XPEL, Inc.: Form 10-Q for the period ended Mar 31, 2023

This Management’s Discussion and Analysis provides material historical and prospective disclosures intended to enable investors and other users to assess the financial condition and results of operations of XPEL, Inc. (“XPEL” or the “Company”). Statements that are not historical are forward-looking and involve risks and uncertainties discussed under the heading “Forward-Looking Statements” in this report and under “Business," "Risk Factors,” "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Financial Statements and Supplementary Data" in the Annual Report which is available on the SEC’s website at www.sec.gov (http://www.sec.gov).

Forward-Looking Statements

This quarterly report on Form 10-Q contains not only historical information, but also forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are subject to the safe harbor created by those sections. In addition, the Company or others on the Company’s behalf may make forward-looking statements from time to time in oral presentations, including telephone conferences and/or web casts open to the public, in press releases or reports, on the Company’s internet web site, or otherwise. All statements other than statements of historical facts included in this report or expressed by the Company orally from time to time that address activities, events, or developments that the Company expects, believes, or anticipates will or may occur in the future are forward-looking statements, including, in particular, the statements about the Company’s plans, objectives, strategies, and prospects regarding, among other things, the Company’s financial condition, results of operations and business, and the outcome of contingencies, such as legal proceedings. The Company has identified some of these forward-looking statements in this report with words like “believe,” “can,” “may,” “could,” “would,” “might,” “forecast,” “possible,” “potential,” “project,” “will,” “should,” “expect,” “intend,” “plan,” “predict,” “anticipate,” “estimate,” “approximate,” “outlook,” or “continue” or the negative of these words or other words and terms of similar meaning. The use of future dates is also an indication of a forward-looking statement. Forward-looking statements may be contained in the notes to the Company’s condensed consolidated financial statements and elsewhere in this report, including under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Forward-looking statements are based on current expectations about future events affecting the Company and are subject to uncertainties and factors that affect all businesses operating in a global market as well as matters specific to the Company. These uncertainties and factors are difficult to predict, and many of them are beyond the Company’s control. Factors to consider when evaluating these forward-looking statements include, but are not limited to:

• Our business is highly dependent on automotive sales and production volumes.
• We currently rely on one distributor for sales of our products in China.
• A material portion of our business is in China, which may be an unpredictable market and is currently suffering trade tensions with the U.S.
• We must continue to attract, retain and develop key personnel.
• We could be impacted by disruptions in supply.
• Our accounting estimates and risk management processes rely on assumptions or models that may prove inaccurate.
• We must maintain an effective system of internal control over financial reporting to keep stockholder confidence.
• Our industry is highly competitive.
• Our North American market is currently designed for the public’s use of car dealerships to purchase automobiles which may dramatically change.
• Our revenue could be impacted by growing use of ride-sharing or other alternate forms of car ownership.
• We must be effective in developing new lines of business and new products to maintain growth.
• Any disruptions in our relationships with independent installers and new car dealerships could harm our sales.
• Our strategy related to acquisitions and investments could be unsuccessful or consume significant resources.
• We must maintain and grow our network of sales, distribution channels and customer base to be successful.
• We are exposed to a wide range of risks due to the multinational nature of our business.
• We must continue to manage our rapid growth effectively.
• We are subject to claims and litigation in the ordinary course of our business, including product liability and warranty claims.
• We must comply with a broad and complicated regime of domestic and international trade compliance, anti-corruption, economic, intellectual property, cybersecurity, data protection and other regulatory regimes.
• We may seek to incur substantial indebtedness in the future.
• Our growth may be dependent on the availability of capital and funding.
• Our Common Stock could decline or be downgraded at any time.
• Our stock price has been, and may continue to be, volatile.
• We may issue additional equity securities that may affect the priority of our Common Stock.
• We do not currently pay dividends on our Common Stock.
• Shares eligible for future sale may depress our stock price.
• Anti-takeover provisions could make a third party acquisition of our Company difficult.
• Our directors and officers have substantial control over us.
• Our bylaws may limit investors’ ability to obtain a favorable judicial forum for disputes.
• The COVID-19 pandemic could materially affect our business.
• Our business faces unpredictable global, economic and business conditions, including the risk of inflation in various markets.

