XPEL, Inc.: Form 10-Q for the period ended Mar 31, 2024

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:

• We are highly dependent on the automotive industry. A prolonged or material contraction in automotive sales and production volumes could adversely affect our business, results of operations and financial condition.
• We currently rely on one distributor for our products in China.
• A significant percentage of our revenue is generated from our business in China, a market that is associated with certain risks.
• The loss of one or more of our key personnel or our failure to attract and retain other highly qualified personnel in the future, could harm our business.
• A material disruption from our contract manufacturers or suppliers or our inability to obtain a sufficient supply from alternate suppliers could cause us to be unable to meet customer demands or increase our costs.
• Our asset-light business model exposes us to product quality and variable cost risks.
• Our accounting estimates and risk management processes rely on assumptions or models that may prove inaccurate.
• Fluctuations in the cost and availability of raw materials, equipment, labor and transportation could cause manufacturing delays, increase our costs and/or impact our ability to meet customer demand.
• Our industry is highly competitive.
• Harm to our reputation or the reputation of one or more of our products could have an adverse effect on our business.
• Our revenue and operating results may fluctuate, which may make our results difficult to predict and could cause our results to fall short of expectations.
• Technology could render the need for some of our products obsolete.
• Infringement of our intellectual property could impact our ability to compete effectively.
• If changes to our existing products or introduction of new products or services do not meet our customers’ expectations or fail to generate revenue, we could lose our customers or fail to generate any revenue from such products or services and our business may be harmed.
• We depend on our relationships with independent installers and new car dealerships and their ability to sell and service our products. Any disruption in these relationships could harm our sales.
• We may not be able to identify, finance and complete suitable acquisitions and investments, and any completed acquisitions and investments could be unsuccessful or consume significant resources.
• We may incur material losses and costs as a result of product liability and warranty claims.
• Our failure to satisfy international trade compliance regulations, and changes in U.S. government sanctions, could have a material adverse effect on us.
• We may seek to incur substantial indebtedness in the future.
• We cannot be certain that additional financing will be available on reasonable terms when required, or at all.
• Our variable rate indebtedness exposes us to interest rate volatility, which could cause our debt service obligations to increase significantly.
• General global economic and business conditions affect demand for our products.
• A public health crisis could impact our business
• Economic, political and market conditions can adversely affect our business, financial condition and results of operations.

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

The Company is a leading provider of protective films and coatings, including automotive paint protection film, surface protection film, automotive and commercial/residential window films, and ceramic coatings with a global footprint, a network of trained installers and proprietary DAP software. The Company is dedicated to exceeding customer expectations by providing high-quality products, leading customer service, expert technical support and world-class training.

The Company 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 and other road debris, thereby fully protecting the 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 the Company 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.

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 2023, we completed four acquisitions in furtherance of this objective. We believe our channel strategy uniquely positions us to be wherever the demand takes us and is a key part of our ability to drive sustained growth.

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.

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, 2024 and 2023 (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, 2024 and 2023 (in thousands):

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The following table summarizes revenue results for the three months ended March 31, 2024 and 2023 (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, 2024 and 2023 (in thousands):

Product Revenue. Product revenue decreased 0.7% over the three months ended March 31, 2023. Product revenue represented 74.2% of our total revenue for the three months ended March 31, 2024 and 78.4% for the three months ended March 31, 2023. Revenue from our paint protection film product line decreased 1.1% for the three months ended March 31, 2024. Paint protection film sales represented 54.4% and 57.7% of our consolidated revenues for the three months ended March 31, 2024 and 2023, respectively. This decrease was due to lower demand in the U.S., primarily in the after-market channel, and lower sales to XPEL's China distributor. Sales to China reached a record high in the fourth quarter of 2023. Consequently, first quarter 2024 China sales were negatively impacted as our distributor sold through the inventory purchased at the end of last year.

Revenue from our window film product line declined 2.9% for the three months ended March 31, 2024. Window film sales represented 16.1% and 17.5% of our consolidated revenues for the three months ended March 31, 2024 and 2023, respectively. This decline was due mainly to lower revenue into China. Excluding China, total window film revenue grew 10.3%. Architectural window film revenue increased 33.1% to $1.8 million. This increase was due mainly to increased product awareness and demand in most of our regions.

Other product revenue for the three months ended March 31, 2024 grew 18.5% to $3.3 million and represented 3.7% of revenue. This increase was driven by an increase in demand for our non-film related products such as ceramic coating, plotters, chemicals and other film installation tools and accessories. Our FUSION ceramic coating product revenue grew 24.4% to $1.4 million. This increase was due mainly to increased demand for our ceramic coating products.

Geographically, outside of the U.S. and China, we experienced solid growth in most operating regions during the three months ended March 31, 2024, due mainly to increased product awareness and adoption.

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. Due mainly to increases in the Company's dealership services business resulting from increased car counts, increased content per vehicle and from our OEM business, service revenue grew 25.5% over service revenue for the three months ended March 31, 2023. Service revenue represented 25.8% and 21.6% of our consolidated revenue from the three months ended March 31, 2024 and 2023, respectively.

