Earnings Call Transcript - XPEL Q3 2025

Operator, Operator

Greetings, and welcome to the XPEL, Inc. Third Quarter 2025 Earnings Call. Please note that this conference is being recorded. I will now turn the conference over to your host, Mr. John Nesbett of IMS Investor Relations. Please proceed.

John Nesbett, Investor Relations

Good morning, and welcome to our conference call to discuss XPEL's third quarter 2025 financial results. 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. A transcript of this call will be available on the company's website after the call. 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 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 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

Thank you, John, and good morning. Welcome to our third quarter call. In Q3, we achieved a record revenue growth of 11.1% to $125.4 million, driven primarily by the U.S. market, which also saw an 11.1% increase to $71.7 million. Both our independent and dealership channels experienced double-digit revenue growth during the quarter, which is encouraging and shows good momentum. The EU region also performed well, with revenue rising 28.8% to a record $16.5 million. While we faced challenges in Q3 last year, this made for an easier comparison, yet we still delivered excellent results. Additionally, we completed our anticipated acquisition of our Chinese distributor in early September. Since this acquisition closed late in the quarter, we did not see a significant financial impact, but SG&A expenses were elevated from acquisition-related fees, along with additional SG&A costs starting in September. We are moving forward with the integration, and our team has been energized by the addition of talented individuals. Both our team and customers are enthusiastic about the opportunities this presents for our business in China. Customer reception has been very positive, which is very encouraging. Although we face significant integration work, we recognize a substantial opportunity. We are continuing to emphasize our focus on the OEM and 4S business in China. This acquisition, in conjunction with previous acquisitions in Japan, Thailand, and India, solidifies our presence in the Asia-Pacific region. We are observing similar trends across various regions; for example, Canada has seen a revenue decline this year, continuing a slow market trend. Q1 experienced sluggishness, Q2 showed improvement, but Q3 did not match Q2's performance, reflecting broad-based slowdowns across our entire customer portfolio. Meanwhile, Europe showed significant growth, while India and the Middle East experienced modest gains, although their performance can be inconsistent due to the distributor sale dynamics. We remain optimistic about these markets, as they are priorities for us with promising potential. Latin America remained flat, mainly due to challenges in Mexico and a shift from a distribution model to a direct model in Brazil. Looking ahead to Q4, we expect revenue in the range of $123 million to $125 million, considering the typical seasonal patterns in the U.S. and North America. If we reach these figures, it would translate to year-over-year growth of approximately 13% to 14% for 2025. On the gross margin side, we did experience some pressure in Q3 compared to our typical trend, mainly from unfavorable price increases, which impacted gross margin by about 170 basis points. However, if we disregard this specific effect, we've seen gross margin growth year-over-year. This impact is not related to tariffs, and we have addressed this issue moving forward, anticipating a recovery starting in Q4 and continuing into Q1. Another factor affecting near-term gross margins is the nature of our acquisition of the China distributor, as we are working through inventory acquired in the transaction. While doing so, we are only recognizing profits equivalent to the previous distributor's margin as this inventory reflects their former cost. The main rationale for acquiring distribution is to improve gross margins, which we project will increase significantly as we deplete existing inventory. Barry will elaborate on the unique inventory structure related to the transaction. It's important to note that we acquired roughly $22 million in inventory as part of the deal, so you'll see an increase on our balance sheet due to this transaction, which is structured favorably for us. Our underlying inventory trends and improving turnover rates remain strong, so I urge you not to take the balance sheet at face value regarding inventory. As we move through this inventory, we expect strong cash flow due to reduced replacement times and customer needs. We will see benefits starting in Q1 when we fully capture both sides of the margin, as both supplier and distributor for the first time. In Q1 and Q2 next year, we anticipate record gross margins at the consolidated level based on these changes. SG&A costs are currently high as we invest in our operations to support new market entry. We need to optimize our corporate cost structure, although most recent costs have originated from channel and distribution investments. Now that we've largely completed these investments, aside from some additional spending