We believe the items we have outlined above are important factors that could cause estimates included in our financial statements to differ materially from actual results and those expressed in a forward-looking statement made in this report or elsewhere by us or on our behalf. We have discussed these factors in more detail in the Annual Report. These factors are not necessarily all of the factors that could affect us. Unpredictable or unanticipated factors we have not discussed in this report could also have material adverse effects on actual results. We do not intend to update our description of important factors each time a potential important factor arises, except as required by applicable securities laws and regulations. We advise our shareholders that they should (1) be aware that factors not referred to above could affect the accuracy of our forward-looking statements and (2) use caution when considering our forward-looking statements.

Company Overview

Founded in 1997 and incorporated in Nevada in 2003, XPEL has grown from an automotive product design software company to a global provider of after-market automotive products, including automotive surface and paint protection, headlight protection, and automotive window films, as well as a provider of complementary proprietary software. In 2018, we expanded our product offerings to include architectural window film (both commercial and residential) and security film protection for commercial and residential uses, and in 2019 we further expanded our product line to include automotive ceramic coatings.

XPEL began as a software company designing vehicle patterns used to produce cut-to-fit protective film for the painted surfaces of automobiles. In 2007, we began selling automotive surface and paint protection film products to complement our software business. In 2011, we introduced our ULTIMATE protective film product line which, at the time, was the industry’s first protective film with self-healing properties. The ULTIMATE technology allows the protective film to better absorb the impacts from rocks or other road debris, thereby fully protecting the painted surface of a vehicle. The film is described as “self-healing” due to its ability to return to its original state after damage from surface scratches. The launch of the ULTIMATE product catapulted XPEL into several years of strong revenue growth.

Our over-arching strategic philosophy stems from our view that being closer to the end customer in terms of our channel strategy affords us a better opportunity to efficiently introduce new products and deliver tremendous value which, in turn, drives more revenue growth for the Company. Consistent with this philosophy, we have executed on several strategic initiatives including:

• We began our international expansion by establishing an office in the United Kingdom.
• We acquired Parasol Canada, a distributor of our products in Canada.
• We opened our XPEL Netherlands office and established our European headquarters
• We continued our international expansion with the acquisition of Protex Canada Corp., or Protex Canada, a leading franchisor of automotive protective film franchises serving Canada, and
• We opened our XPEL Mexico office.

2018

• We launched our first product offering outside of the automotive industry, a window and security film protection for commercial and residential uses.
• We introduced the next generation of our highly successful ULTIMATE line, ULTIMATE PLUS.
• We acquired Apogee Corporation which led to formation of XPEL Asia based in Taiwan.

2019

• We were approved for the listing of our stock on Nasdaq trading under the symbol “XPEL”.

2020

• We acquired Protex Centre, a wholesale-focused paint protection installation business based in Montreal, Canada.
• We expanded our presence in France with the acquisition of certain assets of France Auto Racing.
• We expanded our architectural window film presence with the acquisition of Houston-based Veloce Innovation, a leading provider of architectural films for use in residential, commercial, marine and industrial settings.

2021

• We expanded our presence into numerous automotive dealerships throughout the United States with the acquisition of PermaPlate Film, LLC, a wholesale-focused automotive window film installation and distribution business based in Salt Lake City, Utah.
• We acquired five businesses in the United States and Canada from two sellers as a continuation of our acquisition strategy. These acquisitions allowed us to continue to increase our penetration into mid-range dealerships in the US and solidify our presence in Western Canada.
• We acquired invisiFRAME, Ltd, a designer and manufacturer of paint protection film patterns for bicycles, thus further expanding our non-automotive offerings.
• We expanded our presence in Australia with the purchase of the paint protection film business of our Australian distributor.

Strategic Overview

XPEL continues to pursue several key strategic initiatives to drive continued growth. Our global expansion strategy includes establishing a local presence where possible, allowing us to better control the delivery of our products and services. We also add locally-based regional sales personnel, leveraging local knowledge and relationships to expand the markets in which we operate.

We seek to increase global brand awareness in strategically important areas, including pursuing high visibility at premium events such as major car shows and high value placement in advertising media consumed by car enthusiasts, to help further expand the Company’s premium brand.

XPEL also continues to expand its delivery channels by acquiring select installation facilities in key markets and acquiring international partners to enhance our global reach. As we expand globally, we strive to tailor our distribution model to adapt to target markets. We believe this flexibility allows us to penetrate and grow market share more efficiently. Our acquisition strategy centers on our belief that the closer the Company is to its end customers, the greater its ability to drive increased product sales. During 2022, we acquired the paint protection film business of our Australian distributor in furtherance of this objective.

