Earnings Call: Q2 2020

Aug 12, 2020

Greetings, and welcome to the XPEL, Inc. 2nd Quarter 2020 Earnings Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. It is now my pleasure to introduce your host, John Nesbitt of IMS Investor Relations. Thank you, John. You may begin. Good morning, and welcome to our conference call to discuss XPEL's financial results for the Q2 of 2020. On the call today are 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 will take questions from our call participants. I'll now take a moment to read the Safe Harbor statement. During the course of this call, we'll make certain forward looking statements regarding XPEL 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. Often, but not always, forward looking statements can be identified by the use of words such as plans, is expected, expects, schedule, 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. 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 or 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 of 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. Okay. With that out of the way, I'll now turn the call over to Ryan. Go ahead, Ryan. Thanks, John. Appreciate it. Good morning, everyone, as well. Welcome to the Q2 2020 conference call. During our Q1 earnings call in May, I indicated we were seeing signs that the business in many of our regions is turning the corner, but after the pandemic, after the 21% revenue decline we talked about in April. Well, I've been certainly been pleased with our results in Q2, which by almost all measures was an outstanding quarter for us and a fantastic comeback from April, certainly well ahead of what could have been given the COVID-nineteen impact. Revenue for the quarter grew 19% over Q2 2019 to $35,800,000 and certainly topped our expectations. Revenue ramp up acceleration began in May and June ended up being a record monthly revenue month for XPEL. And just for context, June revenue was over double April revenue, so quite a swing. We will also review our performance by region. Some things have been similar across regions, a pronounced decline followed by a strong rebound. What's been inconsistent among regions is the timing of entering the decline and the duration of the decline. The China region continued the momentum we saw in April as revenues grew over 200% to just under $10,000,000 for the quarter. Obviously, China had an easy comp as Q2 2019 was a weak quarter based on the previous inventory build prior to the quarter prior to that quarter, which we previously discussed. This was the 2nd highest revenue quarter for China after the 13,500,000 dollars we saw in Q4 of last year. As a reminder, we accelerated a few million in revenue from Q1 2020 into Q4 2019 just based on the timing of shipments. China auto sales were up over 10% during Q2, so we're certainly benefiting from that. Our forecast out of China has been consistent and strong. Obviously, there's still question in China as there is now in other parts of the world, how much demand is being driven by pent up demand during shutdowns and how much is the new normal? Hard to say for sure, obviously something we're watching closely. At this point, we're expecting year over year growth in China compared to Q3 2019 for Q3, which was the Q1 in which we saw significant increases last year, which also then translates to modest sequential growth in China from Q2 2020 to Q3 2020. As a reminder, in 2019, our China revenue was very back half loaded. So obviously, we're very pleased with China and very pleased to see how the markets perform coming out of a very severe shutdown, very severe COVID impact. Outside of China, our APAC business grew 7.7% for the quarter. Pandemic impact is very spotty in the APAC countries, so it's been pretty hard for us to forecast near term impact there. APAC, which excludes China, has probably been the most volatile for us during the pandemic. So we have the least visibility about this part of the market. We also have large distributor orders, which are subject to timing comparisons. U. S. Business finished down only 2.3% for the quarter, which was a great result considering the U. S. Was down 36% in April as we previously mentioned. The year over year decline in the U. S. Dropped dramatically in May and we returned to year over year growth in June. That strong year over year growth continued in July. Similar to China, I have questions around whether we're satisfying pent up demand or resuming a normal selling process. It's been fairly widely reported cash down payments have increased on average for new car purchases in the U. S. As things have reopened. So this helps suggest the changing prioritization of spend as a result of the pandemic impact, but it's too early to call that for sure. But we have really seen the U. S. Come roaring back, very happy about that. Canada U. S. Dollar revenue declined 24.1% for the quarter. Canada had a strong lockdown compared to the U. S, particularly in Quebec. Our installation businesses in Canada are performing extremely well. We've added extra working hours just to meet the demand. So we're a little bit unable to square that fully with the overall trend in Canada. It was certainly unfortunate timing with our ProTech Center acquisition in February just before COVID, but it's performed very well, As we talked about in May, we saw fairly strong performance in the early days and the EU lockdowns were not as universal as some other countries, particularly in the markets in which