in Brazil, we can look forward to greater efficiency. The China acquisition will introduce approximately $5 million in annual SG&A costs, including intangible amortization. However, once we benefit from the full gross margin, we expect to gain around $10 million in annual operating income from China. It's crucial to view SG&A and gross margin together when evaluating the business's trajectory, especially as we anticipate gross margin realization in the coming year. We believe now is the ideal time to finalize our investments in these key markets. The current environment poses challenges for many competitors, but we are committing resources where it counts for our long-term strategy. Our investments in these countries are front-loaded. They are critical markets, and meaningful development requires our direct involvement, positioning us well for the future. Over the last 18 months, we have thoroughly evaluated our capital allocation strategy, including exploring M&A opportunities in adjacent products and services within our broader industry. After a detailed review, our Board has concluded that the best strategy is to continue nurturing our core business. While potential adjacent opportunities may arise in the future, many opportunities remain within our core business that we haven’t fully realized yet. Once we reach our full operational potential, we may reassess those adjacent ventures, but pursuing them now would be premature. Ultimately, even though we are excited about other growth possibilities, our core business remains our priority, guiding our near-term decisions. Thus, we plan to enhance our manufacturing and supply chain through various means, including direct capital expenditure, M&A, or joint ventures. We aim to raise gross margin by about 10 percentage points to 52% to 54% by the end of 2028 through these initiatives. With this increase in gross margin across our businesses, particularly where we manage our distribution directly, we are targeting operating margins in the mid to high 20s. Consistent with this, we anticipate investments ranging from $75 million to $150 million during this period, a broad range reflecting our numerous options to achieve these goals. Regardless, these expenditures present favorable returns without the risks associated with branching into additional lines of business. Additionally, we will actively pursue service business acquisitions related to our core focus, especially in dealership services. While these opportunities are relatively sparse and smaller in scale, we will continue to identify and secure them as part of our strategy. Despite these investments, we anticipate having excess cash due to a solid balance sheet, strong cash flow, and a willingness to maintain modest leverage. Assuming these factors remain stable, there may be opportunities to return cash to shareholders, with share repurchases appearing particularly appealing considering our valuation outlook. Turning to the business itself, we have many exciting developments. We've previously discussed our product line expansions, including color films and windshield films, and we'll spend the coming year maximizing their potential. Our product lineup is now quite strong, and our focus will shift from adding new products to selling more of our existing offerings and enhancing current products. Launching and developing new products are costly endeavors, and we’ll prioritize achieving a return on our prior investments. Our OEM interests are robust among global car manufacturers, though existing program performance has not met expectations, in part due to manufacturing disruptions that create fluctuating demand, adding pressure on costs. We are continually improving our ability to navigate this environment month by month, and it remains a key area of focus and growth for us. Our referral personalization platform, which facilitates online installations for consumers on behalf of partners, particularly OEMs, is generating increased volume for our aftermarket network. This model is unprecedented, and continued interest from other parties reflects its value to our installer partners, especially as the retail aftermarket remains sluggish. We expect to expand this program further in the coming year and beyond. Lastly, I want to touch on our investments in the DAP. Although our SaaS platform priority has shifted to accommodate other initiatives, work on it continues steadily. Some team resources have been reallocated to our personalization platform, yet we are making progress with DAP, enhancing customer efficiency and ultimately driving product sales. We recognize the substantial consumer demand in the aftermarket channel, and our goal is to address the associated inefficiencies. It’s an important time for us with numerous developments underway, and we are confident in our strategic choices moving forward. We are thrilled to have completed our acquisition in China, which required significant effort and will solidify our direct distribution model in key global markets. This achievement is significant, and it will yield considerable benefits for us. I appreciate the hard work of our team and everyone involved in bringing this project to fruition. Now, I'll turn it over to Barry.