We also continue to drive expansion of our non-automotive product portfolio. Our architectural window film segment continues to gain traction. We believe there are multiple uses for protective films and we continue to explore those adjacent market opportunities.

Trends and Uncertainties

Macroeconomic uncertainties persist in the U.S. and other parts of the world as inflation, rising interest rates and the changes in value of the U.S. Dollar relative to other major currencies have recently affected the economic environment and consumer behaviors. Additionally, while we have not experienced any material supply chain disruptions directly, the automobile industry has experienced component shortages, increased lead times, cost fluctuations and logistic constraints. Some or all of these could continue throughout the remainder of 2023. This economic uncertainty could impact vehicle sales in the U.S. or other parts of the world, which could adversely affect our business, results of operations and financial condition. See Risk Factors - “We are highly dependent on the automotive industry. A prolonged or material contraction in the automotive sales and production volumes could adversely affect our business, results of operations and financial condition” included in Part I, Item 1A - Risk Factors, in the Annual Report on Form 10-K.

While Russia’s invasion of Ukraine has not had a material direct impact on our business, the nature and degree of the effects of that conflict, as well as the other effects of the current business environment over time remain uncertain. See Risk Factors- “We are exposed to political, regulatory, economic and other risks that arise from operating a multinational business” included in Part I, Item 1A - Risk Factors, in the Annual Report on Form 10-K.

Key Business Metric - Non-GAAP Financial Measures

Our management regularly monitors certain financial measures to track the progress of our business against internal goals and targets. We believe that the most important measure to the Company is Earnings Before Interest, Taxes, Depreciation, and Amortization (“EBITDA”).

EBITDA is a non-GAAP financial measure. We believe EBITDA provides helpful information with respect to our operating performance as viewed by management, including a view of our business that is not dependent on (i) the impact of our capitalization structure and (ii) items that are not part of our day-to-day operations. Management uses EBITDA (1) to compare our operating performance on a consistent basis, (2) to calculate incentive compensation for our employees, (3) for planning purposes including the preparation of our internal annual operating budget, (4) to evaluate the performance and effectiveness of our operational strategies, and (5) to assess compliance with various metrics associated with the agreements governing our indebtedness. Accordingly, we believe that EBITDA provides useful information in understanding and evaluating our operating performance in the same manner as management. We define EBITDA as net income plus (a) total depreciation and amortization, (b) interest expense, net, and (c) income tax expense.

The following table is a reconciliation of Net income to EBITDA for the three months ended March 31, 2023 and 2022 (in thousands):

(Unaudited)

Use of Non-GAAP Financial Measures

EBITDA should be considered in addition to, not as a substitute for, or superior to, financial measures calculated in accordance with GAAP. It is not a measurement of our financial performance under GAAP and should not be considered as alternatives to revenue or net income, as applicable, or any other performance measures derived in accordance with GAAP and may not be comparable to other similarly titled measures of other businesses. EBITDA has limitations as an analytical tool and you should not consider it in isolation or as a substitute for analysis of our operating results as reported under GAAP.

EBITDA does not reflect the impact of certain cash charges resulting from matters we consider not to be indicative of ongoing operations; and other companies in our industry may calculate EBITDA differently than we do, limiting their usefulness as comparative measures.

Results of Operations

The following table summarizes the Company’s consolidated results of operations for the three months ended March 31, 2023 and 2022 (in thousands):

The following table summarizes revenue results for the three months ended March 31, 2023 and 2022 (in thousands):

Because many of our international customers require us to ship their orders to freight forwarders located in the United States, we cannot be certain about the ultimate destination of the product. The following table represents our estimate of sales by geographic regions based on our understanding of ultimate product destination based on customer interactions, customer locations and other factors for the three months ended March 31, 2023 and 2022 (in thousands):

Product Revenue. Product revenue increased 15.9% over the three months ended March 31, 2022 Product revenue represented 78.4% of our total revenue for the three months ended March 31, 2023 and 80.8% for the three months ended March 31, 2022. Revenue from our paint protection film product line increased 12.7% for the three months ended March 31, 2023. Paint protection film sales represented 57.7% and 61.2% of our consolidated revenues for the three months ended March 31, 2023 and 2022, respectively. The increase in the total amount of paint protection film sales was primarily due to increased demand for our film products in multiple regions partially offset by a decrease in sales to China resulting from lingering regional impacts of the COVID-19 pandemic. This net increase in demand was driven primarily by an increase in the overall number of our customers together with increased sales to existing customers.

