XPEL, Inc. (XPEL) Q2 2015 Earnings Report, Transcript and Summary

Greetings, and welcome to the XPEL Technologies Second Quarter 2015 Earnings Conference 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. It is now my pleasure to introduce your host, Jen Belodeau of IMS. Please go ahead.

Thank you. Good morning and welcome to our conference call to discuss XPEL Technologies’ financial results for the 2015 second quarter and first six months. On the call today Ryan Pape, XPEL’s President and Chief Executive Officer, who will review the company’s financial results and provide an overview of the business operations and future growth strategies. Immediately after this prepared comments, we’ll take questions from our call participants. I’ll take a moment now to read the safe harbor statement. During the course of this call, we will make certain forward-looking statements regarding XPEL Technologies Corp. and its business, which may include but not are not limited to anticipated use of proceeds from capital transactions, expansions 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, proposes or variations including negative variations of such words and phrases or state or statements that perceives that certain actions, events or result may, could, would, might, or will be taken, occur or be achieved. Such statements are based on the current expectations of the 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 risks 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 the forward-looking statements, there may be other factors that 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 laws, forward-looking statements speak only as of the date in which they are 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. With that done, I will turn the call over to Ryan. Go ahead, Ryan.

Thank Jen and good morning and welcome to our quarterly earnings conference call. I hope you’ve all had a chance to review our second quarter 2015 earnings that we released earlier this morning. The second quarter performance was strong, characterized by solid revenue growth and profitability as we built upon the momentum we developed in the first quarter of the year. We continued to take market share and attract new customers to the market and the industry from across the world. Revenue in the second quarter grew to 11.3 million, which was a 35% increase as compared to the second quarter of 2014, and a sequential increase of 40% as compared to the first quarter of 2015. This was our first full quarter, including Parasol Canada and our strategy to increase our presence directly in key markets is paying off. We saw very strong revenue growth in Canada and Europe. Both revenue and net income were impacted by weakness and the currencies were exposed too in these subsidiaries, but our direct presence was invaluable in being able to drive growth. In a more traditional distribution model, the foreign currency pressure on distributors in Canada and Europe would have been immense. While we did suffer reduction in gross margin in those markets as a result, traditional distributors would have been in the much harder and less sustainable position, which ultimately would have impacted us, even greater. Overall, we are very pleased and very committed to this strategy While we achieved substantial revenue growth in the quarter, the growth was not quite at the level we anticipated due to a few factors. The growth rate of our business outside Canada, Europe, and the US was reduced significantly in the quarter from the previous sequential and year-over-year comparisons. Our growth rate in Q2 and Q3 of last year was particularly driven by our growth in China. However, in order to create a more sustainable and structured market, at the end of last year, we rationalized our distributor base in China, as we’ve talked about a few times. This has a long term benefit of bringing more value to our brand and it creates more value for a limited number of distributors, and also creates a more orderly market in China. In the near term, this resulted in a year-over-year decline of our strong sales into China. The rate of decline continues to moderate sequentially which is what we expect to happen, but it’s still impactful to the overall business. That said, we are fully committed to the strategy or pleased with the results and we continue to explore other strategies aligned with it, and we still fully expect to return to growth in China in the future. Additionally, we saw a decline in the rate of growth internationally outside of China. This was a bit more surprising as we had surveyed our previous currency exposure and we expected a more muted response from these international distributors. In fact, we believe some distributors are intentionally carrying less inventory in an attempt to hedge against possible improvement of the exchange rate that affects them. Many of our distributors are also in other lines of business that may have unrelated currency exposure, but that ultimately impacts us as it impacts the profitability of their entire operation. These types of distributors internationally, they may only order once or twice per quarter. So it’s more difficult for us to forecast their short term demand. Looking forward, the currency impact and other factors that are a drag on the growth rate remain. Hence while we expect to see continued strong growth in Q3, we do not expect an increased growth rate from this quarter. While the growth in the first quarter in Canada was