to enhance gross margin. Thus, we have both channel and product mix working in our favor. Concurrently, we are diligently working on supply chain aspects for all products, focusing on the actual material costs and additional costs related to production, purchasing, shipping, and conversion. All these factors contribute to the gross margin expansion. The most significant aspect right now is managing material costs and other elements of the cost of goods, which still have potential for further improvement in the coming years. There is some uncertainty regarding the growth rates in different regions and product lines, which complicates precise predictions. However, I believe we have three potential pathways to increase gross margin beyond fiscal year '23, and achieving success in just two of those would suffice. While the exact implications are unclear, I feel optimistic about our prospects. As for the DAP software, several years ago, it contributed notably to our revenue, but that has shifted as the business has scaled. One of our goals while enhancing the DAP platform is to rejuvenate software revenue. We are also exploring other potential revenue streams, including payments or ancillary revenues, which could serve both our customers and the business while providing high-margin returns. It might be a bit premature to define that in detail, but it's certainly an important consideration. I recall you had one final question, but I can't remember what it was, Jeff.

Jeff Van Sinderen, Analyst

No, that’s okay. I actually just wanted to follow up on the software. What kind of feedback are you getting from dealers on the benefits that they’re seeing to their business?

Ryan Pape, CEO

The feedback we’re receiving now is overwhelmingly positive. This is the largest investment and the most extensive network of chains that XPEL has ever undertaken, and our long-term customers are clearly noticing this change. They're observing our commitment to something that is very important to us. That summarizes the feedback so far, but it may take some time before we receive insights indicating that customers have utilized the strategies we've introduced and have experienced growth in their businesses as a result. That's the outcome we hope for, but I would suggest checking back in a year for those types of success stories to emerge.

Jeff Van Sinderen, Analyst

Okay. Fair enough. One thing we've noticed is that some dealers are pre-loading ceramic coating more than we typically discuss with PPF. I'm curious about your observations on that.

Ryan Pape, CEO

Well, I think it’s similar to the broader question on pre-loading. You have some dealers that like that as a business model and some that don’t. And then of those that do, they might like it for one type of product or another, ceramic coating being one or window tint being one or paint protection being one, could depend on their prior experience or their customer base or what lines they’re carrying. So, that is an element of it. And I think part of the broader push there is that these are real, tangible products that we’re selling that provide demonstrable value, and they aren’t predicated upon having a warranty or insurance attached to them to be useful. And in many respects, in our view, that makes them better products than a lot of the other things that are sold or preloaded. So, that’s kind of the underlying thesis. And then, obviously, from a retail dealer standpoint, we’ve got to show them they can make an equal or greater amount of money doing this or get more consumer acceptance. But I think you’re seeing that happen, and we expect that to be the case across the product line, everything we’re doing and then anything we might add in the future.

Jeff Van Sinderen, Analyst

Okay. Great to hear. Thanks for taking my questions. I’ll take the rest offline.

Ryan Pape, CEO

Thanks Jeff.

Operator, Operator

Thank you. Your next question is coming from Tim Moore from EF Hutton.

Tim Moore, Analyst

Thanks. Ryan and Barry, terrific continued execution and EBITDA margin expansion in the first half was amazing. Three of my questions were already asked, but I have two remaining ones. Your scale and operating leverage benefits have been phenomenal over the past few years, and the gross margin expansion was very good this year. I just want to delve more into the gross margin potential beyond this year. And I know Ryan gave us a little bit sneak peek in the prepared remarks. But Barry, I’m just wondering, was maybe half the gross margin expansion this year from purchasing power and scale? And is the other half maybe from the new products mix that Ryan was talking about? And you actually lapped a lot of those Rivian delayed start-up costs in the first half of this year. They were a bit of a drag last year. So, I guess, I was really kind of wondering, should we think of 42% to 43% as the floor on gross margin, or do you think it could dip a bit if China sell-through accelerates December quarter early next year because the China margins are lower and a little bit dilutive?

Barry Wood, CFO

Yes, Tim, I hope you're doing well. To address your first question, the expansion of our gross margin so far has been influenced by product mix, but primarily by our supply chain improvements. This trend is expected to continue. Looking ahead, we don't foresee a dip in gross margin, though the extent of its increase is uncertain. We certainly believe that 43% is not the upper limit, but many factors will influence this. As Ryan mentioned, we are optimistic about our potential in this area, and it's difficult to predict exactly how high the margin will rise.

Ryan Pape, CEO

I think, Tim, I would add to that relative to China is the good news, bad news, but there was a point where China on a percent of revenue basis was much larger. And so, yes, it is a lower gross margin region for us. But as a percent of revenue with how the rest of the business has grown, it’s just not as impactful now even when we see that rebound relative to offset in a substantial way this other work that’s done. So, the risk of China fundamentally altering margins at this point is pretty low. And if that were to happen, which we don’t think it would be a result of some spectacular performance out of China, which we would gladly take if that happened, but it doesn’t seem likely that that’s going to be the case.

Tim Moore, Analyst

Sure. That’s helpful color. Yes, I remember, it’s been a couple of years. I mean, I think it was 18% of sales a couple of years ago before the lockdowns. That’s good. That’s really helpful color, and it seems like that is a permanent purchasing power and supply chain effort. I know you changed the suppliers a bit last year. That really helped. And my second and last question is, how are dealership services progressing? I know you did a small acquisition a couple of months ago. And just on a high level, Ryan and Barry, I mean, is the number one limiter to installation and distribution target acquisitions or dealership services, your integration team? Because it’s clearly not your cash and liquidity, but obviously, you have to spend a lot of your time on the core business and don’t want to get distracted. So I’m just wondering, are there any limitations on the integration side for pickup in acquisitions?

Ryan Pape, CEO

I believe the limitations we face are less about integrating an acquisition and more about ensuring that our existing operations can be supported at scale with the necessary infrastructure. Our headcount has increased significantly as we’ve rolled out more programs that focus on human capital. As we expand into more countries in a decentralized manner, additional infrastructure is required. Therefore, I don't see the integration of acquisitions as a limiting factor. We are looking for the right deals at the right prices. However, with smaller deals, we might encounter great opportunities or face pricing discrepancies due to the seller's profile. We need to remain patient and adaptable. If something doesn't work out today, we can try again tomorrow. I don't believe integration is a barrier for us, and I don't foresee any issues with deploying the cash we will generate; it’s just a matter of timing for when that happens.

Tim Moore, Analyst

Great. And that Australia acquisition seems like a grand slam, given how much you’ve already grown sales. But, thanks. And that’s it for my questions.

Ryan Pape, CEO

Thank you, Tim.

Operator, Operator

Thank you. There are no further questions in queue at this time. And I would now like to turn the floor back to management for closing comments.

Ryan Pape, CEO

Thank you all for joining us, and thanks team for a great quarter and a lot of hard work to deliver these results. We’re very appreciative of it, and look forward to another quarter. Thank you.

Operator, Operator

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