Revenue from our window film product line grew 29.9% for the three months ended March 31, 2023. Window film sales represented 17.5% and 16.0% of our consolidated revenues for the three months ended March 31, 2023 and 2022, respectively. This increase was due to continued channel focus, increased product adoption in multiple regions and increased demand. Architectural window film revenue increased 6.4% to $1.2 million. This increase was due mainly to increased product awareness and demand in most of our regions.

Geographically, we experienced growth in many regions during the three months ended March 31, 2023. The U.S. region, our largest region, grew 22.8% due primarily to increasing attach rates. Outside the U.S., several regions saw strong growth due primarily to increased product awareness and attach rates. Our China region revenue declined 25.0% compared to the three months ended March 31, 2022 due mainly to the lingering regional impacts of the COVID-19 pandemic.

Service revenue consists of fees for DAP software access and cutbank credit revenue, which represents the value of pattern access provided with eligible product revenue, revenue from the labor portion of installation sales in our Company-owned installation centers, revenue from our dealership services businesses and revenue from training services provided to our customers. Service revenue grew 34.6% over service revenue for the three months ended March 31, 2022. Service revenue represented 21.6% and 19.2% of our consolidated revenue from the three months ended March 31, 2023 and 2022, respectively.

Software revenue increased 20.8% from the three months ended March 31, 2022. The increase was due primarily to increases in total subscribers to our software. Software revenue represented 1.7% of consolidated revenue for both the three months ended March 31, 2023 and the three months ended March 31, 2022. Cutbank credit revenue grew 37.5% from the three months ended March 31, 2022. This increase was due mainly to increased demand for our products and services. Cutbank sales represented 4.7% and 4.1% of our consolidated revenue for the three months ended March 31, 2023 and 2022, respectively. Installation labor revenue increased 14.4% due mainly to increased demand in our Company-owned installation facilities and across our dealership service and OEM networks.

Total installation revenue (labor and product combined) at our Company-owned installation centers for the three months ended March 31, 2023 increased 34.0% over the three months ended March 31, 2022. This represented 17.2% and 15.3% of our consolidated revenue for the three months ended March 31, 2023 and 2022, respectively. This increase was due mainly to increased demand in our Company-owned installation facilities and across our dealership services businesses and OEM networks. Adjusted product revenue, which combines the cutbank credit revenue service component with product revenue, increased 16.9% in the three months ended March 31, 2023 versus the three months ended March 31, 2022 due mainly to the same factors described previously.

Cost of Sales

Cost of sales consists of product costs and the costs to provide our services. Product costs consist of material costs, personnel costs related to warehouse personnel, shipping costs, warranty costs and other related costs to provide products to our customers. Cost of service includes the labor costs associated with installation of product in our Company-owned facilities, costs of labor associated with pattern design for our cutting software and the costs incurred to provide training for our customers. Product costs in the three months ended March 31, 2023 increased 10.4% over the three months ended March 31, 2022 commensurate with our growth in product sales. Cost of product sales represented 49.1% and 53.1% of total revenue in the three months ended March 31, 2023 and 2022, respectively. Cost of services grew 29.4% during the three months ended March 31, 2023 and represented 9.0% and 8.3% of total revenue for the three months ended March 31, 2023 and 2022, respectively. This increase was due primarily to increased installation labor costs commensurate with the growth in installation labor revenue.

Gross Margin

The following table summarizes gross margin for product and services for the three months ended March 31, 2023 and 2022 (in thousands):

Product gross margin for the three months ended March 31, 2023 increased approximately $5.2 million, or 26.2%, over the three months ended March 31, 2022 and represented 37.3% and 34.3% of product revenue for the three months ended March 31, 2023 and 2022, respectively. The increase in product gross margin percentages were primarily due to decreases in product costs, favorable changes in product mix and improved operating leverage.

Service gross margin increased approximately $3.0 million, or 38.6%, over the three months ended March 31, 2022. This represented 58.4% and 56.8% of total service revenue for the three months ended March 31, 2023 and 2022, respectively. The increase in service margin percentage was primarily due to improved operating leverage in our dealership services business commensurate with the improvement of inventory levels at new car dealerships.

