XPEL, Inc.
Q2 2016 Earnings Call Transcript

Published: 30 Aug 2016

[Operator:]

Greetings, and welcome to the XPEL Technologies Second Quarter 2016 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host Mr. John Nesbett. Thank you. You may begin.

[John Nesbett:]

Good morning, and welcome to our conference call to discuss XPEL Technologies financial results for the 2016 second quarter. On the call today we have, Ryan Pape, XPEL’s President and Chief Executive Officer; and Barry Wood, XPEL's Chief Financial Officer to provide an overview of the business and operations and review the Company's financial results. Immediately after the prepared comments, we will take questions from our call participants. Let me take a moment to read the Safe Harbor statement. During the course of this call, we’ll make certain forward-looking statements regarding XPEL Technology Corp’s 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 planned, is expected, expects, scheduled, intends, contemplates, anticipates, believes, propose or variations including negative variations of such words and phrases or state that certain actions, events or results may, could, would, might, or will, taken, and occur or be achieved. Such statements are based on current expectations of the management of XPEL. The forward-looking statements 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 the 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 laws, forward-looking statements speak only as of the date of which they are made and 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:]

Thanks John. Good morning and welcome to our second quarter earnings conference call. Overall, we’re pleased with the continued momentum we’re seeing in the business. The second quarter yielded our largest quarter revenue in our history. Barry will take a deeper dive into the numbers a bit later. But on a constant currency basis, overall revenues increased 22.3% for the quarter versus the prior, and 30.3% year-to-date versus the prior year-to-date, while net income grew 42.5% quarter-over-quarter, and 32.7% on a year-to-date basis. So these results, we think reflect the execution of our core get close to the customer strategy, strategy includes our products, services and support closer to the end-user, which allows us to more effectively control the delivery model for our products and services and helps enhance our brand and strategy. Also, allows us to efficiently leverage the distribution channel to drive margin, and a great example of how this works is the rollout of our Window Tint product line last year. The line nicely complements our industry-leading paint protection film and by effectively leveraging our distribution channel, the Window Tint has grown to be over 6% of our revenue mix, and we think that’s substantial and has an incremental product that helps us drive margin, because it’s established with our existing overhead. Furthermore, strategic partnerships such as our partnership with Tint World, which we announced last quarter shows how expanding the product portfolio will create a more compelling mix that enables us to close certain customers. Domestically, we continue to see very strong demand for our products and services, a leading indicator of this that we talk about a lot is demand for our training classes. These continue to be booked solid through the end of the year as far out as we schedule. So that’s critical we are doing that here and in Europe. Now, we continue also to focus on adding dealerships direct to the customer. Like we’ve said before, we will see more dealerships, new car dealerships on direct as customers in addition to the rest of our channel and we still see strong demand there. Now, we’re also going to be investing in the development and marketing of some of our film products outside of the automotive industry in coming months. We have a lot of customers that already use the film for a plethora of non-automotive uses. And we believe there is really some good opportunity and some low hanging fruit to commercialize these, which can add great value and we’re going to do that in over the coming months. On the international front, we’re excited about the growth. Yesterday, I am sure as many of you saw we announced the addition of our Netherlands location, this is all a continuation of the get close to the customer strategy. As most of you know, Europe is the epicenter of the luxury car world. So the addition of this Netherlands location compliments our UK operation, and it’s going to allow us to effectively meet the demand for our products, while simultaneously maximizing the development of our brand across all Europe. And Europe is a critical location for us to expand our design capabilities, our pattern design capabilities, and that impacts our ability to deliver solution globally. So, between the market itself and the strategic nature of it, we’re very excited about the strategy in Europe. We continued to be pleased with our operations in the UK and Canada, we see strong demand and strong growth and we continue to see demand in China and the Middle East and in other areas where we serve through independent distribution. So we’re seeing good things from our distribution partners there. So we’re pleased with the second quarter results, we did experience some headwinds late in the quarter. During the third quarter of last year, we planned for some enhancements to our paint protection products which required certain production process changes. And we experienced some unexpected problems during the implementation of these changes in the second quarter of this year, which resulted in intermittent supply delays. And at the same time, one of our raw material suppliers experienced some quality issues with their product, which further impacted product availability. So these issues created a perfect storm from a supply interruption standpoint and what I mean is that not only did we experience issues related to our planned product changes, which any time you change anything we’d always accept challenges. But with the concurrently experienced supplies issues with the current product that really impacted the planned overlap between the product as it was produced and the product as we’re going to produce it going forward. So these issues impacted second quarter results particularly in June and they were the main cause for a sequential quarter decline and the rate of revenue growth. These issues are currently being resolved, but we’ll see some impact in the third quarter as well principally from July. But ultimately despite these short-term challenges, these changes will cement our already industry-leading position in the markets that we serve. And we have really robust plans for the product and these are the first steps to execute on those plans and anytime you want to improve the product there is change and potential disruption of change. But it’s important for us to maintain really robust plan continue to drive evolution of the product and that’s what we’re doing. So I will note that despite that, we continue delivered outstanding EBITDA and net income growth. And as we stated earlier, this was a historically significant quarter for us. And I’ll say outright that the aforementioned challenges we had with the product and the changes with the product have absolutely nothing to do with the 3M Lawsuit, we do not have any plans to change anything about our products because of the lawsuit. On that front, as I emphasized during the first quarter call, we’re defending this litigation rigorously and we continue to strongly emphasize that we do not believe the patent is valid, nor do we believe we infringe. So from that standpoint, we like where we are right now in the process, but we will need to let the process play out, so our public comments aside from that will be limited so if you please respect that in Q&A. Before I turn it over to Barry to go through the numbers, I just want to say I’ve never been more excited about the direction of the Company. We have the right team to execute on our strategy and do it in a very passionate way and I look forward to working with them as we continue over the years and months to come. So I'd like to now turn the call over to Barry Wood, our CFO who will provide a more in-depth look at the numbers. Barry started with us on June 1st and he's really hit the ground running. His experience and professionalism will be invaluable in helping to scale up the organization and we see that already both in what he's done with his team and the Company as a whole. So with that, I'll turn over Barry?

