XPEL, Inc. (XPEL) FY 2022 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Executive Summary
Set forth below is summary financial information for the years ended December 31, 2022, 2021, and 2020. This information is not necessarily indicative of results of future operations, and should be read in conjunction with Part I, Item 1A, “Risk Factors,” Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and accompanying notes thereto included in Part II, Item 8, “Financial Statements and Supplementary Data” of this Annual Report to fully understand factors that may affect the comparability of the information presented below (dollars in thousands).
34
| Year Ended December 31, | % Change | ||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | % of Total Revenue | 2021 | % of Total Revenue | 2020 | % of Total Revenue | 2022 vs. 2021 | 2021 vs. 2020 | ||||||||||||||||||
| Total revenue | $ | 323,993 | 100.0 | % | $ | 259,263 | 100.0 | % | $ | 158,924 | 100.0 | % | 25.0 | % | 63.1 | % | |||||||||
| Total cost of sales | 196,481 | 60.6 | % | 166,586 | 64.3 | % | 104,899 | 66.0 | % | 17.9 | % | 58.8 | % | ||||||||||||
| Gross margin | 127,512 | 39.4 | % | 92,677 | 35.7 | % | 54,025 | 34.0 | % | 37.6 | % | 71.5 | % | ||||||||||||
| Total operating expenses | 73,575 | 22.7 | % | 52,561 | 20.3 | % | 30,655 | 19.3 | % | 40.0 | % | 71.5 | % | ||||||||||||
| Operating income | 53,937 | 16.6 | % | 40,116 | 15.5 | % | 23,370 | 14.7 | % | 34.5 | % | 71.7 | % | ||||||||||||
| Other expenses | 1,972 | 0.6 | % | 676 | 0.3 | % | 565 | 0.4 | % | 191.7 | % | 19.5 | % | ||||||||||||
| Income tax | 10,584 | 3.3 | % | 7,873 | 3.0 | % | 4,523 | 2.8 | % | 34.4 | % | 74.1 | % | ||||||||||||
| Net income | $ | 41,381 | 12.8 | % | $ | 31,567 | 12.2 | % | $ | 18,282 | 11.5 | % | 31.1 | % | 72.7 | % |
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.
Trends and Uncertainties
Macroeconomic uncertainties persist in the U.S. and other parts of the world as inflation, rising interest rates and the strengthening of the U.S. Dollar relative to major currencies affected the economic environment and consumer behaviors in 2022. 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 persist into 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.”
The Chinese government recently modified its approach to managing the COVID-19 pandemic when it halted its prolonged lockdown. Consequently, China is experiencing rampant increases in COVID-19 cases. If COVID-19 continues to persist over the long-term, it could continue to have an adverse effect on our China sales. Refer to Risk Factors - ‘A significant percentage of our revenue is generated from our business in China, a market that is associated with certain risks.”
Finally, 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.”
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
35
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 years ended December 31, 2022, 2021, and 2020 (dollars in thousands):
| 2022 | %of Total Revenue | 2021 | %of Total Revenue | 2020 | %of Total Revenue | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Net Income | $ | 41,381 | 12.8 | % | $ | 31,567 | 12.2 | % | $ | 18,282 | 11.5 | % | ||||||||
| Interest | 1,410 | 0.4 | % | 303 | 0.1 | % | 249 | 0.2 | % | |||||||||||
| Taxes | 10,584 | 3.3 | % | 7,873 | 3.0 | % | 4,523 | 2.8 | % | |||||||||||
| Depreciation | 3,433 | 1.1 | % | 1,887 | 0.7 | % | 1,274 | 0.8 | % | |||||||||||
| Amortization | 4,401 | 1.4 | % | 2,501 | 1.0 | % | 956 | 0.6 | % | |||||||||||
| EBITDA | $ | 61,209 | 18.9 | % | $ | 44,131 | 17.0 | % | $ | 25,284 | 15.9 | % |
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 its usefulness as a comparative measure.
36
Results of Operations
This section of this Annual Report on Form 10-K generally discusses the years ended December 31, 2022 and 2021 and year-over-year comparisons between those years. Discussions of the periods prior to the year ended December 31, 2021 that are not included in this Annual Report on Form 10-K are found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2021 and the discussion therein for the year ended December 31, 2021 compared to the year ended December 31, 2020 is incorporated by reference into this Annual Report.