Software revenue increased 32.2% from the three months ended March 31, 2023. The increase was due primarily to increases in total subscribers to our software. Software revenue represented 2.1% and 1.7% of consolidated revenue for the three months ended March 31, 2024 and 2023, respectively. Installation labor revenue increased 34.7% due mainly to increased labor revenue in our dealership services business resulting from increased car counts associated with improving U.S. new car dealership inventories.

Total installation revenue (labor and product combined) for the three months ended March 31, 2024 increased 34.7% over the three months ended March 31, 2023. This represented 22.1% and 17.2% of our consolidated revenue for the three months ended March 31, 2024 and 2023, respectively. Adjusted product revenue, which combines the cutbank credit revenue service component with product revenue, decreased 0.7% in the three months ended March 31, 2024 versus the three months ended March 31, 2023.

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-run 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, 2024 decreased 0.1% over the three months ended March 31, 2023 commensurate with our decrease in product sales. Cost of product sales represented 46.8% and 49.1% of total revenue in the three months ended March 31, 2024 and 2023, respectively. Cost of services grew 31.0% during the three months ended March 31, 2024 and represented 11.2% and 9.0% of total revenue for the three months ended March 31, 2024 and 2023, 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, 2024 and 2023 (in thousands):

Product gross margin for the three months ended March 31, 2024 decreased $0.4 million, 1.6% compared to the same period in the prior year. The decrease in product gross margin percentages was primarily due to lower product revenue and increases in non bill of material costs contained within product cost of goods sold.

Service gross margin increased approximately $2.3 million, or 21.5%, over the three months ended March 31, 2023. This represented 56.6% and 58.4% of total service revenue for the three months ended March 31, 2024 and 2023, respectively. The decrease in service gross margin percentage was primarily due to a higher percentage mix of lower margin installation labor revenue and cost inefficiencies associated with lower revenue in our company-owned installation centers.

Operating Expenses

Sales and marketing expenses for the three months ended March 31, 2024 increased $3.7 million, or 55.7%, compared to the same period in 2023. These expenses represented 11.5% and 7.8% of consolidated revenue for the three months ended March 31, 2024 and 2023, respectively. This increase was primarily due to expenses incurred during the period for our annual dealer conference which occurred in the second quarter of the prior year.

General and administrative expenses grew approximately $3.9 million, or 27.2%, during the three months ended March 31, 2024 over the three months ended March 31, 2023. These costs represented 20.3% and 16.7% of consolidated revenue for the three months ended March 31, 2024 and 2023, 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, 2024 decreased $1.2 million from the three months ended March 31, 2023. Our effective tax rate was 21.4% for the three months ended March 31, 2024 compared with 20.7% for the three months ended March 31, 2023.

Net Income

Net income for the three months ended March 31, 2024 decreased by $4.8 million, or 41.7%, to $6.7 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, 2024, we had cash and cash equivalents of $8.6 million. For the three months ended March 31, 2024, cash used in operations was $5.0 million, and as of March 31, 2024 we had approximately $104.3 million in funds available under our credit facilities. We expect to continue to have sufficient access to cash to support working capital needs, pay for capital expenditures (including acquisitions), and to pay interest and service debt. We believe we have the ability and sufficient resources to meet these cash requirements by using available cash, internally generated funds and borrowing under committed credit facilities. 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 this quarterly report.

Operating Activities. Cash used in operations totaled approximately $5.0 million for the three months ended March 31, 2024, compared to operating cash inflows of $0.7 million for the three months ended March 31, 2023. This decrease was driven by a decline in net income and a net increase in working capital.

Investing Activities. Cash flows used in investing activities totaled approximately $3.1 million during the three months ended March 31, 2024 compared to $2.4 million during the three months ended March 31, 2023.

Financing Activities. Cash flows provided by financing activities during the three months ended March 31, 2024 totaled approximately $5.0 million compared to $1.9 million in the prior year. This increase was due to an increase in borrowings under our credit facility during the 2024 quarter.

Debt obligations, including balances outstanding on committed credit facilities and contingent liabilities as of March 31, 2024 and December 31, 2023 totaled approximately $25.0 million and $19.9 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

The Company has a revolving credit facility providing for secured revolving loans and letters of credit in an aggregate amount of up to $125 million, which is subject to the terms of a credit agreement dated April 6, 2023 (the "Credit Agreement"). As of March 31, 2024 and December 31, 2023, the Company had outstanding balances of $24 million and $19 million under this agreement, respectively.

Borrowings under the 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. At March 31, 2023, these rates were 8.5% and 6.4%, respectively. Both the margin applicable to the interest rate and the commitment fee are dependent on XPEL’s Consolidated Total Leverage Ratio. The Credit Agreement's maturity date is April 6, 2026. All capitalized terms in this description of the credit facility that are not otherwise defined in this report have the meaning assigned to them in the Credit Agreement.

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 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 provides for two financial covenants, as follows.

As of the last day of each fiscal quarter:

1. XPEL shall not allow its Consolidated Total Leverage Ratio to exceed 3.50 to 1.00, and

2. XPEL shall not allow its Consolidated Interest Coverage Ratio to be less than 3.00 to 1.00

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, 2024 and December 31, 2023, 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 8) 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.