excellent, we had started to see some weakness in the oil dominated markets of Western Canada, which are really great markets for us in paint protection film. Car sales in Alberta were up 18% in June according to the preliminary government reports and based on the feedback we get, we are expecting this to continue in July and August. This is one of the most penetrated markets in North America for PPF, so we’ll feel an impact from that drop. Also we expect the currency impact will be more significant in the third quarter as the dollar has continued to strengthen. These factors that impact the growth internationally, they are macro in scope and they don’t appear to have anything to do with the continued increasing adoption rate for paint protection film. Though we’ve got to work through them nevertheless. Gross margin for the quarter remained unchanged at 30% compared to last year, and again any weakening of the US dollar will result directly in increased margins, both from the increased margins and our consolidated operations and then also from any international distributors that we may have reduced pricing or given special pricing to under the circumstances. SG&A expense increased as a percentage of sales slightly to 21%, as compared to 18% in the second quarter of last year, but it declined sequentially as compared to 25% in the first quarter of this year. This 21% number, this is closer to where we want to be. We’ve got an ongoing project to identify efficiencies that have come out of our rapid growth. Principally focused on things that are not customer facing and not directly related to our personnel costs, there’s a lot of opportunity nonetheless. So that project to identify those will be ongoing throughout the rest of the year. It will be partially offset in the near term with expenses related to other ongoing products, projects, and product development already planned and some of those we’ll talk about later. Net income for the second quarter was $605,653 or $0.02 per share, as compared to $595,229 but still $0.02 a share for the same period in 2014. So as we mentioned earlier, our profitability was impacted by exchange rates, and we estimate that if the exchange rates to which we have exposure through our subsidiaries had remained at the same level as a year ago, we would have added approximately $300,000 to pre-tax net income for the quarter. And assuming that the exchange rate stay at the level the dollar remains strong, that’s a trend that we expect will continue. Overtime, we expect to capture this net income through the weakening of the US dollar or through price increases that will inevitably occur in these other markets. Balance sheet remained strong with working capital of 6.7 million, [8.7] million in shareholders’ equity. From a product development standpoint, during the quarter we completed at 18 month a major migration project on our DAP software. We updated, actually finished updating the core technology portions of the program. This is going to enable new features, enable us to better localize the system for our international customers, and then also we’re going to add new features related with the window film business. Related to that, we launched a line of window film during the quarter in the US market. In Canada, we already have exposure to window film by virtue of the Parasol acquisition. In the US, we are still on the soft launch phase, initial feedback and the results so far have been very positive and we expect to ramp up this line of business during the remainder of the year. For those that don’t know, window film is really a complimentary product line and its one that’s already used by many of our customers. So it’s really important to do it and do it well, and we know that if we sell more products to our existing customers, this is a good way to increase the affective growth rate of our existing customers over and above them just growing their paint protection film businesses. Additionally, our dealers will benefit from a new ordering and account management portal in the fourth quarter, which is tied to an expanding logistics footprint that we have in our key markets of the US, Canada and Europe. This will give customers the best-in-class ordering experience. We’ve got a particular focus in this application with mobile ordering, which is very relevant to our customer base. We are focused on making our products the easiest to order and the easiest and the fastest to get delivered. So we’ll additional corporate distribution points in the fourth quarter. Finally to complement our marketing efforts, we will launch a new XPEL website in the fourth quarter which is consistent with our branding and the rest of our marketing and advertising. The website includes a new content management system where we are actually going to encourage our installers to submit and share photos and videos of their work that will provide great examples of the product visually for our customers. Overall, we are pleased with the results and the growth. Our brand awareness and reputation are still strong. We look at the expansion in Europe and in Canada as a success, and we continue to focus on increasing those distribution channels to continue to grow. We are seeing strong interest in paint protection films from installers, from car dealerships, and customers alike. Our training classes remain full. So we thank you for participating in today’s call and look forward to catching up and we are happy to take some questions.

