XPEL, Inc. (XPEL) Q1 2017 Earnings Report, Transcript and Summary

Greetings. And welcome to XPEL Technologies First Quarter 2017 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, John Nesbett of IMS.

Good morning. And welcome to our conference call to discuss XPEL Technologies financial results for the 2017 first quarter. On the call today we have Ryan Pape, XPEL’s President and Chief Executive Officer; and Barry Wood, XPEL’s Chief Financial Officer, will provide an overview of the business operations and review the company’s financial results. Immediately after the prepared remarks, we’ll take questions from our call participants. I’d like to take a moment to read the Safe Harbor statement. During the course of this call, we will make certain forward-looking statements regarding XPEL Technologies Corp. 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 the words such as plans, is expected, expects, scheduled, intends, contemplates, anticipates, believes, proposes or variations, including negative variations, of such words and phrases or state that certain actions, events or results may, could, would, might or will be taken, occur or be achieved. Such statements are based on the current expectations of 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 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 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 on 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 done, I would now like to turn the call over to Ryan. Go ahead, Ryan.

Thanks, John, and good morning. Also welcome to first quarter earnings call. It was a very busy first quarter for us. I think we were able to accomplish several significant priorities for the company and really helped to build momentum going into the summer season. So revenue for the quarter grew 11.8% over the prior year to $12.6 million for the quarter. From a revenue perspective, quarter came in right above where we expected looking at especially in light of quality and supply issues that continued to bleed over from last year into January and February. Regarding that we believe that the product challenges are fully behind us. I think this was demonstrated for us in March, we had all time record monthly revenue -- all time record in March. And now as a result of this product, the manufacturing changes, we have a better product, number one. We have three times the available production capacity available to us. We have set the stage for future innovations and expansions of the product line. So to that end we've launched a new product, [ph] ULTIMATE+XT (3:50), which is a thicker paint protection film with a real deep gloss to it and this is useful in applications where extra thickness is actually required, but it's also a differentiated product, which gives customers and our channel partners something different to sale where there might be appropriate. So this is -- this product possible through a lot of this transition and its started to be sold to select customers in the past few months. So, I think, certainly the transition as we all know it’s been very painful process. But as of end of April and into May, we're now trending better on all of our quality metrics than we have before we started the transition a year ago. So, not only have we returned to where we were, but based on the metrics we look at we are now exceeding that. So that's a very good thing. And I guess, as you can see in the numbers and Barry will discuss, but we built substantial inventory at the end of the quarter, which sort of coincides with seeing the improvements that we expected. So revenue for the quarter was reduced by about 4% due to establishment of warehouse in Dubai. This had the effect of turning what would have been sales in the first quarter into an essence and intercompany transfer where there is no revenue to recognize and those obviously will be sales later. So the key idea here and is very consistent with our -- get close to customer strategy and lot of the other things we do is that, we have distributors and partners, and we have to help them in challenges of working capital and availability of inventory is key to be able to grow business in general, key to be able to grow their business and so by us sort of forward positioning inventory, we think we can accelerate growth. We can mitigate some of the risk associated with that and really be a better partner and then ultimately use as an opportunity to increase margin on those sales as well. So that was established in the first quarter. I also had an impact to revenue growth based on availability of our STEALTH film which is a [indiscernible] film that was kind of last product to fully transition, so we were really light on inventory January, February. That’s 100% transition. We have lots of inventory. So we can consider that one as well. So that's good news for those all kind of weighed on the growth in the first quarter. Barry