Nov 17, 2017
Executives
John Nesbett - IR, IMS Ryan Pape - President and CEO Barry Wood - CFO
Analysts
Alan Weber - Robotti and Company James Barnby - DKAM
Operator
Greetings, and welcome to XPEL Technologies Third Quarter 2017 Earnings Call. [Operator Instructions.
I would now like to turn the conference over to your host, John Nesbett of IMS. Thank you.
You may begin.
John Nesbett
Good morning, and welcome to our call to discuss XPEL’s financial results for the 2017 3rd quarter. On the call today, we have Ryan Pape, XPEL’s President, Chief Executive Officer; and Barry Wood, XPEL’s Chief Financial Officer, to provide an overview of the business and review the company’s financial results.
Immediately after the prepared comments, we’ll take questions from our call participants. Let me take a quick moment to read the Safe Harbor statement.
During the course of this call, we’ll make certain forward-looking statements regarding XPEL Technology Corp. and its business, which may include, but not limited to, anticipated use of proceeds from capital transactions, expansion into new markets, execution of the company’s growth strategy.
Often, but not always, forward-looking statements can be identified by the use of words, such as plans, as expected, expects, scheduled, intends, contemplates, anticipates, believes, proposes or variations, including negative variations of such words or phrases; or state of certain actions, events or results may, could, would, might, or will be taken, occur, or be achieved. Such teams are based on the current expectations of the management of XPEL.
The forward-looking events and circumstances discussed in this the call may not occur by certain specific dates or at all and can differ materially as a result of known and unknown risk factors and uncertainties affecting the company, performance and acceptance of the company’s products, economic factors, competition, the equity markets generally and many other factors beyond the control of XPEL. Although XPEL has attempted to identify important risks that could cause actual actions, events or results to differ materially from those described in the forward-looking statements, there may be other factors that cause actions, events or results to differ from those anticipated, estimated or intended.
No forward-looking statement can be guaranteed, except as required by applicable securities laws. Forward-looking statements speak only as of the date on which they are made, and XPEL undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future results or otherwise.
Okay. With that, I will now turn the call over to Ryan Pape.
Go ahead, Ryan.
Ryan Pape
Thanks, John, and I’ll extend my welcome as well to our third quarter earnings release call. As you probably guessed from our press releases and news the past couple days, it’s been a very active quarter for the company.
I think as we talk about some of the other things we’re working on, you’ll see that’s existed for quite some time through the quarter. So we had a great record-breaking quarter.
Third quarter revenue growing 31.6% to $17.8 million. Obviously, I’m very pleased with our top line numbers.
Puts us back in a range that we’re happy to be, and as we continue to execute on our Get Close to the Customer strategy. So we continue to see strong growth across all our product lines.
Obviously, our really second product line of our window film continue to do well, so represented 10.8% of third quarter revenues. So that’s progressing as we’d expect, and we’re certainly pleased with that.
We’ve seen great revenue growth on our export sales during the quarter. Really, all year long, but the quarter in particular.
We continue to see increasing demand internationally, particularly in Asia. As we discussed in the past, our export sales are primarily sold through distribution partners where margins are lower.
And that trend’s kind of been true across-the-board. So we’ve seen the strongest growth in all the markets that have the lowest margin, either due to distribution, as I just mentioned, or currency.
So if that’s Asia, through distribution. We’ve had a 30-plus-percent growth in Canada, so that’s obviously FX-impacted, lower margin.
And then our European business is doing well, and that’s FX impacted there, too. So that’s been true all year and is still true in Q3.
So to the extent that this impacts our sales mix, so higher percentage of our sales at lower margins for either of those reasons, our overall gross margin will be impacted. And that was certainly was a contributor to our Q3 gross margin degradation.
That said, we have a number of promotional pricing agreements that were established, particularly for some of these export customers and international customers either due to currency impact or as a result of supply challenges we had in 2016. And these are starting to roll off in Q4, and that will continue to happen going into the beginning of 2018.
So that will be a net positive to gross margin. These tend to be some larger accounts and if they’re international or moving volume, they have particularly aggressive pricing for one reason or another.
And so we’re going to see some positive momentum on that the rest of the year and next year. Now we’ve also made a change to our DAP software pricing.
As most of you know, our DAP database has 70,000-plus patterns, and it’s a huge differentiator and driver of our business. It allows customers to install our paint production film efficiently with less waste.
So we’ve changed our DAP pricing in the U.S. and rest-of-the-word segment to incent and better reward customers who use our film.
So put simply, the customers that buy our film pay a lower DAP price than those who don’t through our Captain program. So these changes resulted in some reduction on our access fee revenue, about 70,000 in Q3 over Q2.