[Operator Instructions] Our first question today comes from Adam Goldstein, a private investor. Please proceed with your question.

I’d like to try to understand a little better the reason for the deceleration in the growth rate to 35% this quarter. You mentioned two reasons, one was the year-over-year decline in China and the other one was foreign exchange. Which one of these reasons is, are those roughly equal reasons or is one of those much more significant that the other.

Sure. The overall change in the growth rate from the fourth quarter of 2014 and the first quarter of 2015 till the second quarter, the overall change is a result in really all of our -- as we would call it, our rest of the world international sales. So everything outside of US, Canada, and Europe, and China of course is included in that rest of the world number. But the weakness we saw internationally included China, but was not limited to China. So if we had maintained the similar rest of the world growth rate that we saw in the first quarter of this year and the fourth quarter of 2014, we’d maintain that similar rest of the world growth rate. We would have seen topline revenue growth increase by about 15%.

So from 35 up to 50 I mean.

Approximately.

Okay. That’s quite interesting. It’s hard for me to understand how the foreign exchange rate could be causing such a dramatic change in revenues since you said that there was a $300,000 hit to net income as a result of exchange rates. So even if we added that 300,000 on to the quarterly revenue, it wouldn’t have had nearly that kind of impact.

Sure. No, and you are absolutely correct. So when we look at the $300,000 impact to net income, that’s an impact directly from our international subsidiaries. So that’s a result of the currency pressure in Canada and Europe, reducing the margins out of Canada and Europe. If you’re an international distributor of ours located anywhere else, where you have currency pressure, what you will experience really in essence are higher costs from us and reduced margins. So that’s not currency exposure to us directly in those cases, but essence it’s a de facto price increase do our distributors which results in lower demand.

Okay, so when there’s a fluctuation like that, you don’t immediately lower your prices, you basically try to get the distributors to take the hit fully.

At end of the day, it’s a mixture of both depending on circumstances. But when you look at the rate of decline in various foreign currencies we’ve seen over the past six, nine, or 12 months, we are not necessarily in a position to just lower prices to match that decline, so in most cases that has to be shared with the international distributor, and ultimately that can affect demand. In our case where we have our own distribution in Canada and Europe, we can insulate our end customers more from the impact of the currency, but it still comes at a cost to us which is in the form of reduced margins.

So are your main competitors all US based or do you have some competitors that are not facing this currency problem.

The majority of the product sold globally is made in the US, non-exclusively, but the majority. So this is not a unique phenomenon to us.

Okay, so in that rest of world, where there are other regions, you mentioned Canada actually had a year-over-year decline, was that also true for all of the rest of the world.

No. Just so we are clear, Canada did not have a year-over-year decline. Canada had a very strong volume growth.

I meant to say China, not Canada.

Sure, China. So China had a year-over-year decline which principally is related to the changes we’ve made in the distribution and the strength of China last year. On the Q2-Q3 last year, China was incredibly strong, so we have a really strong comp and then we’ve made changes to distribution. So combination results in a decline. When you look at the other international markets, it’s a bit more mixed. We’ve seen a decline in some, we’ve seen flattened growth in others where we historically had growth and then we still have growth in yet other markets internationally, but the net effect is that that blended rest of the world growth rate was really cut dramatically from the fourth quarter and the first quarter into the second quarter.

Okay. On China, how long do you think it will take to see - do you feel like your new distribution strategy is working or does it need to get more time or perhaps try something different?

No we know it’s working, we are 100% confident in it, and what we’re seeing out of China while impactful is not unanticipated. Previously, we had arguably too many distribution points, and that created a really challenging market for the distributors in country, which ultimately would not be good for us, would not be good for our brand. So by reducing the number of distribution points, it creates a much more orderly and structured market which positions us where we need to be as a premium product. So what we are seeing now is yes, while we have decline in China revenue in the second quarter, we had it in the first quarter, we had in the fourth quarter, we’ll have it in the third quarter. We see that decline moderating. So it’s too soon to say when we expect to return to growth, could be in the fourth quarter, could be into 2016. A lot of that may depend on some of the macroeconomic climate in China which everyone’s familiar with now and changes to the currency there. But we do see that happening.

Okay, my last question. I’m on the website; I don’t see this new window tint product. Is it not on the website yet?

No, it’s not on the website and that’s principally as I mentioned because we are in a soft launch phase with that. So we are just working exclusively with our existing customers as we move in to a more full scale launch.

Do you expect this to be kind of a significant, I mean window tint is an enormous market compared to paint protection films so do you expect this to be a significant revenue driver or not really.

We think it will be significant. We are very methodical in our approach, and it’s important that we do it right and we do it as well, and we do it as uniquely as we do paint protection film. So that will be measured growth as we make sure we have all those things right. But at the end of the day, what we know is that a large portion of our customers buy window film. We know that we have great relationships with the majority of our customers. We know a lot of them would prefer to consolidate purchasing with us. But for window film, paint protection film and whatever else may come next. So we think over time it will be a very important line of business for us.

And what about the next generation paint protection film, you had mentioned that was coming.

Sure. So we are on probably the 7th or 8th version of film in about six years, and we have several enhancements planned and really we are in a phase where we are doing targeted testing on new products and getting customer feedback and then seeing how that will work in to the product mix as we get in to next year.

[Operator Instructions] Our next question today is coming from Tony Pollock from Aegis Capital. Please proceed with your question.

Just to window tint film, is that a net cash outflow to the company right now, and if so what was that in the quarter.

There’s no net cash requirement for the window film program aside from inventory requirements and allocating a portion of our inventory for that product line.

You talked about a next generation of different products, could you expand on that a little more.

Not specifically aside from saying that we’ve had a lot and we’ve been known for a lot of innovation in the paint protection film, and our paint protection film line. And we don’t intend to stop where we are. So we have enhancements to that product that we are working and testing. But as those things go, we get a lot of customer feedback and do a lot of testing before making any changes, because we want to make sure we get them right. So we are engaged in that and that should translate in to new products and updates for the products in 2016.

Be it due to the story, could you go over your competition?