[Barry Wood:]

Thanks, Ryan. Good morning everyone. First let me say what a great ride it has been thus far during my short time here. As Ryan stated, the team here is very passionate about what they do and you can just feel the passion as you walk through the halls here at XPEL. It's a great environment to work in and I am very excited to be part of this team. Before I jump into the numbers let me first say, that we will state certain key measurements on a constant currency basis, meaning we factor out the noise if you will of foreign currency fluctuations. We believe comparing numbers on a constant currency basis provides for a better visibility into our operations and our constant currency numbers are a non-IFRS measure as most of you probably know, and reflect the current period's results as if we were using prior comparative period’s exchange rates. So for the quarter, revenues increased 21% to 13.7 million and 22.3% to 13.8 million on a constant currency basis. On a year-to-date basis revenues increased 28.5% to 25 million and on a constant currency basis 30.3% to 25.3 million. As Ryan mentioned earlier, we continue to see strong demand for our products and services. The majority of our growth came from PPF and Tint product lines, while domestic and international growth rates were both consistently strong despite some continued softness in Western Canada. Gross margin for the quarter declined to 27.5% versus 29.7% in the prior year, while year-to-date gross margins declined 28.2% versus 31.9% in the prior year period. But as mentioned during our first quarter call, effective at the beginning of this year we began allocating more personnel costs to COGS to better reflect the increased dedication of certain employees to the installation business. Normalizing for the effect of this change, gross margin for the quarter would have been 29.4% and 30.3% on a year-to-date basis, reflecting a slight degradation. However, if you factor in currency fluctuation into the gross margin numbers, gross margins effectively held steady for both the quarter and on a year-to-date basis. Diving in a little bit to SG&A expenses, SG&A expenses for the quarter were effectively flat versus prior quarter. On a year-to-date basis SG&A expenses grew 8.7% versus prior year. But if we normalized for the effect of the cost allocation change I mentioned earlier, SG&A expenses grew 14.6% versus prior year quarter and 22.4% on a year-to-date basis versus prior year. I will note however, that SG&A expenses as a percentage of sales declined remarkably for the quarter and on a year-to-date basis. These normalized increases in SG&A for the quarter and year-to-date were due mainly to three areas. One, we had increases in personnel costs as personnel were added to support the growth in the business and we now have over 100 FTEs working in the business. Number two, we had increases in our occupancy costs in support of the ongoing growth of the operations, and three, increases in professional fees due mainly to increases in legal costs. As a side note, we have spent just north of $300,000 on a year-to-date basis on legal fees with the lion share of it on litigation. As Ryan mentioned, we did experience very strong EBITDA and net income growth for the quarter and on a year-to-date basis. On a constant currency basis, EBITDA grew 38.1% to 1.7 million for the quarter and 36.6% to $3 million on a year-to-date basis, while net income grew 42.5% for the quarter and 32.7% on a year-to-date basis. The Company continues to generate strong positive operating cash flow as well. Cash flow from operations for the first six months of the year was a robust $1.3 million. We did use some excess cash to pay down debt during the quarter, as we continue to strengthen our balance sheet. Our liquidity ratios continue to be very strong and our debt to equity ratio declined 47% as of June 30th versus 72% as of December 31st. As we move forward through the rest of the year, from a financial perspective, we will continue to focus on managing our costs as we drive high incremental margins. We’re working on improving the robustness of our planning process and have just started working on our 2017 plan. We’ve also undertaken a transfer pricing study to ensure we maximize our tax efficiency on a global basis, as well as continuing to evaluate our risk management programs, including foreign exchange. As Ryan mentioned, we’re very excited about our direction and what’s to come. Passion about the business is in the DNA of each and every employee of XPEL and that passion ultimately manifests itself into making decisions that add value for our share owners. We have the right strategy, the right people and the right focus to deliver outstanding results in the coming months and years. And with that operator we’ll now open the call for questions.