So that’s our highest margin revenue stream. So obviously, you feel that, but we’ve created a much more streamlined and manageable go-to market strategy in U.S.
and rest-of-the-world. And ultimately, even in spite of that, we expect to fully recover all that DAP revenue over time, and it’s drastically simpler to implement and drastically easier for our sales team to manage.
So we felt that this quarter, but there’s a great streamlining effect there. We’re also in the process of launching a next-generation film, Ultimate plus, which provides easier installation for our installers and along with some of the enhanced optical properties we’ve been introducing over the past year.
So as a result of launching that and with corresponding price adjustments, we expect to see a positive margin contribution from this change in the U.S. market and in some of the international market starting in January.
So that’s a good thing. We have plans to streamline our PPF products mix going forward into 2018 to reduce the number of SKUs.
So a fewer SKUs creates greater efficiency, higher inventory turns within each product line. So this started in Q3, continues into Q4.
We picked up a few low-margin sales in Q3 as we worked some of these product lines out and just as an incentive to move them. So a portion of that one-time COGS expense in Q3 was related to writing off some of these revenant products or versions of products we decided not to otherwise commercialize.
And I think that we’ll see a little bit more of that in Q4, and that was in addition to some of the other changes. So operationally, we’ve made significant changes during the third quarter, and these will have a positive impact on future results.
We consolidated our warehouse operations from three facilities to one in San Antonio. So obviously, there was cause to do that.
And really, one time COGS and SG&A to do that majority in Q3. Some will be in Q4, but as you’re going through that process and also trying to reduce SKUs, it’s just a natural time to clean up inventory and get rid of if there’s damaged product or obsolete products.
So we feel some of that, but it’s a substantial savings long term and a tremendously increased efficiency. So that was in Q3 and Q4.
Already, we’ve eliminated a fourth facility we had in San Antonio where we did a few other things, including our window film training. So we’ve been able to move that into our headquarters operation.
Now we’ve freed-up space, so we’ve sort of drastically simplified the footprint here, which is good for cost and efficiency and everything else. So, as a result of the consolidation, we expect to realize significant efficiencies on our processes resulting in lower cost on a go forward basis, which will have a positive impact on gross margin.
So I think, it’s important to remember that we have significant other costs more than cost of materials that make up the cost of goods sold. So managing those costs is an important factor.
And we’ve reduced our production team significantly in October as a result of the efficiencies from the facility consolidation. This is a savings to COGS going forward net of severance costs related to that, and that’s we’re talking 15 plus people involved in that.
So these are major changes we’ve made. We also restructured our sales and operations team during the quarter, which we believe will better position us to scale in a more efficient manner.
So as a result of these moves, we’ve encouraged some one-time cost related to severance relocation and recruitment. So this impacts our bottom line in the short term, but have a significant impact to the business going forward.
So these costs were approximately 140k for the quarter, and that’s separate from personnel changes that impact COGS, so the production expense. This is in addition to that.
So I can’t really overstate the magnitude of changes we’ve made internally. It’s not like anything we’ve ever done before.
And we’ve also been able to integrate some of the folks from our acquisitions in key positions going forward. So I think these acquisitions, aside from growing the business and all the other benefits from them, they really help develop the future leadership and expand the talent pool of the company probably in a way that we didn’t anticipate directly at the time.
So that’s really a net positive. As we announced Tuesday, we recently acquired Transguard, Inc.
in Boise, so this is another perfect example of our Get Close to the Customer strategy. They obviously have a great reputation in Boise area for high-quality service.
They’re the leading operator in the area, by far. So we think consistent with the strategy, this lets us capitalize on that growing market, and it has really favorable characteristics and great market for these products.
So it’s really a great opportunity to test our strategy. So Boise has a smaller market than we’ve operated in before, but it has fundamentally good dynamics.
So one of those is that due to the size, we really had a limited number of independent installers in the market where Transguard’s really the only one. And that’s done for the right reasons, but can we support more in that market?
Probably, we can. And now that we’re in control there, we have the ability to do that.
So it’s really a test of does our Get Close to the Customer strategy, does our ability to operate in the market actually increase the addressable size of the market? That’s the key question for Boise, Idaho, and I think the answer will be yes.
So excited to see that play out over the next year. And then yesterday, we announced our intent to acquire 100% of Protex Canada, the top franchisor of paint protection and window film in Canada.
So they have over 75 franchise locations in four provinces. The Protex franchisees have been great customers for XPEL back when they purchased through Parasol which was our distributor in Canada.