will talk through the particulars a bit later, but bottomline was impacted by certain really non-recurring expenses related to product overhang, you see this in warrant expense directly, but it’s also sort of laden in a lot of other things where you make accommodations for customers. So we felt that, as well as lot of legal costs related to the 3M lawsuit and other things. So given that I am pleased that we've been able to bring these things to closure during the first quarter and we can really be 100% focused on growing the business and executing the plan that we have. In the quarter we hosted the Dealer Conference in Antonio. This is the first one we've done in a number of years. It came it really great time for a lot of reasons. Those attended by nearly 200 of our customers and their employees, and this was really on short notice. We talked about doing it and decided to do it and didn’t give people a lot of notice and we had a really good turnout. So there were educational tracks related to advanced installation, our DAP software related to our new window film programs and then search engine optimization. We have dealer roundtable and then, of course, what sort of made the conference known and to our customers originally was paint protection film and window film installation contest and there was cash prizes for the top finishers. We also had keynote speakers, really related to helping our customers run better businesses. So it was a great event. We had tremendous feedback, positive feedback, management team and I, we receive tremendous value. It's great to hear firsthand from your customers exactly what they see. They actually get in front of them. Just -- I don’t have the opportunity to get in front of as many customers I would like, so have that many in front of you is a really eye-opening experience. So there's a video on our website and on YouTube which is a recap of the conference. I encourage all to find it and watch it. I think you will be as impressive as the customers were. So we had this conference. We did it eight year -- eight or nine years in the row and stopped for few years. But we will be doing it annually going forward, substantial cost and we sort of felt that and we will get better about running this going forward, but best money spent. So that was a really exciting thing that came at a good time in the first quarter. Right at the end of the quarter, we announced acquisition of Stratashield, which is a leading installer of paint protection film in Dallas, Texas. Houston Orona and the team there really top notch service. We are really excited to have them join the family and this kind of rounds out our presence in the home state of Texas. So we now have a direct presence in all the major markets there. Internationally, we continued to see strong demand. Actually in some respects international was stronger in the first quarter, domestic was a bit weaker just given all the circumstances. Really our expectations from our distributors in China and the Middle East for this year, working hard to make sure that they can succeed, you see steps like what we are doing in Dubai to help facilitate that for everybody's benefit. Tim Hartt has fully relocated to the Netherlands during the first quarter, so he is there full time and we are working hard to get European business fully established so it can start to scale. Being there as an our presence and our people continues to present us with interesting opportunities, that would not happen if we were not there plain and simple. So it’s 100% the right strategy to be there and consisting with all of our strategy and Tim's commitment and willingness to go there and lead the team is helping immensely with knowledge transfer, we have very talented people on both sides of the Atlantic, but you need somebody who can see the big picture and link it together. So having them there full time great thing and we starting to see that pay dividends this quarter. So, I think, you could see, well, it has been a busy quarter. I am excited about the year ahead and I think getting focus solely on the things we need to grow the business. Overall, in terms of where we are, I think, I feel at this moment sort of a better about where we are and where we are positioned and obviously, there is a lot of things we talk about here in terms of challenges and opportunities in getting some of those things behind us. But there's hundreds if not thousands of little things behind the scenes that we work on just to improve the operations of the business and those don't get a lot of attention, but they are just as important. And so, I think, we’ve made great progress on those. We have got a few of these key things behind us and so now it’s time to focus on the blocking and tackling and focus on growing the top and bottomline. So, with that, I'll turn over to Barry to go through the numbers and then we will take some Q&A. Go ahead, Barry.