[Operator:]

Thank you. And at this time, we will be conducting a question-and-answer session. [Operator Instructions] Your first question comes from [Grice Thomas] with El Dorado Asset Management. Please state your question.

[Unidentified Analyst:]

Can you provide some more insight into how things are progressing in Canada?

[Ryan Pape:]

Sure. Canada has always been a really strong market for us and after the acquisition of Parasol in 2015 just really helped to cement our position. We’re seeing as Barry mentioned, we’re seeing some weakness in Western Canada, primarily in the Alberta market, which is historically very strong, but it's obviously hit hard in the oil patch. However, that’s really been not entirely offset for us with growth on the Eastern half of the country, where we do very well and are very strong. So, we continue to work really hard in the market and expand our team there, but we think Canada in many respects is a model for us what we’d like to do in other countries.

[Operator:]

Our next question comes from the line of Adam Goldstein, Private Investor. Please state your question.

[Unidentified Analyst:]

Hello. I’ve got a few questions. The first one is about legal costs. I believe Barry said it was $300,000 year-to-date. Can we assume there is going to be the same kind of run rate throughout the course of the litigation, so $300,000 per every six months?

[Ryan Pape:]

I think it’s going to sort of ebb and flow depending on the tempo on which things progress. But I don’t think that would be an incorrect assumption, I do think for a period of time, we will see cost accelerate, but not disproportionally different than what we’re seeing now.

[Unidentified Analyst:]

Okay. And how about in terms of the deceleration in the growth are, do you think that was purely due to the supply chain issues you discussed or are you seeing some kind of a spec on the business from the litigation itself?

[Ryan Pape:]

Yes. Good question. No, I think, it’s entirely the result of the issue of supply chain throughout ending June and then into July, we had a substantial backlog of orders to deliver on that we were just waiting on right product mix to fulfill. So overall no, we continue to say that buy and large not really an impact on the business from the lawsuit. I’m sure there is some that we don’t know about or that we can’t quantify, but in a measurable way no, we do not see any impact.

[Unidentified Analyst:]

Well, that’s fabulous news, because that was one of -- as an investor in the company that was one of my biggest fears, so that’s very good news. My last question is on the foreign currency translation. I’m a little bit confused about how you guys are handling this change to the constant currency basis. When you’re making that adjustment, is that only for the revenue that’s earned in the local currency? Or is that also, I guess, I’m a little confused about whether your price your products in U.S. dollars or in foreign currency?

[Barry Wood:]

Yes hi Adam, thanks, this is Barry. So the way -- what we do when we’re adjusting on a constant currency, we’re basically taking the exchange rates that were in effect in the prior period. And then adjusting current year numbers, current year foreign numbers based on those exchange rates and then factoring that into the growth. So, basically we’re trying to do is just show you what the world would look like as, summing that nothing had changed from a foreign currency perspective.