we do best. In that sense, we lucked out, but it does highlight how different markets are performing relative to the timing in and out of COVID. As we previously mentioned, we have OEM projects in Europe that have yielded good results for us and they were not overly impacted by the shutdowns. Our UK revenue declined 32% for the quarter. UK had probably the most effective and comprehensive lockdown of all the regions in which we operate except for China, And it was one of the last regions to open back up. So the results not surprising. Now in contrast to the U. S, as I mentioned earlier, we saw steep decline in the UK during the month of May, owing to their lockdown timing, but we returned to growth in June. Latin America revenue declined 5.5%. Our Mexico business, however, has continued to grow for the quarter, which is notable as Mexico continues to be substantially locked down. Mexico was one of the last countries that we have exposure to enter the lockdown and is still being impacted today. Q2 window film revenue grew 80 7.8% and represented 16.6% of total revenue. So this is a great result, obviously an all time high on a percent of revenue basis. And the growth there is really broad. So it's not attributable to just any one region. It's truly global for us. The growth is coming from the automotive segment. Our commercial and residential product line continues to grow. It's still a small part of the overall 16.6%. Although we're seeing a lot of momentum there and we had record sales months for that product line in June and then again in July. So that's great and we'll obviously be talking more about that going forward. Likewise, our Fusion ceramic coating products also hit record sales in June and then again in July as we see increased adoption. We have product line extensions planned here for Fusion that will be released soon. And so we'll be talking more about that as well in the future. From a strategy standpoint, like we mentioned in May, we've also reinitiated our acquisition programs, which we did temporarily suspend at the beginning of COVID. We're in a good cash position and intend to deploy some of that cash throughout the rest of the year and further into those strategies both in the United States and beyond. Overall gross margin for the quarter finished at 32.8%, which was down from 35.3% in Q2 2019. That was primarily driven, as many of you are aware by mix from growth from our 200% growth in China and slight revenue decline in the U. S. China represented about 28% of Q2 revenue, whereas it was only 10% Q2 2019. That being said, we also had some downward pressure on gross margin that related to COVID-nineteen during the quarter. Our installation labor from our installation business has also hits COGS. During the shutdown, we continued to pay our team. Obviously, we knew that would have an impact to gross margin, but it's the only way we would operate. We also incurred additional shipping costs related to some strategies around mitigating AR exposure during the beginning of the COVID impact. And then also additional shipping costs really related to meeting the surge in demand once the various regions began opening up in end of May June. We saw nice leverage during the quarter with SG and A, which finished at 18.4% of revenue. It's close to our internal target of 18%. We saw an impact to sales and marketing expenses during the quarter as many planned marketing events were canceled, and we made the decision to temporarily suspend some other marketing activities at the onset of the pandemic. We previously announced last year our intention to add 90 basis points to our marketing spend on an annualized basis for 2020. It's unlikely we will fully spend that this year, although we expect the sales and marketing expense to increase for the balance of the year off of kind of the Q2 number, Q2 run rate. All this resulted in solid EBITDA net income performance for the quarter, which given the headwinds we saw in April was really great to see. While the Q2 momentum has continued into Q3 so far, there's still obviously quite a bit of uncertainty as to the future impact of COVID and the fallout from COVID. China seems to be on firm footing at this point. U. S. Business has obviously turned a corner. Like I said, we question to what extent we're seeing benefit of pent up demand or consumers reprioritizing their spending. These trends will continue to play out, but I would certainly say it's been encouraging so far. As we look over the rest of the year, we're expecting growth in the high teens in Q3 compared to Q3 2019 based on what we're seeing in the U. S. And beyond, recognizing that our China business ramped significantly last year in Q3 of 2019 compared to Q2. Finally, I want to again thank our team for their unwavering commitment to provide exceptional service to our customers. It's been really a very challenging year thus far from an operational perspective and our team's really stepped up. I want to thank all of the operations team who obviously continue to show up and serve our customers day in, day out even during the pandemic. If you think about it, we pivoted from an environment in end of March into April, where we're looking at every way to minimize expense to make sure we're on the best footing to 1 where we have to meet our highest revenue month ever in June, and that's all in a 90 day span. That's been incredibly challenging operationally. Obviously, these aren't jobs that can be done from home. So we really