Welcome to XPEL Technologies third 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. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. I would now like to turn the conference over to your host, John Nesbett of IMS. Thank you. You may begin.
Good morning, and welcome to our call to discuss XPEL's financial results for the 2017 third quarter. On the call today, we have Ryan Pape, XPEL's President Chief Executive Officer, and Barry Wood, XPEL's Chief Financial Officer. Prior to this call, we'll make certain forward-looking statements regarding XPEL Technologies Corp. and its business, which may include, but not limited to anticipated use of proceeds from capital transactions, expansion into new markets, 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, as expected, expect, schedule, intends, contemplates, anticipates, believe, proposes or variations, including negative variations of such words and phrases or state that certain actions, events or results may, could, would, might and will 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 specific 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 risks 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're made. XPEL undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future results or otherwise. Okay. With that, I will now turn the call over to Ryan Pape. Go ahead, Ryan.
Thanks, John, and I'll extend my welcome as well to our third quarter earnings release call. As you probably guessed from our press releases and news the past couple of days, it's been a very active quarter for the company. I think as we talk about some of the other things we're working on, you'll see that's existed for quite some time through the quarter. We had a great, you know, record-breaking quarter, third quarter revenue growing 31.6% to $17.8 million. Obviously, I'm very pleased with our top line numbers. It puts us back in a range that we're happy to be and, you know, as we continue to execute on our get close to customer strategy. We continue to see strong growth across all our product lines, see increasing demand internationally, particularly in Asia.
As we've discussed in the past, our export sales are primarily sold through distribution partners where margins are lower, and that trend's kind of been true across the board. We've seen the strongest growth in all the markets that have lowest margin, either due to distribution, as I just mentioned, or currency. If that's Asia through distribution, we've had a 30+% growth in Canada, that's obviously FX impacted lower margin. Our European business is doing well and that's FX impact there too. That's been true all year, and it's still true in Q3.
To the extent that this impacts our sales mix, a higher percentage of our sales at lower margins for either of those reasons, our overall gross margin will be impacted, and that was certainly was a contributor to our Q3 gross margin degradation. That said, we have a number of promotional pricing agreements that were established, particularly for some of these export customers and international customers, either due to currency impact or as a result of the supply challenges we had in 2016. These are starting to roll off in Q4, and that will continue to happen going into the beginning of 2018. That'll be a net positive to gross margin.
These tend to be some larger accounts, and if they're international or moving volume, they have particularly aggressive pricing for one reason or another. We're gonna see some positive momentum on that the rest of the year and next year. We've also made a change to our DAP software pricing. As most of you know, our DAP database has 70,000+ patterns, and it's a huge differentiator and driver of our business. You know, it allows customers to install our paint protection film efficiently with less waste. We've changed our DAP pricing in the U.S. and rest of the world segment to incent and better reward customers who use our film. You know, put simply, the customers that buy our film pay a lower DAP price than those who don't through our cut film program.
These changes resulted in some reduction in our access fee revenue, about $70,000 in Q3 over Q2. That's our highest margin revenue stream. Obviously you feel that, but we've created a much more streamlined and manageable go-to-market strategy in the U.S. and rest of the world. Ultimately, even in spite of that, we expect to fully recover all that DAP revenue over time. It's drastically simpler to implement and drastically easier for our sales team to manage. We felt that this quarter, but there's a great streamlining effect there. We're also in the process of launching a next generation film, Ultimate Plus, which provides easier installation for our installers along with some of the enhanced optical properties we've been introducing over the past year.
As a result of launching that and with corresponding price adjustments, we expect to see a positive margin contribution from this change in the US market and in some of the international markets starting in January. That's a good thing. We have plans to streamline our PPF products mix going forward into 2018 to reduce the number of SKUs. Fewer SKUs creates greater efficiency, higher inventory turns within each product line. This started in Q3, continues into Q4. We picked up a few low margin sales in Q3 as we work some of these product lines out, and just as an incentive to move them. A portion of that one-time COGS expense in Q3 was related to writing off some of these remnant products or versions of products we decided not to otherwise commercialize.
I think that we'll see a little bit more of that in Q4, and that was in addition to some of the other changes. Operationally, we've made significant changes during the third quarter, and these will have a positive impact on future results. We consolidated our warehouse operations from three facilities to one in San Antonio. Obviously, there was cost to do that, and really one-time COGS and SG&A to do that, majority in Q3. Some will be in Q4. You know, as you're going through that process and also trying to reduce SKUs, it's just a natural time to clean up inventory and get rid of if there's damaged product or obsolete product.