[Unidentified Analyst:]

Well, I can understand how that works if the product is being priced in the foreign currency. So for instance, let’s say the product was priced in Canadian dollars then it’s easy to see how you change the foreign currency translation as this it was the same as last year. But if the product is being priced in U.S. dollars, there really is no translations and...?

[Barry Wood:]

Yes. No you’re absolutely correct Adam. So our U.S. business operates in U.S. dollars. So there is no impact to that constant currency calculation from the U.S. business. Whereas our Canadian business and our business in the UK operate in Canadian dollars and pound and euros respectively, so it's only those business units that are affecting the constant currency numbers, the U.S. sales would not be.

[Unidentified Analyst:]

Okay, and will that be case also for the Netherlands once that starts taking effect?

[Barry Wood:]

Yes Adam it will, we'll have the same issue there.

[Operator:]

Our next question comes from the line of Andy Preikschat with Edgebrook Partners. Please state your question.

[Andy Preikschat:]

For the last quarter you spoke about potentially U.S. price increase in late summer, I am wondering did that happen?

[Barry Wood:]

That had not happened yet. With what we saw with delays on some of our orders in June, we pushed it off just not wanting to do that at the same time, we're not hitting 100% bill rate at the time we want, so we still anticipate that occurring, but we have definitely delayed it by least 60 days from our original target. So that would take us into fourth quarter probably before we look at actually putting that into effect.

[Andy Preikschat:]

Okay, I am wondering a little bit more on the supplier issue, can you elaborate on how exactly you've fixed the supplier issue because I believe you single source quite a bit including the polyurethane?

[Barry Wood:]

Sure, well the main issue that we experienced in the second quarter was, we're actually making changes to the product to improve it, and specifically we've talked about some of it before, but we've got a multistep plan on what we want do with the product and this is sort of the first step that is supposed to be just an incremental step up and kind of set the stage for changes we want to do in the future. And principally these changes were changes with adhesive and changes with the processes to improve the overall appearance of the product. So what those changes necessitated were actually changes to production processes and changes to some of the adhesive use and what not. And so as processes just as they are being scaled up, you run into inevitable problems that don't always work themselves out when you're doing smaller runs and scale up. So it's just something that had to be worked through and slowdown a little bit to address the root problems and get them tweaked and then scale the production back up and while that happens you see a less inventory that you’d like.

[Andy Preikschat:]

Okay, is there any way to quantify what the Company sales would roughly have been if you had not had the supplier problem?

[Barry Wood:]

Internally, we obviously looked at that, but it's sort of challenging to come out with a number because there is always a lot of assumptions and there is clearly whenever you can't fill an order at the time the customer wants, you're on the risk of losing the order. But you also have sort of the time shifting effect where the customer will take the product, but just take it on a delayed basis. So we saw June and July really impacted the growth over the prior year, and we think that on a going forward basis in August and into September, we'll see that recover and we would expect we had a good august and we would expect to have a really strong September coming out of that and fully clearing any backlog that we have.

[Andy Preikschat:]

Okay great and last question, can you share more about the growth you're seeing in the UK and Europe in terms of planned installer growth?

[Barry Wood:]

Yes, UK has been really a great market for us I mean the growth rate we’ve seen on a year-over-year is huge, obviously starting form a very small base that we have historically. I think we said it before, but it feels like to us that Europe is where the U.S. was five or six years ago, it’s just everything is kind of set back in time. And so we think that that’s really favorable to us. And what we’re finding is that the closer we get to the customers there in the UK operation and now in the Netherlands operation by bringing on established distributor of ours that knows us and knows the product, and that we know to help lead that in Continent of Europe, we get tapped into so many more potential customers and potential really good relationships because we’re there. And you can’t reach them from afar and we don’t think you can reach them by sort of abdicating that development obligation to a third-party, or third-party distributor. So, we’re very bullish on that just because of the penetration rate is so low as it is and there is so many other strategic opportunities for us that come out of Europe just given our over-indexing in terms of penetration rate into the luxury car market and there is ultimately so many synergies that come out in terms of leveraging our pattern design activities and being closer to the stores to where those cars may show up first. So it's just -- we look at it just kind of a win-win on all sides.

[Operator:]

Our next question comes from Jason Hirschman, Private Investor. Please state your question.