Thanks, Ryan, and good morning, everyone. For the quarter, as Ryan mentioned, revenues increased 11.8%, $12.6 million in March was our highest revenue month in the history of XPEL and we are continuing, I mean, the good news there is to -- we are continue to see a strong momentum as we roll into Q2. And as in past quarters, our growth continues to come mainly from ULTIMATE PPF product lines, but tint line is starting to heat up as well as we roll into the summer months. Gross margin for the quarter declined to 26.4% versus 29.1% in the prior year quarter. The decrease was mainly due to significant increase in our warranty cost as Ryan alluded to earlier from prior year resulting from the issues that we have, supply, quality issues and whatnot. As you have seen in previous quarters this line item has been increasing since the introduction of supply challenges last year. Again the good news there is as it based on what we are seeing in our quality metrics which are very much back to normal. Those issues are seem to be now resolved and obviously we expect significant improvement in this line item as we move forward. SG&A expenses for the quarter increased 40.5% versus prior year quarter. This increase is due mainly to a couple of one-time non-recurring items, namely our Dealer Conference, which obviously, clearly, derive a lot of value out of, which is obviously going to be one-time per year event. And then again our legal costs resulting from the 3M litigation as a result of the settlement and as a side note, we incurred about $35,000 legal cost for the quarter. In addition of these non-recurring items, effective January 1 we changed our method of depreciating our fixed assets from double declining balance method to the straight-line method. We made this change to better reflect how we consume the future benefits of these assets and under IFRS this change is considered a change in accounting estimate and we held this -- which we held this prospectively as we move forward. The impact of this change for Q1 was approximately $90,000. Effectively what this change did is it accelerated some depreciation of some of our older assets into 2017, and obviously, what that being done the impact of this change were less than significantly beginning in 2018 and beyond. So absent the impact of these items, SG&A reflected normal increases related to increases in personal cost, as well as various other items to support the growth in the business. And clearly, the gross margin degradation related to the warranty related costs discussed previously, as well as the non-recurring SG&A cost impacted -- had a big impact on our EBITDA to the tune of about $700,000 resulting in total EBITDA for the quarter of $407,000. And obviously we certainly expect market improvement in this line item as we move forward for the rest of the year. And those impacts and then couple that with our depreciation method change we ended the quarter slight net loss of $65,000. On the cash flow front, our net cash used in operating activities totaled approximately $1.2 billion. Again this due mainly to cash outflows related to the buildup of our inventory. Our inventory build was more concentrated late in the quarter as we ensure that our supply, quality issues were resolved and as evidence by the metrics we were seen. Also as many of you know we close on our private placement during the quarter which yielded approximately $2.6 million in capital and again our intent for this additional capital is to fund potential future acquisitions or any capital expenditures and/or for any other general corporate uses. Our balance sheet remains in great shape. Our liquidity ratios continued to be very strong and our debt-to-equity ratio declined to 40.9% as of the end of the quarter versus the end of last year. So, as Ryan stated, indeed Q1 was a very active and busy quarter for us. Our supply and quality issues are now finally behind us, as well as the 3M lawsuit. And as Ryan alluded to we do feel really good about where we are right now and the good news there too is that we are seeing that momentum that was built up late in the quarter continue in the Q2. So we expect to deliver outstanding results as we execute on our strategy moving forward. So, with that, Operator, we will now open the call up for questions.

Thank you. [Operator Instructions] Our first question is from [ph] Adam Goldstein (16:59), private investor. You may begin.

Hi. I have got a few questions about the geographic segment reporting in the financial statements and the first one is, I assume what is listed as U.S. sales also includes rest of world sales were expelled sales through distributors such as in China, is that correct?

Hi, Adam. Yes. It’s Barry. That’s correct.

Okay. So of the $9.73 million in U.S. segment sales this quarter, can you give us some idea of the breakdown between U.S. customers versus rest of world customers through distributors?

Yeah. Adam, we are not -- we don’t disclose that information, but what I can say is that, obviously, with our concentration in Dubai, it’s a very important piece of business for us. So we continue to see -- we are expecting to see some tremendous growth out of those areas as we move forward.

Okay. Maybe you could give me an idea of how does the rest of world or let me get to the third question, so does the sales listed in Europe, does that include all sales in U.K. and Continental Europe or only those sales that are running through U.K. and Netherlands?

So those are going to be the sales that are running through U.K. and the Netherlands.

Oh! Okay. So sales to Europe that are not -- that are -- I mean, well, so are there sales in Continental Europe that are not running through those, I am just trying to understand, it that…

Yeah. Just, yeah, just, yes, I am sorry, Adam, just to be clear, so it’s -- those are sales sold out of U.K. and Europe to any place. So any place they sale too would be included in that number.

Okay. So basically that includes all of Europe.

That’s correct.

Okay. Well, so that’s interesting information because in the past, this is the first quarter where it was described as Europe instead of U.K., I think. And so the sales in Europe are very much lower than the U.S. even though the populations are roughly the same, I think and...