We feel some of that, but it's a substantial savings long term and a tremendously increased efficiency. In Q4 already, we've eliminated a fourth facility we had in San Antonio, where we did a few other things, including our window film training. We've been able to move that into our headquarters operation now that we've freed up space. We've sort of drastically simplified the footprint here, which is good for cost and efficiency and everything else. As a result of the consolidation, we expect to realize, you know, significant efficiencies on our processes, resulting in lower costs on a go-forward basis, which will have a positive impact on gross margin.
I think it's important to remember that we have significant other costs, more than cost of materials that make up our cost of goods sold. Managing those costs is an important factor. We've reduced our production team significantly in October as a result of the efficiencies from the facility consolidation. This is a savings to COGS going forward, net of severance costs related to that. You know, we're talking 15+ people involved in that. These are major changes we've made. We also restructured our sales and operations team during the quarter, which we believe will better position us to scale in a more efficient manner. As a result of these moves, we've incurred some one-time costs related to severance, relocation, and recruitment.
This impacts our bottom line in the short term but have a significant impact to the business going forward. These costs were approximately $140K for the quarter, and that's separate from personnel changes that impact COGS, so the production expense. This is in addition to that. You know, I can't really overstate the magnitude of changes we've made internally. It's not like anything we've ever done before. We've also been able to integrate some of the folks from our acquisitions in key positions going forward. I think, you know, these acquisitions, aside from, you know, growing the business and all the other benefits from them, they really help develop the future leaders a great reputation in Boise area for high-quality service. They're the leading operator in the area by far.
We think consistent with the strategy, this lets us capitalize on that growing market, and it has really favorable characteristics and a great market for these products. You know, can we support more in that market? Probably we can. Now that we're in control there, we have the ability to do that. It's really a test of, does our get-close-to-the-customer strategy, does our ability to operate in the market actually increase the addressable size of the market? That's the key question for Boise, Idaho, and I think the answer will be yes. We're excited to see that play out over the next year. Yesterday, we announced our intent to acquire 100% of Protex Canada, a top franchisor of paint protection and window film in Canada.
They have over 75 franchise locations in four provinces. You know, the Protex franchisee, since we acquired Parasol in 2015, they've been a great customer, and we've had a five-year exclusive supply agreement where all the franchisees have to purchase these products from us. Protex has a revenue stream of royalties from franchisees, as you might expect, on sales, and then a rebate from XPEL directly . We would remit a royalty back to Protex as the franchisor. You can imagine that that rebate is particularly costly for us in a low Canadian dollar environment where we've been due to US dollar product costs. You know, Protex network has been growing their sales at a substantial rate, so the net effect of the Canadian dollar plus the rebate is substantial.
The net effect of that combined, you know, really amounts to another situation where we have a relatively low export type margin. In addition to the strategic nature of the acquisition, this will also positively contribute to the overall gross margin position. You know, in addition to that, obviously it de-risks the revenue we currently receive from the Protex franchisees continued growth. We've got a dedicated management team there, and, you know, we intend to support them and help them. We also want them to run the business because they need to stay and be 100% for the Protex brand outside of Canada. Doesn't mean it won't happen, but it's not on the radar at this point.
Overall, I think, really a great deal for us, really helps us in a lot of ways. Long term will bring a lot of efficiency where we can leverage some of the back-office teams for finance and accounting. Important to remember that, you know, as Protex, we're buying really a high margin revenue stream. If you wanna think of it as an acquisition and we're offsetting hit the COGS, if you don't think of it that way. All in all, really good, really happy to do that. I think as you could see, third quarter was pretty transformational. You know, like we said, we're pleased with the top-line growth. I think the opportunities for revenue growth continue to be strong as we go forward.
Where I think we do good. I think we'll continue to do better. Overall, really a good quarter for us. With that, I'll turn it over to Barry, and we can dig into the numbers some and then take some questions. Barry?