Operating Expenses

Sales and marketing expenses for the three months ended March 31, 2023 increased $0.4 million, or 5.8%, compared to the same period in 2022. These expenses represented 7.8% and 8.8% of consolidated revenue for the three months ended March 31, 2023 and 2022, respectively. This increase was due to continued investment in our sales and marketing efforts partially offset by timing of our annual dealer conference which was held in the second quarter of this year compared to the first quarter of 2022.

General and administrative expenses grew approximately $3.0 million, or 26.2%, during the three months ended March 31, 2023 over the three months ended March 31, 2022. These costs represented 16.7% and 15.8% of consolidated revenue for the three months ended March 31, 2023 and 2022, respectively. The increase was due mainly to increases in personnel, occupancy costs, and professional fees to support the ongoing growth of the business.

Income Tax Expense

Income tax expense for the three months ended March 31, 2023 increased $1.0 million from the three months ended March 31, 2022. Our effective tax rate was 20.7% for the three months ended March 31, 2023 compared with 20.5% for the three months ended March 31, 2022.

Net Income

Net income for the three months ended March 31, 2023 increased by $3.6 million, or 46.5%, to $11.4 million.

Liquidity and Capital Resources

The primary source of liquidity for our business is available cash and cash equivalents, cash flows provided by operations and borrowing capacity under our credit facility. As of March 31, 2023, we had cash and cash equivalents of $8.3 million. For the three months ended March 31, 2023, cash provided by operations was $0.7 million. We currently have $94 million of availability under our new credit facility with Wells Fargo. We expect to have sufficient access to cash to support working capital needs, capital expenditures (including acquisitions), and to pay interest and service debt. We are focused on continuing to generate positive operating cash to fund our operational and capital investment initiatives. We believe we have sufficient liquidity to operate for at least the next 12 months from the date of filing this report.

Operating Activities

Cash provided by operations totaled approximately $0.7 million for the three months ended March 31, 2023, compared to operating cash outflows of $4.3 million for the three months ended March 31, 2022. This increase was driven by an increase in net income and a reduction in inventory purchases partially offset by other changes in working capital.

Investing Activities

Cash flows used in investing activities totaled approximately $2.4 million during the three months ended March 31, 2023 compared to $2.6 million during the three months ended March 31, 2022.

Financing Activities

Cash flows provided by financing activities during the three months ended March 31, 2023 totaled approximately $1.9 million compared to $7.9 million in the prior year. This decrease was due to a decrease in borrowings under our credit facility during the 2023 quarter.

Debt obligations, including balances outstanding on committed credit facilities and contingent liabilities as of March 31, 2023 and December 31, 2022 totaled approximately $29.0 million and $27.0 million, respectively.

Future Liquidity and Capital Resource Requirements

We expect to fund ongoing operating expenses, capital expenditures, acquisitions, interest payments, tax payments, credit facility maturities, future lease obligations, and payments for other long-term liabilities with cash flow from operations and borrowings under our credit facility. In the short-term, we are contractually obligated to make lease payments and make payments on contingent liabilities related to certain completed acquisitions. In the long-term, we are contractually obligated to make lease payments, for contingent liabilities, and for repayment of borrowings on our line of credit. We believe that we have sufficient cash and cash equivalents, as well as borrowing capacity, to cover our estimated short-term and long-term funding needs.

Credit Facilities

Throughout the three months ended March 31, 2023, the Company had a $75.0 million revolving line of credit with a financial institution. The facility was utilized to fund the Company's working capital needs and other strategic initiatives, and was secured by a security interest in substantially all of the Company's current and future assets. Borrowings under the credit agreement bore interest on at the Wall Street Journal U.S. Prime Rate less 0.75% per annum if the Company's EBITDA ratio (as defined in the Loan Agreement governing the facility) was equal to or less than 2.00 to 1.00 or the Wall Street Journal U.S. Prime rate less 0.25% if the Company's EBITDA ratio was greater than 2.00 to 1.00. The facility also included a fee of 0.25% of the unused capacity on the facility. The interest rate for this credit facility as of March 31, 2023 and December 31, 2022 was 7.25% and 6.75%, respectively. The Company paid interest charges on borrowings under this facility of $0.5 million during the three months ended March 31, 2023, and had a balance of $28.0 million and $26.0 million as of March 31, 2023 and December 31, 2022, respectively. The maturity date of this facility was July 5, 2024.