Yeah. Adam, it’s Ryan. I think you're right. I mean, that’s, however, you kind of slice and dice it, that’s the fact and that’s one of the reasons that we’ve made a significant investment in the U.K. and Netherlands to support that market, because it just very much market that is not established. It feels like in many respects like the U.S. market did five or six years ago. So structurally there are different things about automotive business there. There is different sort of consumer preferences. So the ultimate attachment rate in Europe lower equal to or higher than the U.S. I think that's a good question, but the reality is it should be for US significantly higher than it is and there's a lot of run rate there to make that happen.

Do you have any information about the, I mean, is that an issue, is that an issue of overall paint protection film penetration or an issue of market share for XPEL?

It’s both. The overall paint protection film market and the penetration the vehicle sold allow, the available data is low sort of anecdotally and empirically it's a lot lower, it is just a lot less sold and done in Europe by anyone. And then within that, I think, our market share -- maybe changing now but our market share historically was lower just due to our reliance on distributors in Europe that may or may not have performed like we would want over time, which is part of the pivot to do it directly. So I think both are true, but the overarching reason is it as a product category it's just not as well known, it’s not as highly penetrated the vehicle sold at this point as the product class.

Okay. Then my last question is little bit getting back to the second one I asked. I realized you are not going to give precise breakdown I guess for competitive reasons, but can you just give me some color, some idea, if we take the $775,000 sales to Europe, how does that compare to the rest of world sales…

Well, I think…

… anything outside of U.S., Europe and Canada?

Yeah. I mean, I would say that, the European sales relative to rest of the world, relative to the U.S. comparatively speaking still very small.

Okay. All right. All right. Thank you very much.

Okay. Thanks, Adam.

Our next question is from [ph] Brace Thomas, Northrop Asset Management (22:27). Please state your question.

Good morning. Could you provide us little more sense as to the market opportunity in Dubai and why it makes sense for XPEL to be there?

Yeah. So it's not so much the market opportunity in Dubai proper is that we have distributors in the region and our distributors much like a lot of our end customers and installers, there tend to be smaller businesses and to grow a distribution business particularly want that’s thousands and thousands of miles away end up with significant working capital challenges. You may have ocean freight to take 35 days. You may have time in the warehouse. You may have extended terms of receivables and certainly in Middle East extended terms are common for certain types of customers. And so when you put all that together, lacking unlimited capital if you are a distributor, you just run into problems where there may be sales, there may be customers that need extended terms, there may be marginal deals that you can’t get, because working capital needs and this is plain to see and it is true pretty much with every distributor we’ve ever dealt with and so our approach. And it’s also true with our installers and the end customers who as we have talked about before they need product quickly. They tend to not carry 60-day supply in their shop, so we built the infrastructure and the system to try and get them product cheaply and quickly to cater to that fact. So that's true there too and you run into a situation where we may be carrying inventory that's destined for this market but because of thousands of miles away and a boat ride away and whatever it might be, ultimately it's not in the right place. So if we can sort of take the low the forward position inventory in key places to make it available to our distributors on a shorter period of time and ideally charge more for the privilege that tends to help everybody sell more and make more deals and so that’s what we have done. Dubai is a great place to do that and so that's where the inventory physically is located. But it's not specific to the market in Dubai. That is just a good choice for logistics.

Okay. Great. Thanks a lot.

Our next question is from [ph] Jason Hirschman, private investor. Please state your question.

Hi, guys. How are you doing today?

Great, Jason.

Okay. Just, I got a few questions for you if you don’t mind. You sort of alluded to this in your commentary, but it sounds like the warrantee issues really are not going affect XPEL sales growth in the U.S.A. particularly over the medium-term, that is just was a short-term effect and you haven’t really lost any customers or distributors because of it?