Thanks, Ryan. Good morning, everyone. Before I get started here, I FRS measure and reflect the current period's results as if we were using the prior comparative period's exchange rates. For the quarter, revenues increased quarter. It was a record-breaking quarter for us as where our previous quarterly record was $17 million, which happened in the second quarter of this year. As Ryan also mentioned, growth was strong across all of our major product lines. Our window film product line represented 10.3% of total revenue for the quarter and 8.5% of year-to-date revenue. On a year-to-date basis, revenues grew 23.4% to $47.5 million. Gross margin for the quarter versus Q2 2017, which came in a little above 27%. This degradation was due to three main factors.
First, as Ryan mentioned, the increasing mix of export sales. Secondly, as Ryan also mentioned, we recorded some write-downs of inventory as we prepared for the consolidation of our warehouse facilities and also the product consolidation. Lastly, we saw obviously some margin degradation due to the debt pricing change Ryan referenced earlier as higher margin software revenue was replaced with lower margin product sales, albeit for very good business reasons. The combination of these three items accounted for the margin degradation we saw in Q3, especially relative to Q2 2017. We see this margin degradation as an aberration and expect to. The warehouse consolidation and the product consolidation gross margin win would have been right around 27%. The impact on that was significant.
This year to date, margin degradation was due to, you know, supply overhang issues we discussed during our Q1 earnings call and also the Q3 items that I just mentioned. On the SG&A front, SG&A expenses for the quarter increased 37.7% versus prior quarter and 39.2% on a year-to-date basis. While we continue to invest in the business in Europe and in other areas to build scale, we did incur, you know, one-time costs related to the restructuring of our staff that Ryan mentioned totaling about $140K. Also, as we've noted in prior quarters, effective January 1st, we changed our method of depreciating our fixed assets from the double declining balance method to the straight-line method.
As we stated before, this change was made to better reflect how we consume the future benefits of the assets. This change accelerated depreciation of some of our older assets into 2017, and the impact of this will lessen significantly beginning in 2018 and beyond. The impact of this change for Q3 was about $90K. Represent about 18.6% of total sales, which we think is more reasonable given our continued investment to scale the operations. Again, while we're pleased with our progress thus far, we'll continue to focus on SG&A and invest where appropriate in order to maximize operating leverage. Another item. Staff our European operations, which is obviously significant.
You know, now that we kind of have the plumbing built there, you know, our rate of SG&A growth will certainly reduce as we move forward, and we'll continue to gain operating leverage as sales continue to ramp up in that region. EBITDA for the quarter decreased $0.4 million- $1.2 million and decreased to $1.1 million- $3.2 million on a year-to-date basis. The Q3 decrease was due mainly to the gross margin degradation discussed earlier, as well as the SG&A increase. If you factor out our non-recurring items that would impact EBITDA would have been $1.9 million for the quarter or a 24% increase over the prior year. Net income for the quarter decreased $0.28 million versus prior year quarter, finishing at $0.44 million.
On a year-to-date basis, net income decreased to $1.3 million. On a constant currency basis, net income was $0.43 million for the quarter and $1.12 million on a year-to-date basis. Net income, if you factor in our one-time adjustments, would have been right at about $1.1 million, a 35% increase over the prior year. Operating cash flow for the quarter turned slightly positive as we completed our planned inventory build up pursuant to the execution of our strategy to place inventory closer to our end customers. On a year-to-date basis, our net cash used in operating activities totaled approximately $3.5 million, due again mainly to the outflows related to our planned inventory buildup.
Our inventory turnover for year-to-date 2017 was about 3.0 times versus 3.8 times in prior year-to-date period. Our balance sheet continues to be very strong as evidenced by our liquidity ratios and our debt equity ratios are continue to be optimized. We accomplished much in Q3 and, you know, we think we're turning in the right direction to set us up to scale efficiently in the future. While we're pleased kind of with our progress thus far, you know, we know we still have a lot of work to do and we'll continue to get after that. With that, operator, we'll now open the call up for questions.
Thank you. We will now be conducting question and answer session. If you would like to remove your question from the queue and for participants using speaker equipment, it may be necessary to press the star key. Lift the handset before pressing.
A question about the Protex acquisition. Can you just explain kind of what system-wide-?
Sure, Alan. good to hear from you. I think when we haven't released the revenue number for Protex, but, you know, it's relatively minimal when you consider that their revenue stream is royalties and rebates from us. It's not an overall material amount. I think that, you know, they have a great presence in Canada, have done exceptionally well. You know, particularly in Eastern Canada, there's brand awareness around the Protex name like you don't see in very many places. Well, fundamentally, our goal is to sell product, and that's a key goal with the Protex opportunity as well, as opposed to some where, you know, primary goal is to sell franchises. We obviously want to expand the network there, and we will, and that's actually happening.