have a bit of gratitude to them on the team. As I've said before, our team is really what sets XPEL apart. Very proud of the effort at every level and every area of the organization during these times. And I'm really proud that we can honor the commitment I made very early on that we would not have any reductions in our workforce as a result of this, even when things looked far more uncertain early on, which we did honor that. So with that, I'll turn it over to Barry. Barry, take it away. Thanks, Ryan, and good morning, everyone. Clearly, Q2 was a very solid quarter for us with revenues growing 19% to $35,800,000 which is the 2nd highest quarter in our history. Included in this was approximately $300,000 in new revenue, net of product sales related to our February acquisition of ProTech Centre in Montreal. And we also had about $200,000 of revenue included in Q2 19 related to our 2019 dealer conference that was out of period. And if you normalize for those items, revenue would have grown approximately 18.5 percent and total revenue for the first half of the year grew 17.1 percent to $64,200,000 Product revenue in the quarter grew 21.8% to approximately $31,000,000 And in this category, paint protection film grew 14.6 percent to $24,200,000 due mainly to the strong performance in China during the quarter. And as Ryan pointed out, our window film product line continued to over perform. Window film ended up being 16.6% of revenue, which again was a record high. Q2222020 service revenue grew 3.8% for the quarter and 13.7% for the first half of the year. And in this category, software revenue grew 4.4% for the quarter and 9.3% for the first half of the year due mainly to increases in DAP subscribers. Cut bank credits revenue declined 21.9% for the quarter and 8.6% for the first half of the year. And as we've discussed in the past, our cut bank revenue is the value assigned to the square footage added to customers' cut bank when they buy our film. And this effectively is just a reclass out of product revenue. And this decline resulted mainly from declines in product revenue in the U. S. Canada, where the cut bank program is more prevalent. And obviously, less cut bank affiliated product revenue means less square footage assigned to cut bank revenue and therefore, less cut bank revenue. Installation labor revenue grew 45.1% for the quarter and 49.8% for the first half of the year. Our total installation revenue, combining product and labor, increased 45.2%, represented 8% of our total revenue. And if you exclude the impact from the ProTech Center acquisition, total installation revenue grew right at 28.3% for the quarter. And this growth is attributable to increase in demand for installed services, primarily in Europe, and that's mainly related to our OEM projects over there. Our U. S. Installed business was flat for the quarter, while our Canadian installed business, excluding ProTech Center, declined substantially, all due to COVID-nineteen impacts. In our training program, which resumed during the second half of the quarter and that continues to ramp up here. Gross margin for the quarter grew 10.5 percent to $11,700,000 And as Ryan mentioned, our gross margin percentage finished at 32.8% versus 35.3% in Q2 2019. Gross margin for the 1st 6 months grew 17.4 percent and represented 34.3 percent of sales, which was similar to the same period last year. And obviously, gross margin can vary from quarter to quarter depending on our distributor direct customer mix, but gross margin improvement remains a top priority for us. Our Q2 2020 SG and A expense was essentially flat versus Q2 2019 and represented 18.4% of total revenue. And for the 6 months ended June 30, 2020, total SG and A expenses were up 16.9% and represented 22.5% of revenue. Overall, we realized about $700,000 in savings from our expense management initiatives in Q2 in response to the pandemic and there was these were primarily in reductions in travel and sales and marketing. And some of this came naturally with the suspension of travel and cancellation of certain marketing events. We also took advantage where we could of government programs in all the jurisdictions where we operate. And this yielded another approximately $200,000 of expense offset. And as we mentioned last quarter, we also elected to defer salaries from members of the management team, which we did end up paying back during the quarter. So as we think about SG and A for Q3 and Q4, we're expecting slight increases to the Q2 run rate as some of these cost saving initiatives are rolled back in and travel and other initiatives resume. Sales and marketing expenses declined 7% during the quarter. And if you normalize for the dealer conference costs in Q2 2019, which were out of period, sales and marketing would have grown by about 18.9%. On a year to date basis, sales and marketing grew 27.3% compared to the same period last year. Q2 2020 general and administrative expenses grew 1.9% versus Q2 2019. And for the 6 months ended June 30, 2020, general and administrative expenses were up 12.5%. And I'll also point out that you'll notice an increase in our interest costs in Q2 for the first half of the year. And this increase is related to interest on the lines of credit that we drew down in late March, early April in response to COVID. And we did pay all the lines back in June. And also, as you may recall from last quarter, we did experience over a $400,000 in foreign currency loss late in Q1 that is reflected in our