Barry Wood, SVP and CFO

Thanks, Ryan, and good morning, everyone. Just a couple more bullet points on our top-line performance. Our total window film product line grew 22.2% in the quarter, and this continues to be a nice growth driver for us. Our total installation revenue increased a little over 21% in the quarter. And this includes product and service for our dealership services business, our corporate-owned stores, and our OEM business, all had solid performance in the quarter, notwithstanding the OEM choppiness Ryan mentioned. Our corporate store performance, as we've said in the past, is a decent indicator of how the aftermarket is doing. On a year-to-date basis, our total revenue grew 13.1%. Our total SG&A expenses grew 20.8% in the quarter to $35.7 million, and this was 28.4% of total revenue. We did have approximately $1.3 million in added acquisition related to SG&A and approximately $0.8 million in bad debt and some other costs that are not expected to reoccur. On a year-to-date basis, SG&A grew 18.2% to $102.7 million. Our EBITDA did decline in the quarter at 8.1% to $19.9 million, and our EBITDA margin finished at 15.9%. On a year-to-date basis, our EBITDA grew 4.6% to $57.8 million, and our year-to-date EBITDA margin was 16.3%. Net income for the quarter decreased 11.8% to $13.1 million, reflecting a 10.5% net income margin and EPS for the quarter was $0.47 per share. On a year-to-date basis, net income grew 3.7%, reflecting a 10.7% net income margin, and our year-to-date EPS was $1.37 per share. I thought it would be useful to give a brief overview of the structure of the China transaction given its complexity. We first formed a new entity in which we have a 76% interest. This new entity then acquired the assets of our Chinese distributor. The purchase consideration for this totaled just under $53 million before discounting for time value of money. And there are essentially three components to the consideration. First, obviously, there was a cash upfront. Second, there was deferred consideration or really cash payable over a four-year period. And thirdly, there was consideration contingent on future sales of what we considered as excess inventory as of the close date. This excess inventory was part of the inventory acquired, and the contingency is structured such that we pay some consideration if the excess inventory is sold at a profit, but we effectively are not penalized if any of the excess inventory is sold at a loss or has never sold and needs to be written off. As Ryan mentioned, in the overall transaction, we effectively added approximately $22 million in inventory if you consider inventory acquired and inventory contributed by minority holders. The first two items, the cash upfront and the deferred consideration, are about 75% of the total consideration. And for various customary legal reasons unique to the transaction, only a portion of the cash paid upfront was actually remitted and the rest of the upfront payment will be paid very soon. And this is important to understand when you look at our balance sheet as we've broken these components out there. The remaining upfront payment still payable and the contingent consideration is reflected in the short term. And other short-term liabilities on the balance sheet. The deferred consideration, the cash payable over a four-year period, is reflected in other long-term liabilities. So as Ryan mentioned, we're certainly happy to get this deal behind us. It was somewhat a complicated deal, and there was a lot of hard work done by several people to make this happen. We have a great team in the region, and we are really looking forward to watching them grow that market. Our cash flow provided by ops was $33.2 million for the quarter compared to $19.6 million in Q3 last year, which was a record for us. And you may notice if you're looking at our balance sheet, a decent size increase in our AP and accrued liabilities line, there's nothing unusual there as this is related primarily to timing. We've got extended terms with most of our raw material suppliers. So timing of payments can create some fluctuations, but it's all in the normal course of business. I'll also add that we did see a slight improvement in our cash conversion cycle in the quarter. So all in all, a solid quarter for us, and we look forward to closing out the year strong. And with that, operator, we'll now open the call up for questions.

Operator, Operator

And your first question is coming from Jeff Van Sinderen from B. Riley.

Jeff Van Sinderen, Analyst

I would like to revisit a point you mentioned in your prepared comments regarding some unexpected price increases you encountered. Could you explain how these occurred and what steps you took to address them? Additionally, could you connect this discussion to your strategy of bringing more manufacturing in-house?

Ryan Pape, President and CEO

Yes, Jeff, absolutely. We did see some price increases that were noticeable during the quarter. As we mentioned, this resulted in about a 170 basis point impact to gross margin. Looking at the broader industry, it's been a tough time for many, leading to various decisions on how to manage businesses and address margin concerns due to lower demand. The overall tariff situation has posed challenges for some suppliers trying to find extra margin elsewhere. However, we have a solid group of suppliers, and where there are significant price hikes that aren't justifiable, we have numerous options for mitigation. This issue was addressed, and we expect to see a reversal in Q4. Furthermore, we recognize an incredible opportunity to invest in becoming the highest quality and lowest cost provider of our products. With the best supply chain, distribution, and brand, we believe we are well positioned for long-term success. Our approach isn't limited to a single strategy; while there are aspects of the supply chain we could bring in-house, we also have excellent partners for deeper collaborations. We've been analyzing this for quite some time and understand that by investing in our business, we can achieve significant gross margin improvements. Moving forward, we need to prioritize these investments to optimize our existing operations rather than exploring other business lines where we may not have a competitive edge or as much experience. This decision has been made collectively with the Board, and we have a strong team ready to execute our strategy.

Jeff Van Sinderen, Analyst

Okay. And then curious on the rollout of your colored films. I noticed some marketing around that. It seems pretty exciting. Any color you can give us, I guess, on early dealer embracement of that? And how impactful do you expect the colored films to be to your business over the next year or two?

Ryan Pape, President and CEO

Yes, it's a great question. The rollout has been excellent and well received. Our team has executed the best product rollout in our history, which I recognize from both an external and internal perspective. We have taken a relatively conservative view on this, particularly regarding the growth opportunity in the aftermarket color change business, which has existed for a long time. We are considering whether we can capture market share or if underlying demand is set to increase. Initially, we believed there was a market where we could gain share, but it appears that the market is expanding. With improved products and better marketing, there seems to be more interest than I expected. We may see increased engagement from both dealerships and OEMs wanting to provide consumers with more options than a traditional automotive color palette allows. If these initiatives gain traction, there is substantial potential for growth. It's still early for us, but I'm quite pleased and optimistic about what lies ahead.