We wanna do it and be smart about it, because we have, you know, other incentives than just advancing the number of franchises via the product sale. It's gotta be good for everybody. I think that what it represents in Canada and where it exists is, you know, it's another option for customers who are looking for, you know, that extra level of support, the team on the ground to help and an identity and a product mix that is, you know, locked and set. It works exceptionally well there, and it will continue to do so as we grow it in Canada. You know, if you believe it works well there's certainly other places where it could work well too.
That said, you know, it's been existing in one form or another since, you know, the late 1980s, early 1990s in terms of predecessor companies in Canada. There's a lot of history there, and it doesn't represent that we think, you know, there's a shift to that model or anything elsewhere. It's certainly another tool in our, in our arsenal and one we'll continue to look at.
Okay, great. Thank you.
Thanks, Alan.
Our next question is from Adam Goldstein, private investor. Please state your question.
Hi, guys. Congratulations on the revenue growth this quarter. That was excellent. Any, would you say that kind of momentum is continuing into the fourth quarter or not?
Yeah, I think, you know, You know, was strong in the third quarter, and we expect strong revenue growth to continue.
Okay. I got a question about how the accounting works for Protex before they were acquired. You mentioned rebates. Were the rebates accounted as a decrease in net revenue for XPEL, or were they accounted for as an increase in COGS?
Hi, Adam. This is Barry. They were accounted for as an increase in COGS for us.
Okay. It would seem that we You know, as Ryan mentioned, it seems like that would cause an improvement in gross margin, but As you were saying, the revenue stream is immaterial, I guess we really shouldn't see an effect on gross margin then?
No, I think, you know, as you stated, Adam, with the accounting, you know, the net effect of that rebate and the consolidation, you know, there will be a net effect to COGS on that. I mean, relative to Or a positive effect rather. You know, relative to the overall picture, you know, that's not insignificant, but you're still in a, you know, low Canadian dollar environment. You have these other factors which drive it too. The net effect is that over the next year and into the future, that will be a positive contributor there. You know, the cost in SG&A that you pick up with Protex is, you know, more fixed than the rebate we pay, which scales directly with revenue.
As that operation has grown over time, you know, they've been able to pick up the efficiency of more fixed SG&A, but increasing revenue in the form of the royalty from us and the rebate from us and the royalty from franchisees. Our expectation would be that we get the benefit of that going forward now and fully expect to.
Okay, great. My last two, I guess they're kind of requests. I wonder if you'd consider improving the disclosure a bit on a couple of things, about rest of world separately, so we could understand the business a little better.
Yes. That's something that's under review now for next year.
Okay, great. One more thing, on disclosure. Especially as you guys continue to do acquisitions of installers, it would be interesting to see how XPEL's business breaks down in terms of installation business versus, you know, the whole-
Associated costs from the installation side. you know, this geographic component, so it needs to be, you know, the proper metric for dissemination. It turned into a tremendous success on the product side because we were able to unlock the market and bring on a lot of new customers. I wouldn't be unhappy with that. From that standpoint. When we're looking at it, we're increasingly looking at it as a P&L by market for the folks we have managing it. Our direction to our team for the Boise market, same as a Las Vegas market or Houston market, is that we want you to drive performance of this market using everything we have at our disposal, which is service revenue and product revenue.
Ultimately, we're not sort of internally biased to how that should be. The reality is it doesn't tend to go one way or the other. It will end up as a mix. I think that, you know, looking at the service revenue component going forward probably does make sense. Ultimately, what we're trying to do is create, you know, geographic centered accountability for our team operating, whether it's a region or a local market, and giving them the sort of tools and some of the autonomy they need to run that market best based on the type of customers in the setup. You know, I definitely understand your point, and I think that folds in with the geographic reporting.
You know, it's certainly, I think, a challenge even for us with access to all the information, 'cause you've got a lot of competing things and a lot of different ways to win. Certainly understand your point.
Okay. Well, just one revenue is higher margin than the product revenue. Like, if, I'm just dollars they spend. I guess I'm guessing.
Yeah
of those dollars that go to the product is kind of small compared to the overall paint protection.