And then, obviously, since we’ve acquired Parasol in 2015, they’ve been a great customer. And we’ve had a five year exclusive supply agreement where all the franchisees have to purchase these products from us.
So Protex has a revenue stream of royalties from franchisees, as you might expect on sales, and then a rebate from XPEL of around 7% to 8% of purchases. So franchisees would buy from XPEL directly.
We would sell to them, we would collect from them, and we do this already. But then, we would remit a royalty back to Protex as the franchisor.
So you can imagine that, that rebate is particularly costly for us in a low Canadian dollar environment where we’ve been due to U.S. dollar product cost.
So Protex network has been growing their sales at a substantial rate, so the net effect of the Canadian dollar plus the rebate is substantial. And the net effect of that combined really amounts to another situation where we have a relatively low export type margin.
So in addition to the strategic nature of the acquisition, this will also positively contribute to the overall gross margin position. So in addition to that, obviously, a de-risk to revenue.
We currently received from the Protex franchises is that, that agreement will up for renewal in 2020. The Protex brand is very well known throughout Canada.
We look forward to participating in the continued growth. We’ve got a dedicated management team there, and we intend to support them and help them.
But we also want them to run the business because they need to stay and be 100% focused on serving the franchisees we have and growing that. So it’s important that we maintain that balance.
So at this point, we have no plans for the Protex brand outside of Canada. It doesn’t mean it won’t happen, but it’s not on the radar at this point.
So overall, I think really a great deal for us, really helps us in a lot of ways. Long term, it will bring a lot of efficiency where we can leverage some of the back-office teams for finance and accounting.
But important to remember that as Protex, we’re buying really a high-margin revenue stream, and if you want to think of it as an acquisition; and we’re offsetting hit to COGS, if you don’t think of it that way. So all in all, really good, really happy to do that.
So I think as you can see, third quarter was pretty transformational. Like we said, we’re pleased with the top line growth.
I think the opportunities for revenue growth continue to be strong as we go forward. We’re heavily focused on controlling SG&A growth.
I think as Barry will mention, roughly almost a third of our Q3 SG&A growth is related to our European operations. So we’ve invested heavily there and we have a solid team now.
So we’re really focused on SG&A growth and margin enhancement. These come top priority after sales growth, so we put sales growth above all, but we are very focused on those things.
So I think we can -- I think we do good. I think we’ll continue to do better.
But overall, really a good quarter for us. So with that, I’ll turn it over to Barry, and we can dig into the numbers some and then take some questions.
Barry?
Barry Wood
Thanks, Ryan. And good morning, everyone.
Before I get started here, let me first say that we’ll state certain key measurements on a constant currency basis as we think that provides additional visibility into our operations. Constant currency numbers are not IFRS measure and reflect the current period’s results as if they -- we were using the prior comparative periods of exchange rates.
For the quarter, revenues increased 31.6% to $17.8 million. Obviously, a record quarter for us.
On a constant-currency basis, revenues grew 30.7% for the quarter. It was a record-breaking quarter for us as -- where our previous quarterly record was $17 million, which happened in the second quarter of this year.
As Ryan also mentioned, growth was strong across all of our major product lines. Our window film product line represented 10.3% of total revenue for the quarter and 8.5% of year-to-date revenue.
On a year-to-date basis, revenues grew 23.4% to $47.5 million. Gross margin for the quarter grew 11.6% to $4.3 million and declined as a percentage of sales to 23.9% versus prior year quarter and represents a sequential decline in gross margin versus Q2 2017, which came in a little above 2.27%.
This degradation was due to three main factors: First, as Ryan mentioned, the increase in mix of export sales. Secondly, as Ryan also mentioned, recorded some write-downs of inventory as we prepared for the consolidation of our warehouse facilities and also the product consolidation.
And lastly, we saw obviously some margin degradation due to the debt pricing change Ryan referenced earlier as higher-margin software revenues replaced with lower margin product sales, albeit for very good business reasons. The combination of these three items accounted for the margin degradation we saw in Q3, especially relative to Q2 2017.
But we see this margin degradation as an aberration and expect to, for all the reasons Ryan alluded to, see improvement in this areas in the future. If you just sort it for the one-time items in COGS relative to the warehouse consolidation and the product consolidation, gross margin would’ve been right around 27%.
So the impact on that was significant. On a year-to-date basis, gross margin grew 12.5% to $12.2 million and decreased as a percentage of sales from 28.2% to 25.7%.
This year-to-date margin degradation was due to supply overhang issues we discussed during our Q1 earnings call and also the Q3 items that I just mentioned. On the SG&A front, SG&A expenses for the quarter increased 37.7% versus prior quarter and 39.2% on a year-to-date basis.