The following tables summarize revenue results for the years ended December 31, 2022, 2021 and 2020 (dollars in thousands):
| Year Ended December 31, | % Change | % of Total Revenue | |||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | 2020 | 2022 vs. 2021 | 2021 vs. 2020 | 2022 | 2021 | 2020 | ||||||||||||||||||
| Product Revenue | |||||||||||||||||||||||||
| Paint protection film | $ | 192,374 | $ | 169,880 | $ | 110,786 | 13.2 | % | 53.3 | % | 59.4 | % | 65.5 | % | 69.7 | % | |||||||||
| Window film | 54,370 | 38,363 | 20,951 | 41.7 | % | 83.1 | % | 16.8 | % | 14.8 | % | 13.2 | % | ||||||||||||
| Other | 11,430 | 9,040 | 4,525 | 26.4 | % | 99.8 | % | 3.5 | % | 3.5 | % | 2.8 | % | ||||||||||||
| Total | $ | 258,174 | $ | 217,283 | $ | 136,262 | 18.8 | % | 59.5 | % | 79.7 | % | 83.8 | % | 85.7 | % | |||||||||
| Service Revenue | |||||||||||||||||||||||||
| Software | $ | 5,213 | $ | 4,373 | $ | 3,489 | 19.2 | % | 25.3 | % | 1.6 | % | 1.7 | % | 2.2 | % | |||||||||
| Cutbank credits | 16,317 | 12,372 | 7,785 | 31.9 | % | 58.9 | % | 5.0 | % | 4.8 | % | 4.9 | % | ||||||||||||
| Installation labor | 42,828 | 24,253 | 10,925 | 76.6 | % | 122.0 | % | 13.2 | % | 9.4 | % | 6.9 | % | ||||||||||||
| Training and other | 1,461 | 982 | 463 | 48.8 | % | 112.1 | % | 0.5 | % | 0.3 | % | 0.3 | % | ||||||||||||
| Total | $ | 65,819 | $ | 41,980 | $ | 22,662 | 56.8 | % | 85.2 | % | 20.3 | % | 16.2 | % | 14.3 | % | |||||||||
| Total | $ | 323,993 | $ | 259,263 | $ | 158,924 | 25.0 | % | 63.1 | % | 100.0 | % | 100.0 | % | 100.0 | % |
37
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 years ended December 31, 2022 and 2021 (dollars in thousands):
| Year Ended December 31, | % | % of Total Revenue | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | Increase | 2022 | 2021 | ||||||||||||
| United States | $ | 189,890 | $ | 133,457 | 42.3 | % | 58.6 | % | 51.5 | % | ||||||
| China | 33,993 | 46,305 | (26.6) | % | 10.5 | % | 17.9 | % | ||||||||
| Canada | 38,997 | 30,540 | 27.7 | % | 12.0 | % | 11.8 | % | ||||||||
| Continental Europe | 24,713 | 19,605 | 26.1 | % | 7.6 | % | 7.6 | % | ||||||||
| Middle East/Africa | 10,499 | 9,736 | 7.8 | % | 3.2 | % | 3.8 | % | ||||||||
| United Kingdom | 10,298 | 7,714 | 33.5 | % | 3.2 | % | 3.0 | % | ||||||||
| Asia Pacific | 9,026 | 7,706 | 17.1 | % | 2.8 | % | 2.9 | % | ||||||||
| Latin America | 5,411 | 3,788 | 42.8 | % | 1.7 | % | 1.4 | % | ||||||||
| Other | 1,166 | 412 | 183.0 | % | 0.4 | % | 0.1 | % | ||||||||
| Total | $ | 323,993 | $ | 259,263 | 25.0 | % | 100.0 | % | 100.0 | % |
Revenue
Product Revenue. Product revenue increased 18.8% during the year ended December 31, 2022 as compared to 2021 and represented 79.7% of our consolidated 2022 revenue. Within this category, revenue from our paint protection film product line increased 13.2% as compared to the prior year and represented 59.4% of total revenue for the year ended December 31, 2022. This growth was due mainly to increases in demand for our film products across multiple regions partially offset by a decrease in sales to China resulting from regional impacts of the COVID-19 pandemic. The increase in demand in non-China regions was driven by both an increase in the number of customers and increased revenue from our existing customers.
Revenue from our window film product line grew 41.7% in the year ended December 31, 2022 and represented 16.8% of our consolidated annual 2022 revenue. This product line contains both automotive and architectural window film. Automotive window film grew 37.1% to $48.7 million for the year ended December 31, 2022. This increase was due to continued channel focus, increased product adoption in multiple regions and increased demand. Architectural window film revenue increased 98.2% to $5.7 million. This increase was due mainly to increased product awareness and adoption in most of our regions.
Geographically, we experienced growth in many regions during the year. The U.S. and Canadian markets are our most mature markets. Our continued strong growth in these markets was being driven primarily by increased paint protection film attachment rates. Outside of these more mature markets, our continued strong growth was driven by increased product awareness and adoption. An exception to this generally positive trend was our market in China, which saw repeated disruptions during the year as a result of ongoing COVID-related impacts.
Service revenue. Service revenue consists of revenue from fees for DAP software access, 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 business, and revenue from training services provided to our customers. During 2022, service revenue grew 56.8% over service revenue for the year ended December 31, 2021.