Yeah, I think what you're saying is that, you know, for us in aggregate, on the service revenue of installing the product, we have a higher gross margin on that and higher revenue dollars per car, both, than we do when we sell the product. I think that's accurate. Now, the difference in those type of operations is you've got facilities, you've got different personnel expense, so you have a higher fixed cost probably for that incremental revenue too. You know, if you were a marginal operation or a marginal time of year or a bad month or whatever you say, you know, you've still got a hurdle rate to go through for your fixed cost. The dynamic there is a little bit different.
Overall, I think you're correct that we see a higher gross margin from the installation business than we do product sales business and higher revenue per vehicle. That's correct.
Okay. All right. Great. It does I mean, that is a great reason then to sort of disclose that better so that we can see those two types of revenues. All right, that should do it. Thanks for taking my call.
Okay. Sure. Thanks, Adam.
I'm a longtime shareholder, I appreciate the primary focus to increase sales and decrease cost of goods. I've got two questions. One, are you paying in stock in it for any of these?
Hey, Max. Good to hear from you. No, these are cash, and they tend to have a significant seller finance component over a number of years.
Okay. I asked that in anticipation of my second question. I find that your website is absolutely atrocious. I hate to say that. If you go to your website, I cannot find who the corporate officers are.
Yeah
corporate directors. I think that being the first, you know, thing that somebody would look at at your company, needs vast improvement. I'm just wondering if you're going to take a look at it. I don't know how potential investors would look at this company when they can't get information, and it's been frustrating. I've asked this question many times. three or four years ago, I asked if you guys are gonna go to the US market. Do you have any plans in that regard to get off the Canadian market? I think it would be a benefit to you to improve the share price significantly if you told the story much better. I don't know if that's a question or a comment.
Yeah. Well, I think, you know, all the feedback is good. I think, as far as I know, last I checked, the management team and directors should be listed on the website. If that's not there, we'll certainly take a look at that. I think that, you know, first thing, first story I wanna tell on the website's about the product, not about the company. Understand that's me operating from a different perspective than you are, but your point's well taken. I think we can, we can look at that and probably dress that up substantially.
I think that, you know, we've talked about it before. Long term for this company, it makes sense to list in the U.S., having the resources to do it, along with 1,000 other things, and stacking that up with all the competing priorities that we need to make the business better, and grow the business and all the other things. I think there's a unanimous agreement that that's in our future, and that we're going to do that.
Okay. Thank you.
James, are you there?
Good morning, guys. Can you hear me?
Morning, James.
Okay. Yeah, my question is just about, you know, you made the Protex acquisition, you're streamlining the SKUs, obviously this is gonna be, you know, fairly different business kind of in the near future here going forward. In order to make those decisions that you made, you must have some view on what this is gonna do incrementally to gross margin. I was wondering if you, if you have a view of where gross margins go from here, you know, for 2018, 2019. Yeah, that's my question.
I think that, you know, the hardest area for us to forecast is where is the growth and where do we see the growth? The reality is that, you know, if you look at this year, we have Canada growing very nicely, unlike the previous year where it was growing slower. We have Europe growing nicely, and we have Asia and China growing very nicely. They're all three growing faster than the U.S. in the past several quarters. If that continues or the rate of growth there continues, you obviously see a lower margin contribution than you would in the U.S. business, aside from, you know, the ability to raise prices in those markets or gross margin. Certainly, the Q3 adjusted gross margin, which looks a lot like Q2.
You know, we're trying to get to the, to the point that, you know, that's the absolute floor, and we're moving in the opposite direction. You know, our sense is that, through the pricing adjustments and some of the contractual adjustments we are doing, the changes six months, that, you know, we're gonna be in a position to see gross margins begin to increase into, you know, end of this year, beginning of next year. That's not just from pricing and mix and Protex. It's from things like, you know, optimizing our production costs, which is, you know, the changes that we've made there, you know, may be worth a half or a point of COGS for the year if they were annualized. There's lots of ways that impact that.
To say, where's it gonna be for 2018? You know, I can't tell you what it's gonna be. I do know for given customers and given regions that we're making improvements there where it was and where it'll be. I don't know the mix, what the mix is gonna be next year between U.S. growth and China growth. I'd love to be able to forecast it, but, you know, we get very limited information to be able to do that. That's gonna be the ultimate driver of the, of the consolidated gross margin.