On April 6, 2023, this facility was terminated and a new $125.0 million Credit Agreement was established with Wells Fargo Bank, N.A. Borrowings under this new Credit Agreement bear interest, at XPEL’s option, at a rate equal to either (a) Base Rate or (b) Adjusted Term SOFR. In addition to the applicable interest rate, the Credit Agreement includes a commitment fee ranging from 0.20% to 0.25% per annum for the unused portion of the aggregate commitment and an applicable margin ranging from 0.00% to 0.50% for Base Rate Loans and 1.00% to 1.50% for Adjusted Term SOFR Loans. Both the margin applicable to the interest rate and the commitment fee are dependent on XPEL’s Consolidated Total Leverage Ratio.

Obligations under the Credit Agreement are secured by a first priority perfected security interest, subject to certain permitted encumbrances, in all of XPEL’s material property and assets.

The terms of the Credit Agreement include certain affirmative and negative covenants that require, among other things, XPEL to maintain legal existence and to remain in good standing, comply with applicable laws, maintain accounting records, deliver financial statements and certifications on a timely basis, pay taxes as required by law, and maintain insurance coverage, as well as to forgo certain specified future activities that might otherwise encumber XPEL and certain customary covenants.

The Credit Agreement also provides for two financial covenants:

1. Its Consolidated Total Leverage Ratio to exceed 3.50 to 1.00, and

2. Its Consolidated Interest Coverage Ratio to be less than 3.00 to 1.00.

The Credit Agreement's maturity date is April 6, 2026.

Under the Credit Agreement:

“Adjusted Term SOFR” means, for purposes of any calculation, the rate per annum equal to (a) Term SOFR for such calculation plus (b) the Term SOFR Adjustment; (as defined in the Credit Agreement) provided that if Adjusted Term SOFR as so determined shall ever be less than 0%, then Adjusted Term SOFR shall be deemed to be 0%.

“Base Rate” is defined as the highest of (a) the Administrative Agent’s prime rate, (b) the Federal funds rate plus 0.50%, or (c) Adjusted Term SOFR for a one-month tenor in effect on such day plus 1.00%.

“Consolidated Total Leverage Ratio” is defined as the ratio of consolidated funded indebtedness on such date to Consolidated EBITDA for the most recently completed Reference Period.

“Consolidated Interest Coverage Ratio” is defined as the ratio of Consolidated EBITDA for the most recently completed Reference Period to XPEL’s consolidated interest expense for the most recently completed Reference Period.

“Consolidated EBITDA” is defined as consolidated net income (i) plus all of the following: (a) consolidated interest expense; (b) tax expense measured by net income, profits or capital (or any similar measures), paid or accrued, including federal and state and local income taxes, foreign income taxes and franchise taxes; (c) depreciation, amortization and other non-cash charges or expenses (including stock based compensation and write-downs of goodwill), excluding any non-cash charge or expense that represents an accrual for a cash expense to be taken in a future period; (d) all transaction fees, charges and other amounts (including any financing fees, merger and acquisition fees, legal fees and expenses, due diligence fees or any other fees and expenses in connection therewith) in connection with any Credit Agreement permitted acquisition, investment, disposition, issuance or repurchase of equity interests, or the incurrence, amendment or waiver of indebtedness permitted hereunder (other than those related to the certain transactions or with respect to any amendment or modification of the Loan Documents), in each case, whether or not consummated, in each case to the extent paid within six months of the closing or effectiveness of such event or the termination or abandonment of such transaction, as the case may be; provided that (1) the aggregate amount added back pursuant to this provision with respect to any one transaction shall not exceed $2,000,000 for the applicable period and (2) any amounts added back for such applicable period shall be set forth in reasonable detail on XPEL’s compliance certification for such period; (e) non-cash charges and losses (excluding any such non-cash charges or losses to the extent (1) there were cash charges with respect to such charges and losses in past accounting periods or (2) there is a reasonable expectation that there will be cash charges with respect to such charges and losses in future accounting periods); and (f) unusual and non-recurring expenses, charges or losses (excluding losses from discontinued operations); and (ii) less the sum of the following, without duplication, to the extent included in determining consolidated net income for such period: (a) interest income; (b) federal, state, local and foreign income tax credits of XPEL and its subsidiaries for such period (to the extent not netted from income tax expense); (c) any unusual and non-recurring gains; (d) non-cash gains (excluding any such non-cash gains to the extent (A) there were cash gains with respect to such gains in past accounting periods or (B) there is a reasonable expectation that there will be cash gains with respect to such gains in future accounting periods); and (e) any cash expense made during such period which represents the reversal of any non-cash expense that was added in a prior period pursuant to clause (i)(c)

above subsequent to the fiscal quarter in which the relevant non-cash expenses, charges or losses were incurred.