Operator, Operator

And your next question is coming from Steve Dyer from Craig Hallum.

Matthew Raab, Analyst

This is Matthew Raab on for Steve. In the PR, you called out the mid- to high 20% operating margin by 2028. Given the investment in manufacturing, that implies 10 points of expansion over the next few years. I guess whether it'd be organic or inorganic growth, what are the revenue assumptions underpinning that margin expansion?

Ryan Pape, President and CEO

I believe we have been clear in stating that we expect to achieve low double-digit organic revenue growth, despite the challenges and weaknesses we are experiencing. We maintain this outlook for the midterm and are not altering our expectations for revenue growth during this period.

Matthew Raab, Analyst

Okay. That's helpful. And then maybe just a couple of housekeeping items. Maybe, Ryan, if you could just give an update on the sentiment across the aftermarket in the dealer channel. Q4 guiding to 15% growth in the quarter, obviously, good. But any other further detail you have there would be great.

Ryan Pape, President and CEO

Yes. I mean, I think it's a real challenge. I mean, if you look at sort of our peers in the aftermarket and other places, there's a real mix sentiment. What we found interestingly is that the weakness in the sort of trough in sentiment has sort of bounced around globally. Obviously, you had the U.S., you've got sort of Canada now. You had Europe maybe at some point last year. And we've kind of seen it more negative and then recover some. I think if you look at the retail automotive business in the U.S., they're certainly back in the mode of looking for extra gross profit as things are tougher there and just compression in margins and challenges with affordability and tariff impacts into new car pricing and all that. And so that's negative in the sense that that's still a headwind for the consumer where you have upward pressure on pricing and affordability. Maybe we get some relief from sort of the interest rate situation in terms of affordability overall. But it's positive for us in the sense that when it's tougher for dealers, there's more push to find other ways to make money in the things that we provide more value on a percentage basis when it's harder overall. So I think from that standpoint, that's actually quite positive. I just think we've never been in an environment where you get more differing views on what's happening. I don't think there's this universal consensus that things have substantially improved or that the consumer sentiment is way better. But at the same time, there hasn't been any sky-falling moment. So our approach has been that we have to power through. We've got to be mindful of those dynamics, but we've got to set the company up for long-term success and make investments where we need to make it. And we know that the consumer and demand picture, it will all settle out. And I think you've seen some stress. Barry mentioned in his remarks, bad debt, there was an aftermarket chain of some sort that filed for bankruptcy that we had some exposure to. So you see a little bit of signs of stress like that, nothing meaningful or material to the business overall. But I think that's kind of emblematic of what's going on. And then you've also seen an influx of competitors into this space. And this current environment makes it more challenging for them, especially those trying to get rooted and footed, and that's all the more reason why we need to keep the pedal to the metal and maintain and grow our positioning. So long answer to your question, but I think it's a mixed bag overall.

Matthew Raab, Analyst

Understood. And then on gross margin, it sounds like there's a little bit of a drag expected in Q4, just given some of that China inventory and then expect a record in Q1 and Q2 '26. Level of the impact there across those three quarters would be helpful.

Ryan Pape, President and CEO

Well, yes, there will be some impact from China due to the higher-priced inventory and the decline in some of the price increases, which will continue into Q4. However, when comparing to Q4 of '24, that period had relatively low gross margins. Therefore, we expect to see some improvement in gross margin in Q4 compared to the previous year, although we won't fully realize our potential until the end of Q1 when we account for all the margin in China and have addressed the cost increases we’ve experienced.

Matthew Raab, Analyst

And then any commentary on Q1 and Q2 '26, just the level of improvement expected there?

Ryan Pape, President and CEO

I think I'm hesitant to quantify it any more than we have, only because we've got to turn the inventory and sell what we've got. But our position is that we will be seeing highest gross margins we've seen as we get into that time frame.

Operator, Operator

And this does conclude today's question-and-answer session. I would now like to turn the floor back to management for closing remarks.

Ryan Pape, President and CEO

I want to thank everybody for joining us today and thank our team for doing an amazing job, and we've got a big contingent at the SEMA Show in Las Vegas, a big annual event, and we're on a great display. So thanks, everyone.

Operator, Operator

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