Do you guys have an internal target that you use to make decisions, like, of where you think?
Yeah. Well, but we have targets by segment. I have a target for Europe, I have a target for Canada, I have a target for China, and I have a target for the U.S.
What I don't know, I have a guess on the mix, right?
Ultimately, I don't get to choose the mix. The question, what it, in practice is saying, "What is our market price? What does our sales price in Canada need to be relative to the market, relative to the competition? What does our price through distribution need to be to China to be competitive and allow our distributor to make a margin?" Those are the things we can control. How well each of those perform relative to one another, we can make a guess at it, to a certain extent, we're along for the ride.
Okay. I don't wanna beat this too much, but I'm gonna ask just another part on gross margins here. Do you think, you know, it's more reasonable to expect the gross margins that we experienced in Q3 here? Or do you think it's more reasonable to expect something closer to what was observed in 2016?
No, I don't think Q3 as a go forward is what we're expecting. We're expecting to move back to sort of 2016 and hopefully beyond that as we work through all these initiatives.
Okay. Perfect. My last question, kind of relates to your response to my first question is, and you mentioned again is that your priority has continued to be, like the top priority is revenue growth. I'm wondering if you could just outline again why you see that as your top priority, and then if you ever see yourself shifting to be more conscious of margins and having that as a top priority.
Well, I think that, you know, focusing on growth to be a growing company and grow a company to a certain scale, is certainly a well-understood concept. I mean, we could maximize our gross and net profitability as a $50 million a year company and hop along like that. That certainly doesn't come close to satisfying my vision for this company, nor I think what, you know, all shareholders can realize if we grow. Yes, you have, you know, gross margins and the incremental gross margin on a given sale and what that does to your aggregate, but you still have the net margin of the business, which even a low gross margin sale, theoretically contributes to that net margin as your, as your overhead costs are fixed.
I could tell you my salary hasn't increased with sales from $3 million in 2009. Wish it had. All of those things are opportunity, and it really depends what kind of company do you wanna become. For me, we can become a much larger company, which ultimately generates a lot more net operating margin. If that means we accept lower margin sales to China or lower margin sales to Canada due to FX in the meantime, I think that's great because all of that pays dividends over the long term as you raise prices, lower costs, and keep your operating expenses, expense growth constrained.
Okay, perfect. That's all for me. Thank you.
Yeah. Thanks, James.
Our next question is from Jason Hirschman, private investor. Please state your question.
Hi, Ryan. Hi, Barry. Thanks for providing some clarity around the restructuring charge and all those changes going on in XPEL. It's impossible to keep up practically. Got one question for you on margins, and then I'll move on to a wholly different topic. You mentioned in your commentary that there's some pricing contractual agreements for overseas markets, or I think you said rolling off in the next few months. Are they going to be reset to a new level, or are you implementing a completely new pricing approach for those contractual agreements?
No. I mean, put simply, there are some key customer concessions that were made in 2016 due to limited inventory availability when we had our supply issues. With some of those key accounts, it's pretty simple. The price is going up, and they tend to be low margin accounts, or low margin sales, those have sort of an outsized impact for that customer base.
Are you increasing expenses and investments in these installers that are temporarily driving down profitability or even all the way to breakeven and so that you can sort of spur them for faster growth?
Well, I wouldn't say that's true on a location-by-location basis, but it's sure true just with the aggregate investment we're making in the business. I mean, if we bought the Protex business, for example, and then simultaneously we've established a window film training center that's got people dedicated to it. You know, that has the net effect of probably muting the net contribution from that acquisition, as an example. I don't think that the investment that you speak to is necessarily happening at that to eat up any incremental margin from that business directly. I think it's not tied to that, but tied to just the other initiatives and things we're doing.
It looks to me, just looking at the numbers, that, you know, the gross margin issues are just purely because of mix, you know, between different geographic regions, you know, mostly whether it's in China is lower margin, let's say. The SG&A investments or higher SG&A is because of investments made in Europe, and in the U.S., in your, you know, sort of like direct markets. Is that a fair characterization?