year to date number on that line item. So we did see some nice leverage in the quarter as reflected in our EBITDA and net income performance. Q2 2020 EBITDA increased approximately $1,300,000 for the quarter over quarter to $5,700,000 reflecting an EBITDA margin of 15.8%. And this was our 2nd highest EBITDA quarter in our history. And on a year to date basis, EBITDA grew 14% and represented 12.8 percent of total revenue. Q2 twenty twenty net income increased 32.1 percent versus Q2 2019 to $4,000,000 and represented 11.1 percent of total revenue, and EPS for the quarter came in at $0.14 per share. On a year to date basis, net income grew 14.7% and represented 8.7% of total revenue. Q2 cash flow from operations was very strong at $11,500,000 buoyed by strong EBITDA performance and changes in working capital primarily related to reductions in our inventory levels. And this was by far a record quarter for cash flow generation for us. We did a nice job managing our inventory levels as we dealt with the rapid increase in demand during the latter half of the quarter, which certainly contributed to the strong operating cash flow performance. That being said, we exited the quarter with lower inventory levels than we like, so we anticipate building that back up as we move through the rest of the year. And we also continue to study our target inventory levels and the possibility that we may be trading lower inventory for higher operational costs. So we'll continue to be looking at that as we move forward. And as I mentioned earlier, we did pay back our lines of credit during the quarter. And you may also recall from our last call, we did close on a $6,000,000 term debt facility with the Bank of San Antonio in May. In total, we have just under $26,000,000 in cash on the balance sheet, and we anticipate that will fund future acquisitions while also providing us the flexibility to manage through any future COVID-nineteen pandemic uncertainty. And finally, I want to echo Ryan's comments regarding our team and especially our operations team. We've done a great job serving our customers and really serving on the front lines there. So, great work on that front. So obviously, great quarter for us, and we're hopeful these positive trends continue as we move through the rest of the year. And with that, operator, we'll open the call up for questions. Thank you. We will now be conducting a question and answer Our first questions come from the line of Steve Dyer with Craig Hallum. Please proceed with your question. Thanks. Good morning, guys, and really appreciate the detail always. So thank you. Just a couple for me. Window fill looked like it really sort of began to inflect in the quarter. So I guess kind of a 2 parter there. As you look forward and through half of Q3, does that feel like there's some catch up in there given it's still a relatively speaking small number? Or is that a number you think you can grow off of? And I guess just as you look at the categories for Q3, would you expect to get to that high teens number sort of similar growth rates of the different categories or is there a deviation there? Yes, Steve. No, good question. I think when we look at that, there's nothing in this quarter that we would say is sort of out of period or abnormal relative to the trajectory on the window film business. So I think we expect that to continue to grow alongside the rest of the business going forward. So I wouldn't I would not expect that there was any catch up on, say, window film for any reason in the quarter that wasn't present for other product lines. I think what you're seeing there is just more and more adoption of the product, both the automotive and the architectural really across the world. And it takes time to win the customers. It takes time to show them that this is a good product. And we're really just seeing the fruits of that now continue to develop. And you make an interesting point. Is architectural starting to be a more meaningful piece of that mix or is it still quite a bit of Yes. No, it's like we mentioned, it's still small, but it's becoming more meaningful. And we expect to talk more about that and have a number of investments and other things planned. But we did see record sales for the architectural in June and then another record in July. And really with any new product, that's sort of what we expect because it does take time to win new customers, allow them to evaluate it and then sort of build on that. So I think while the automotive window film has been in our product portfolio for several years now, it's not surprising to me at all that we really see that continue to grow now, as opposed to say winning all the business when we initially launched it. And I think we'll see similar thing with the architectural film and then the other products we've got. That's helpful. And then as you look towards the next quarter, you gave very good granularity and maybe I missed this, but just as it relates to gross margin, how should we think about China mix in Q3 relative to Q2? Yes. I think our sense is that the China mix is going to be very similar, maybe slightly less in Q3 than Q2, but we don't expect a big substantial swing one way or the other. So it's probably comparable or slightly less is overall percent. Got it. One more for me and then I'll turn it over. As you talked a little bit about M and A, as you think about that, is sort of your strategy the same, which is smaller installation centers? Or is there any deviation? Would