Within the service revenue category, software revenue increased 19.2% from the year ended December 31, 2021. This increase was due primarily to increases in customers subscribing to our software. Cutbank credit revenue grew 31.9% from the year ended December 31, 2021. This increase was due primarily to the aforementioned increases in demand for our products and services. Installation labor revenue increased 76.6% from the year ended December 31, 2021, due mainly to acquisition related revenue growth coupled with strong demand at our Company-owned installation facilities and across our dealer service and OEM network.
38
Training revenue increased 48.8% from the year ended December 31, 2021 as we continue to grow our global training presence.
Total installation revenue (labor and product combined) at our Company-owned installation centers for the year ended December 31, 2022 increased 76.6% over the year ended December 31, 2021. Same store sales growth was approximately 40.5% from the year ended December 31, 2022. Adjusted product revenue, which combines the cutbank credit revenue service component with product revenue, increased by 19.5% from the year ended December 31, 2021 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, certain personnel costs, shipping costs, warranty costs and other costs related to providing products to our customers. Cost of service includes the labor costs associated with installation of product in our Company-owned facilities and across our dealer-service network, costs of labor associated with pattern design for our film-cutting software and the costs incurred to provide training for our customers. Product costs in the year ended December 31, 2022 increased 12.3% over the year ended December 31, 2021 commensurate with the growth in product revenue. Cost of service revenue grew 73.7% during the year ended December 31, 2022. The increase was due primarily to increased labor costs associated with our dealership services businesses acquired in 2021.
Gross Margin
The following table summarizes gross margin for product and services for the years ended December 31, 2022, 2021 and 2020 (dollars in thousands):
| Year Ended December 31, | % Change | % of Category Revenue | |||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | 2020 | 2022 vs. 2021 | 2021 vs. 2020 | 2022 | 2021 | 2020 | ||||||||||||||||||
| Product | $ | 88,269 | $ | 65,997 | $ | 37,760 | 33.7 | % | 74.8 | % | 34.2 | % | 30.4 | % | 26.7 | % | |||||||||
| Service | 39,243 | 26,680 | 16,265 | 47.1 | % | 64.0 | % | 59.6 | % | 63.6 | % | 71.8 | % | ||||||||||||
| Total | $ | 127,512 | $ | 92,677 | $ | 54,025 | 37.6 | % | 71.5 | % | 39.4 | % | 35.7 | % | 34.0 | % |
Product gross margin for the year ended December 31, 2022 increased approximately $22.3 million, or 33.7%, over the year ended December 31, 2021 and represented 34.2% and 30.4% of total product revenue for the years ended December 31, 2022 and 2021, respectively. The increase in product gross margin percentages was primarily due to improved product costs, lower percentage of sales to lower margin distributors (primarily our China Distributor), and favorable changes in product mix.
Service gross margin increased approximately $12.6 million for the year ended December 31, 2022, and represented 59.6% and 63.6% of total service revenue for the years ended December 31, 2022 and 2021, respectively. The decrease in service gross margin percentage was primarily due to a higher percentage of lower margin installation labor revenue relative to other higher margin service revenue components.
Operating Expenses
Sales and marketing expenses for the year ended December 31, 2022 increased 38.8% compared to 2021. These expenses represented 7.8% and 7.0% of consolidated revenue for the years ended December 31, 2022 and 2021, respectively. This increase was due mainly to increased personnel, increased expenses related to marketing events that were suspended in 2021 due to COVID-19 and travel related expenses to support the on-going growth of the business.
General and administrative expenses grew approximately $13.9 million, or 40.6%, during the year ended December 31, 2022. These costs represented 14.9% and 13.2% of total consolidated revenue for the years ended December 31, 2022 and 2021, respectively. The increase was due mainly to increases in personnel, occupancy costs, information technology costs and professional fees to support the ongoing growth of the
39
business and acquisition related expenses including amortization associated with the intangible assets acquired in 2021.
Other Expense
Other expense consists of interest expense and foreign currency gain/loss. Interest expense increased during the year as a result of increased borrowings and increased interest rates under the Company’s line of credit facility. Foreign currency exchange loss increased during the year due to fluctuations in the various currencies in which we conduct business.
Income Tax Expense
Our provision for income taxes increased 34.4% to $10.6 million in the year ended December 31, 2022 as compared to the year ended December 31, 2021, primarily due to the increase in our pre-tax income year over year. Our effective income tax rates for the years ended December 31, 2022 and 2021 were 20.4% and 20.0%, respectively. The increase in our effective rate was primarily due to the impact of international operations. See Note 14 of the Notes to our Consolidated Financial Statements for further information.