I think that's accurate. When you look at the installation businesses as well, you know, if we were to acquire and then consolidate installation business, you know, there's a portion of that that is COGS, be it, you know, labor required to install the products. That's COGS. You have really businesses that per revenue dollar versus selling a roll of film, you know, have a higher SG&A component per revenue dollar than selling a roll of film does also. Be it a facility, an electric bill, things related to facilities and premises. That results in, you know, higher SG&A expense for those facilities, but that's really should be offset with higher gross margins from the installation business.
I think, you know, you're right in that, you know, as Barry talked about, I mean, close to 30% of our SG&A increase in Q3 is related to the European operation. That's, you know, that's huge, and that's substantial. You know, we've made a major investment there, and that business continues to develop. You know, that business by itself, like us overall, you know, they've gotta go grow through that cost structure. They're growing through that cost structure in an environment of, you know, the bad FX condition too. You feel that. You know, you do that, and you do a few other moves investing in the US business or the corporate side and, you know, that's where that SG&A growth is driven from.
You've introduced a brand new PPF film in China called, and I'm gonna try and say this with some emphasis, ZEUS, also an improved ULTIMATE PLUS in North America. I think these films are modestly higher priced than, you know, LUX PLUS in China or ULTIMATE in North America, right?
Yeah
How are they doing?
No. Yeah. We've got an additional product in China that is higher priced that's, you know, we're only two months into that. That's doing well. That's contributing to sales growth there. You're correct in that, in that is a higher margin product that was added. The ULTIMATE PLUS in the U.S. is really the next generation of the ULTIMATE film, and that'll coincide with some pricing adjustments there. We think it's actually quite an improved product in terms of installation characteristics. You know, it's important when you think about the product, everyone thinks about what does a consumer think of the product and, you know, that's very important. Consumers think about, you know, and sometimes the installers are telling the consumer what product.
If you can, if you can bring a solid win to the installer, that's tremendous. That's what, with the ULTIMATE PLUS and the changes we've made to make it easier to install, that's really who that's, who that's geared towards.
Finally, any initial thoughts or reflections on the flat glass business? Is this going to become like a window tint size business or is there any guidance you can give us just about the quality issues?
Yeah. Just to recap so everyone knows what you're talking about. A component of the window film business that we've launched is a flat glass or a commercial and residential film business. You know, this is attractive to us for a couple reasons. Is in terms of addressable market size, it's very large. It gets us over time exposure beyond automotive, which has always been a, you know, sort of tertiary priority for the business. Then we have a built-in, ready-made way to access that additional line via some of our existing customers. That product line is brand new for us. We've just started some of the initial announcements and sales of that. We certainly, over time, have very high expectations for that.
You know, if you look at our 10%+ of revenue as window film today, the vast, vast majority of that 95%+ is, automotive film. To expect that over time on the commercial and residential side, you know, we can build a substantial business there, that's what we expect.
Okay. Well, I appreciate the all the answers and thanks for all the hard work.
Yep. Thanks, Jason.
Our next question is from Meredith Brill with Brill Capital.
I was wondering if you could give some information about the timelines of the rollout in the U.S.
The ULTIMATE product over this past year and then this, you know, final change which adjusts the installation characteristics, that's sort of the most substantial change to the installer. Some of the other changes, you know, benefit installer and consumer alike. We've started selling that product to select customers over the past 60 days. And then in December and into January, we're gonna be pushing hard to roll that out and work towards moving, you know, many or most of the customer base in the U.S. over to that product.
Okay. Canada as well.
Canada as well, yes.
Yeah. Okay. Is that concurrent with some sort of price adjustments or?
Yes. Yeah. That will be for most customers, at a higher price, which will increase the margin on that product for us.
Okay, great. You're gonna keep, I'm assuming, the ULTIMATE just as a backup until everyone sort of migrates.
Yeah, we are. You know, it'll be somewhat based on customer feedback, how that coexists and what the timeframe is. You know, we've got a real initiative to simplify the number of SKUs. You know, there's.
Right
the ULTIMATE product which we all talk about, but then we've got essentially, four or five other products that we sell, different product in China which is even a further different product. We have to be real mindful of that. The goal is to probably transition that completely at some point. You know, we'll wait and work with the customers and see how that goes over the first couple months of next year.
Okay. Vic, thank you very much for taking my call.
Okay.
Thank you.
Thanks, Meredith.
Ladies and gentlemen, we have reached the end of the question and answer session. I would like to turn the call back to management for closing remarks.
Thanks everybody for the questions and for your participation. We'll talk to you next quarter.
Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.