Yeah. I think both are probably true. So any time that you're failing to deliver the customer what they want whether its quality they want, on the time they want or the product they want or the quantity they want, that's a negative thing. And ultimately you have customers who they may go elsewhere. They may split their spend. They may just kind of delay, could have any number of negative consequences. And so, we've been experiencing that to some extent for the past year. But I think at the end of the day, our value proposition, what we are doing still remains high and so certainly we've had customers that have gone elsewhere, split their spend or whatever. But we've been the beneficiary of that at other times. It cuts both ways, when other people have had similar problems. So I think that we felt that and that, you do have work to do to maintain the same momentum that you had and make sure you didn't lose any ground. But I think that largely that is the near-term issue and it’s one that we are sort of coming out of now. We have got to work extra hard because of that. But if you look out in the future, I don't think, over the medium-term it's a big impact.

Do you see the one negative affect being diminished ability to take price in 2017 in the American market or other markets?

Yeah. Absolutely. I mean there is a number of negative immediate near-term affects as a result of that. I mean when your inventory is low or your quality is not where you want, if you are trying to do things structurally with how you conduct your business, you are trying to address pricing, you are trying to change programs, whatever you are trying to do, the natural and I think reasonable conclusion, well, now is not the time, now is not the time, now is not the time.

Sure.

So that’s definitely negative and I think that was true last year for sure.

Sure. Sure. Let me just change gears a little bit and ask you about your installation points, I mean, it’s becoming an increasingly important part of your business. Could you provide a little commentary how the -- how revenue is looking at your in Las Vegas or your Texas locations, is it continuing to grow?

Yeah. Overall, we see growth, it -- the installation business revenue on location by location basis has a bit more volatility than we see, so you have kind of big swings month-to-month. But we've seen in several locations sort of record revenue months popping up here or there in the past six months. So I think that that's been good. And I think what's important to sort of reiterate is that the locations are good business by themselves and we are glad we have them and we intend to have more of them in a prudent way. But they are also part of the cohesive strategy to try and better develop each of those local markets where sales to other people, product sales may be lacking or maybe low. So we also -- when we look at it we are looking at not just installation volume in that market but total gross or net profit contribution on a city by city basis, because ultimately the underlying goal here is to obviously generate net income from it, but to move more product in these markets and if us being involved to do it is what it takes to do it great, if us being in there helps other people do it better, great, doesn't really matter, so we kind of look at it holistically. And I would trade installation revenue in the local market for one of our customers, if they could do it better or they were better positioned or better located or whatever the circumstance was. So we look at but that trading installation revenue or film revenue at that point. So we look at it holistically. But, overall, I think, it's a winning strategy.

Sure. And my last question is, there's been a lot of commentary in the overall automotive news arena particularly in United States that the automotive cycle may be topping in used cars, are you seeing any of that and do you see any effect on XPEL from new car sales or the growth rate starting to stagnate?

Yeah. So, no, we haven't seen effects from it at this point. We've heard more people talking about it and obviously, as you mentioned, there has lots been written about it and there's some underlying truth to the numbers, however, you want look at it. I think that when you look at where the majority of our business is concentrated, I think, we're less susceptible to some of those cycles just when you look at typical, it makes where we penetrate the highest the typical buyers there, they are not looking for subprime financing and things like that. But there is overall certainly something be mindful of and something that we look at. But we have not seen it in a major way. You do have anecdotal feedback from this part of country or that dealership or this or that, that sales are offered slower or this is that. But you kind of get that all the time. But I do think it's something, we have to monitor and realize that there is a cycle to it, I think, that if you -- you got to kind of backstopped that against overall health and strength of the economy in general. And I think we are probably a little more correlated to the overall strength of the economy than we are the particular cycles of automotive business. But as penetration into other makes grows as a window film line grows, which tends to be more broad-based and paint protection film in terms of penetration into different makes, that will change that a bit and will bring us a little bit broader market exposure. But right now I think that we are kind of on the fringe of it a little bit.

Okay. Well, those are my questions. Thank you very much.

Okay, Jason. Thank you.

Ladies and gentlemen we have reached the end of the question-and-answer session. I would like to turn the call back over to management for closing remark.

This is Ryan. I want to say thanks to everybody for participating. Have a great turnout on the call today and we look forward to talking to you next quarter. Thank you.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.