“Reference Period” is defined at any date of determination as, the period of four consecutive fiscal quarters ended on or immediately prior to such date for which financial statements of XPEL have been delivered to the Administrative Agent.

“SOFR” means a rate equal to the secured overnight financing rate as administered by the SOFR Administrator.

“SOFR Administrator” means the Federal Reserve Bank of New York (or a successor administrator of the secured overnight financing rate).

The Credit Agreement contains representations and warranties by XPEL, which were made only for purposes of the Credit Agreement and as of specified dates. The representations, warranties and covenants in the Credit Agreement were made solely for the benefit of the parties to the Credit Agreement, are subject to limitations agreed upon by such parties, including being qualified by schedules, may have been made for the purposes of allocating contractual risk between the parties instead of establishing these matters as facts, and are subject to standards of materiality applicable to the parties that may differ from those applicable to others. Others should not rely on the representations, warranties and covenants or any descriptions thereof as characterizations of the actual state of facts or condition of XPEL or any of its subsidiaries or affiliates. Moreover, information concerning the subject matter of the representations, warranties and covenants may change after the date of the Credit Agreement, which subsequent information may or may not be fully reflected in XPEL’s public disclosures.

The Company also has a CAD $4.5 million revolving credit facility through HSBC Bank Canada, and is maintained by XPEL Canada Corp., a wholly-owned subsidiary of XPEL. This Canadian facility is utilized to fund the Company's working capital needs in Canada. This facility bears interest at HSBC Canada Bank’s prime rate plus 0.25% per annum and is guaranteed by the parent company. As of March 31, 2023 and December 31, 2022, no balance was outstanding on this line of credit.

Critical Accounting Estimates

There have been no material changes to the Company’s critical accounting estimates from the information provided in the Annual Report on Form 10-K.

Related Party Relationships

There are no family relationships between or among any of our directors or executive officers. There are no arrangements or understandings between any two or more of our directors or executive officers, and there is no arrangement, plan or understanding as to whether non-management stockholders will exercise their voting rights to continue to elect the current Board. There are also no arrangements, agreements or understandings between non-management stockholders that may directly or indirectly participate in or influence the management of our affairs.

We have operations that expose us to currency risk in the British Pound Sterling, the Canadian Dollar, the Euro, the Mexican Peso, the New Taiwanese Dollar, and the Australian Dollar. Amounts invested in our foreign operations are translated into U.S. Dollars at the exchange rates in effect at the balance sheet date. The resulting translation adjustments are recorded as accumulated other comprehensive loss, a component of stockholders’ equity in our condensed consolidated balance sheets. We do not currently hedge our exposure to potential foreign currency translation adjustments.

Borrowings under our revolving lines of credit or our Credit Agreement (see Note 13) are subject to market risk resulting from changes in interest rates related to our floating rate bank credit facilities. For such borrowings, a hypothetical 200 basis point increase in variable interest rates may result in a material impact to our financial statements. We do not currently have any derivative contracts to hedge our exposure to interest rate risk. During each of the periods presented, we have not experienced a significant effect on our business due to changes in interest rates.

If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could adversely affect our business, financial condition and results of operations.

Evaluation of Disclosure Controls and Procedures

We have established and maintain a system of disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed in our reports filed with the SEC pursuant to the Securities Exchange Act of 1934, as amended ("Exchange Act"), is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required disclosures.

Management, with the participation of our CEO and CFO, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, our CEO and CFO have each concluded that as of the end of the period covered by this report, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate, to allow timely decisions regarding required disclosures.

Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives as specified above. Management does not expect, however, that our disclosure controls and procedures will prevent or detect all error and fraud. Any control system, no matter how well designed and operated, is based upon certain assumptions and can provide only reasonable, not absolute, assurance that its objectives will be met. Further, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.