Sure. There’s three or four main competitors that we have and you’ll certainly find a lot about them if you look in to it. I think where we look at ourselves is different, is we are focused on this, and we are trying to create a differentiated business model and provide exceptional value and exceptional customer service. And we think that we can do that successfully and we do that successfully by dealing directly with the installer and the dealerships and the purchasers of this product in key markets and by having a really focused marketing strategy which brings awareness to XPEL and drives sales for our customers.

Could you tell me what you spend in R&D and capital expenditures?

Yeah, so you will see a lot of that in financials. Our largest R&D expense is related to the creation of our templates that go in to our software program, and that’s few hundred thousand dollars a year. In terms of R&D in to the film, we do incur some costs in developing and testing the film. But they are significantly less than the R&D cost associated with our templates. When you look overall from a capital expenditure standpoint, we outsource manufacturing of the product. So it’s really fairly asset-light business in that respect.

[Operator Instructions] Our next question comes from (inaudible) from a private investor. Please proceed with your question.

Can you discuss US specific operating performance?

Yeah, the US business continues to be strong. Historically, we’ve seen a lower growth rate in the US than we have internationally. That spread was not quite as wide in this quarter, but it’s strong and we’re seeing good growth. We’ve really focused on two ways, we have to continue to acquire new customers in the US and we also have to find ways to help increase the growth rate from our existing customers. And those are really two different things, but long term for us, they are equally important.

Okay and just another one. In Canada, what would you say is your short to mid-term strategy with regards to pricing and how you do plan on adjusting to the FX impact in Canada specifically?

Yeah, the FX impact in Canada is strong, as I know you know. And we really have one primary option which is to raise prices in Canada. We did a small price increase, about mid-way through the second quarter. When you look at the overall decline in the Canadian dollar that ends up relatively modest. I think what happens with that remains to be seen. We know that our customers cannot necessarily increase their prices infinitely, immediately, especially if they are seeing any challenges in the local economy. So we have very much sort of the wait and see attitude. Thank fully in the position we are, where we are operating directly, we are able to take that approach. If we were still operating solely through distribution in Canada, it would be a really tough scenario. So we have a wait and see approach, some of that we obviously monitor what our competitors do. But ultimately if the Canadian dollar stays at the current level for an extended period of time, there’s going to be more price increases, that’s just unavoidable.

Okay, so do clarify on if any of your competitors have increased prices in Canada yet.

We have mixed reports and it’s something we track, but not something that I really want to discuss publicly what we know they are doing or not. But we do look at that, that’s not the only factors, but it certainly is a factor we consider when looking how best your approach is.

Your next question today is coming from Paras (inaudible), a private investor. Please proceed with your question.

Couple of questions, one about Europe; in Germany you got signed a deal, an exclusive deal, but I haven’t heard much in terms of distribution. I haven’t heard much about it, and obviously recently with the UK expansion you’ve gone with a different strategy. So can you talk a little bit more about Germany, what’s happening and is there any plan to potentially changing that deal?

We do have a strong distributor in Germany. We do not have any exclusive distribution arrangements anywhere in Europe. We may sort of act as if we do in the best interest of developing distribution, but we are really open and flexible in Europe to whatever the appropriate strategy needs to be.

And then the other thing is in last quarter’s conference call you talked about an expansion in Europe potentially opening another site or another location, can you talk a little bit more about that.

Yeah, we still have that plan and we are anticipating having a presence in the Netherlands by year-end, and we expect we’ll still likely meet that timing. That’s just a further expansion upon the strategy. The UK was our first sort of landing spot in Europe and that’s principally because we knew people there, we knew great additions to our team, and the UK itself is a large market, twice the population in Canada. So that’s why we started in the UK. And at the same time, we recognize that the UK is not the best entry point for the rest of Europe. So we know we need to be in continental Europe and we’ve really embarked on a similar strategy that we had in the UK, which was to take our time and find the best people that we could employ to open that operation and that’s what we intend to do.

And then last question is, with the company business small as is mentioned is asset-light and with the cash building up, is there any plans to deploy that cash in terms of any in the main strategy or expanding with company-owned stores.

Obviously we are looking at all possible ways to expand the business. We have no shortage of initiatives to sort of identify overtime the best strategy. So I can’t comment specifically, but it’s something that we are actively engaged in and our desire as we stated multiple times is to build a business that’s substantially larger. And so in order to that we are going to do more and different things overtime and we actively look to do that.

We’ve reached the end of our question-and-answer session. I’d like to turn the floor back over to management for any further or closing comments.

I want to thank everybody for your support and for attendance on the call today, and we look forward to talking next quarter. Thank you.

That does conclude today’s teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.