Net Income
Net income for the year ended December 31, 2022 increased by 31.1% to $41.4 million compared to the prior year due primarily to continued strong revenue growth and improved margins.
40
Liquidity and Capital Resources
The primary source of liquidity for our business is cash and cash equivalents and cash flows provided by operations. As of December 31, 2022, we had cash and cash equivalents of $8.1 million. For the year ended December 31, 2022, cash flows provided by operations were $12.1 million. We expect to continue to have sufficient access to cash to support working capital needs, 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 filing this Annual Report.
Operating activities. Cash flows provided by operations totaled approximately $12.1 million for the year ended December 31, 2022, compared to $18.3 million for the year ended December 31, 2021. The decrease in operating cash flows for the year ended December 31, 2022 was driven primarily by changes in working capital and increased inventory purchases to offset supply chain risk. This decrease was partially offset by an increase in operating earnings.
Investing activities. Cash flows used in investing activities totaled approximately $14.2 million during the year ended December 31, 2022 compared to cash use of $56.8 million the year ended December 31, 2021. This decrease in cash used was due mainly to less cash outlay for acquisitions in 2022.
Financing activities. Cash flows provided by financing activities during the year ended December 31, 2022 totaled approximately $0.6 million compared $19.2 million in the prior year. This decrease was due primarily to less incremental borrowing on our committed credit facilities. Debt obligations, including balances outstanding on committed credit facilities, as of December 31, 2022 and December 31, 2021 totaled approximately $26.1 million and $25.5 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. 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, pay contingent liabilities as they are earned, and repay 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
As of December 31, 2022, we had a $75.0 million revolving line of credit agreement with a financial institution. The facility is used to fund the Company’s working capital needs and other strategic initiatives, and is secured by substantially all the Company’s current and future assets. Borrowings under the credit agreement bear interest on borrowed amounts at the Wall Street Journal U.S. Prime Rate less 0.75% per annum if the Company's EBITDA ratio (as defined in the facility) is 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 is greater than 2.00 to 1.00. The interest rate for this credit facility as of December 31, 2022 was 6.75%. The Company paid interest charges on borrowings under the facility of $1.3 million during the year ended December 31, 2022. As of December 31, 2022, the Company had borrowed $26.0 million under this line of credit. This facility matures on July 5, 2024.
The Loan Agreement governing the facility contains customary covenants relating to maintaining legal existence and good standing, complying with applicable laws, delivery of financial statements,
41
payment of taxes and maintaining insurance. The Loan Agreement contains two financial covenants. The Company must maintain:
1.Senior Funded Debt divided (as defined in the Loan Agreement) by EBITDA (as defined in the Loan Agreement) at or below 3.50 : 1.00 when tested at the end of each fiscal quarter on a rolling four-quarter basis, and
2.A minimum Debt Service Coverage Ratio (as defined in the Loan Agreement) of 1.25 : 1.00 at the end of each fiscal quarter when measured on a rolling four-quarter basis.
XPEL Canada Corp., a wholly-owned subsidiary of XPEL, Inc., also has a CAD $4.5 million revolving credit facility through HSBC Bank Canada. This facility is utilized to fund our 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 December 31, 2022 and December 31, 2021, no balance was outstanding on this facility.
Critical Accounting Estimates
We have adopted various accounting policies to prepare the consolidated financial statements in accordance with U.S. GAAP. Certain of our accounting policies require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. We identified the critical accounting policies which affect our more significant estimates and assumptions used in preparing our consolidated financial statements.
Certain of the most critical estimates that require significant judgment are as follows:
Business Combinations
The accounting for a business combination requires the excess of the purchase price for the acquisition over the net book value of assets acquired to be allocated to the identifiable assets of the acquired entity. Any unallocated portion is recognized as goodwill. We engaged an independent third-party valuation specialist to assist with the fair value allocation of the purchase price paid for our various acquisitions to intangible assets. This required the use of several estimates and assumptions including the customer attrition rate, forecasted cash flows attributable to existing customers, the discount rate for the customer relationship intangible asset and future royalties, contributory asset charges, and forecasted revenue growth rates. Although we believe the assumptions and estimates made were reasonable and appropriate, these estimates require judgment and are based in part on historical experience and information obtained from the management of the acquired entities.
Inventory Valuation
Inventories are stated at the lower of cost or net realizable value. Cost is determined on a weighted average cost basis. We record inventory write-downs for scrap and excess or obsolete inventories based on assumptions about historical demand calculations, forecasted usage, estimated customer requirements and product line updates. These assumptions are inherently uncertain and changes in our estimates and assumptions may cause us to realize material write-downs in the future.
Recently Adopted Accounting Pronouncements and Accounting Pronouncements Not Yet Adopted
Refer to Note 1 to the Consolidated Financial Statements for discussion of recently adopted accounting standards and accounting standards not yet adopted.
42
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.