you look to go bigger? Would you look to do product extensions? Any sort of change of plans there at all? Well, I think we're open to bigger, but in our space, bigger is a bit harder to find. So there aren't a lot of prospects there. Product line expansion is always a possibility, but we've got this great portfolio of products now that we really need to expand and double down on. So if it was product related, it would probably be more built around something we're already doing. So I think more than likely that sort of leads us to our bread and butter sort of channel strategy, which is installation and then distribution in country in other countries in which we want to operate directly. Got it. Okay. Nicely done, guys. Thanks. Thanks, Steve. Thank you. Our next question has come from the line of Jeff Van Sinderen of B. Riley. Please proceed with your questions. Good morning, everyone. Let me add my congratulations on the strong metrics for Q2. I know you touched on this a bit in your prepared comments, but any more color on how you're thinking about how much of the rebound is pent up demand? I guess what you're looking at there to determine that and how sustainable you think the growth rate that you've experienced is going forward all else being equal? Well, I think we're looking at it kind of 2 ways. We're trying to look at it, say how is the automotive business performing in the countries in which we operate And then how long lasting and durable has that been? I mean, you've seen in China where you had relatively good sales numbers many months now as opposed to say, one really good month following opening up. And then I guess to a lesser extent, we're looking at is it we seeing pent up demand solely from customers of ours that had lower inventory during the pandemic. We sort of alluded to that fact for Q1 where we saw our DAP usage trend higher than our film purchasing suggesting there was a bit of a destock with our customers. And that may very well have happened, but given how little inventory most of our customers carry, I think it's pretty negligible. So at this point, I think we feel pretty strong that we're seeing something that isn't just a rebound to satisfy that pent up demand. I think there in the world we're in today, there are a lot of factors, while many of them anecdotal, but there are a lot of factors that I think are driving car ownership and driving a lot of the things that would ultimately help our business. So that's but that's really all we know. If we one of the concerns has been, particularly in the U. S, inventory levels at new car dealerships have been really low. Would that impact the business? We sort of thought maybe if it would, We'd see that in July, didn't really see that, saw really good results in July as well. So knowing the limits of what we can know, we feel pretty encouraged that we're not just satisfying a month or 2 of demand for when things were shut down. Okay, good to hear. And then I know you mentioned kind of how you're thinking about acquisition targets, but just wondering are you seeing or you sensing that maybe opportunities are improving around acquisitions given the current environment? I would say so. I think this process, whether you're someone in our industry or us, it exposes your vulnerabilities and weaknesses. And I think that when you look at the profile of the type of acquisitions we look at, I think that point has been acutely made to a lot of people. So I think that that does help us in that process. We had talked earlier that we kind of had a hard time closing some of the deals we were looking at because we just thought the valuation was not meeting our criteria coming into this. So I think we're a little bit optimistic that's going to help us open that up. But that will be proven out really over the rest of the year, if we're right about that. Okay, good. And then just one more for me if I could squeeze it in. How should we think about your marketing plans for second half? Well, we proactively cut a number of things at the pandemic onset as a lot of companies did. And then we were also subject to a lot of canceled activities relative to our event marketing, which is a pretty big component of our marketing. So we had kind of things we decided to curtail and then things that were just curtailed on us. I think we're many of the events that we would look at in the second half of the year have been canceled. So those are expenses that we're probably not going to have. On the flip side though, some of the other digital marketing and other things that we do that we may have curtailed, we definitely either have resumed those or will resume and expand upon those. So we're definitely going to see an increase from the first half run rate or more specifically, probably the Q2 run rate, but I don't think it will meet the expanded amount we talked about last year wanting to really drive kind of that 90 basis points increase in total spend. I don't think we'll meet that for the year. Just really because in many of the ways we spend the money, we just literally can't. Got it. Thanks for taking my questions and continued success. Thanks, Jeff. There are no further questions at this time. I would like to turn the floor back over to management for any closing remarks. I'd like to thank everybody for joining us. Thank you for your time and we look forward to speaking with you next quarter. This does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation and have a great day.