[Unidentified Analyst:]

I have few questions for you this morning and thank you very much for breaking out the segment revenue, I think starting with the annual report and also starting with Q1. And that’s actually the source for my first question. Because I was noticing that the Canadian pretax margins let’s say in Q1 were around 15% and the way I compute them now in Q2 there are around 3.7% and what was a pretax margins. So I am wondering if you can perhaps provide a little color around that. Why there is such a big variation from one quarter to another quarter given that the -- probably the currency was fairly even from that -- for those two quarters?

[Barry Wood:]

Yes hi Jason, this is Barry. So, we’ve started to do a little bit of transfer pricing work in Canada so there maybe some effect from that. The other thing in the second quarter also, our supply issue is also obviously affecting Canada also. So there may be some impacts from that. But we would expect as we continue to dive more into the transfer pricing issues we’ll start to normalize on those margins a little bit as we go forward.

[Unidentified Analyst:]

Okay. And just if you could provide a little bit more color perhaps on the, your European acquisition and Netherlands, may we presume that the principals of that business are staying on is that the intent?

[Ryan Pape:]

Yes hi Jason, good to hear from you, it’s Ryan. Yes, absolutely. So Connectin was a business that was founded three or four years ago, principally just to sell XPEL products. So, they’ve been fully invested in XPEL from the start and no one believed in everything that we’re about. So I think it's really safe to assume it’s still a very small business obviously, but for us it's purely strategic in the sense that we know we have the right team and both with the Company history and subject matter and just so we’ve been able to see how they operate. And so absolutely they are and in this instance, we wouldn’t be doing it otherwise.

[Unidentified Analyst:]

Okay. And just to -- I know you’ve already answered a few questions on the supply disruption, but it sounds like probably in the fourth quarter, that the things are going to get back to normal. And in fact, you may even recapture some of those sales that got delayed. Is that a fair assumption?

[Ryan Pape:]

Yes. That’s our expectation at this point based on everything we see is it -- we expect to be kind of operating fully normally in the fourth quarter. I mean, obviously you got to get there before you know. But that’s what we expect and we’re already feel like we’re on the other side of it and are climbing back up to where we need to be.

[Unidentified Analyst:]

Right. And just finally, just one final little question that about Window Tint since it has reached over 6% of sales, it’s been pretty impressive there. Is it fair to say that the gross margins, the Window Tint are consistent with the gross margins for the PPF? I believe you may have said that? I don’t know.

[Ryan Pape:]

Yes. So in the limit, we expect comparable gross margins, I think what we’ve seen so far as the rollout has gone, as we’ve acquired a couple of fairly high volume accounts in terms of redistributors, which are on the lower end of the anticipated margin scale for Tint. So I think we’re slightly under the average for PPF today. But we don’t expect it to stay like that, we expect it to meet or exceed on a go forward basis just as we kind of round up the customer mix.

[Unidentified Analyst:]

Okay. And just as this one small little last question. Is this change to the [indiscernible] the film may presume that there is no real changes to your expected gross margin that the -- or a price increase set for that, is it just an ongoing…?

[Ryan Pape:]

Yes, correct, yes this is not a change that we would differentiate the product in such a manner to sell it differently or to adjust the price on that basis alone. That’s correct.

[Operator:]

Our last question comes from the line of James Barnby with Donville Kent Asset Management. Please state your question.

[James Barnby:]

I’m just wondering if you could give us a little more details on how we should think about that Connectin acquisition. I’m assuming, it’s not the same magnitude as Parasol, but we just like to kind of hear about kind of where it fits. Is it a Parasol or is it closer to your UK acquisition and then if you could outline kind of your plans for financing that as well? Thank you.

[Ryan Pape:]

Sure, sure. No, compared to Parasol, the business is much-much smaller. So while there is -- once you do the inter-company eliminations it’s slightly accretive to revenue, I mean it’s relatively minor. This is really about looking at what one of our distributors is doing. And with our support and our team’s support and our engagement that we can really help accelerate what’s happening. So it is really entirely about getting a presence in the market, getting the right team onboard and to serve as the basis for building a much larger business. So from that standpoint, our purchase price and what not was not a material amount of money, so there is no concerns on financing it and it’s purely strategic for us.

[Operator:]

That does conclude our Q&A session. At this time, I will turn it back to management for closing remarks.

[Ryan Pape:]

I want to thank everybody for participation with the call and we look forward to talking to you again next quarter. Thank you.

[Operator:]

This concludes today's conference.