While we continue to invest in the business in Europe and in other areas to build scale, we did incur one-time costs related to the restructuring of our staff that Ryan mentioned totaling about 140k. Also as we’ve noted in prior quarters, effective January 1, we changed our method of depreciating our fixed assets from the double declining balance method to the straight line method.
And as we’ve stated before, this change is made to better reflect how we consume future benefits of the assets. This change accelerated depreciation of some of the older assets into 2017, and the impact of this will lessen significantly beginning 2018 and beyond.
And the impact of this change for Q3 was about 90k. So if you normalize for our one-time restructuring costs and this depreciation change, SG&A expenses would have grown 28.5%, a rate less than our sales growth and represent about 18.6% of total sales, which we think is more reasonable, given our continued investment to scale the operations.
But again, while we’re pleased with our progress thus far, we’ll continue to focus on SG&A and invest where appropriate in order to maximize operating leverage. Another item of note, and Ryan alluded to this as well, our SG&A for our European business increased to about 250k versus prior year quarter, which is really about -- accounts for about one/third of our SG&A growth in the quarter.
Keep in mind that we’ve added approximately $1 million in annualized SG&A cost to complete and fully staff our European operations, and -- which is obviously significant. But now that we kind of have the plumbing built there, our rate of SG&A growth will certainly reduce as we move forward and we’ll continue to gain operating leverage as sales continue to ramp up in that region.
EBITDA for the quarter decreased $0.4 million to $1.2 million and decreased to $1.1 million to $3.2 million on a year-to-date basis. The Q3 decrease was due mainly to the gross margin degradation discussed earlier as well as the SG&A increase.
If we factor out nonrecurring items that would impact EBITDA, EBITDA would have been $1.9 million for the quarter or a 24% increase over the prior year. Net income for the quarter decreased $0.28 million versus prior year quarter, finishing at $0.44 million.
On a year-to-date basis, net income decreased to $1.3 million. On a constant-currency basis, net income was $0.43 million for the quarter and $1.12 million on a year-to-date basis.
Net income, if you factor in our one-time adjustments, would have been right at about $1.1 million, a 35% increase over the prior year. Operating cash flow for the quarter turned slightly positive as we completed our planned inventory buildup pursuant to the execution of our strategy to place inventory closer to our own customers.
On a year-to-date basis, our net cash used in operating activities totaled approximately $3.5 million, due again mainly to the outflows related to our planned inventory buildup. Our inventory turnover for year-to-date 2017 was about 3.2 times -- I’m sorry, three times versus 3.8 times in prior year-to-date period.
Our balance sheet continues to be very strong as evidenced by our liquidity ratios, and our debt-to-equity ratios are -- continue to be optimized. We accomplished much in Q3 and we think we’re turning in the direction in a lot of key areas.
But as Ryan also mentioned, we made significant changes internally. It was a lot of hard work by a lot of folks, but it was absolutely necessary to set us up to scale efficiently in the future.
And while we’re pleased kind of with our progress thus far, we know we still have a lot of work to do and we’ll continue to get after that. So with that, operator, we’ll now open the call up for questions.
Operator
Thank you. We’ll now be conduction question-and-answer session.
[Operator Instructions] Our first question is from Alan Weber with Robotti and Company. Please state your question.
Alan Weber
So a question about the Protex acquisition. Can you just explain kind of what the system-wide revenues are there?
And does that franchise model lead you to think that you can expand that in other areas? I’m just curious about that.
Ryan Pape
So I think when -- we haven’t released the revenue number for Protex, but it’s relatively minimal when you consider that their revenue stream is royalties and rebates from us, so it’s not an overall material amount. I think that they have a great presence in Canada, have done exceptionally well, particularly in Eastern Canada.
There’s brand awareness around the Protex name like you don’t see in very many places. So I think when we look at this, we’re looking at it in Canada as a franchise opportunity, maybe a little bit differently than others might.
So fundamentally, our goal is to sell product, and that’s a key goal with the Protex opportunity as well as opposed to some where primary goal is to sell franchises. So we obviously want to expand the network there, and we will, and that’s actually happening.
But we want to do it and be smart about it because we have other incentives than just advancing the number of franchises be at the product sales, so it’s got to be good for everybody. And I think that what it represents in Canada and where it exists is it’s another option for customers who are looking for that extra level of support, the team on the ground to help in identity, product mix that is lock and set.
And it works exceptionally well there, and it will continue do so as we grow it in Canada. I think if you believe it works well there, there’s certainly other places where it can work well, too.
But that said, it’s been existing in one form or another since the late ‘80s, early ‘90s in terms of predecessor companies in Canada, so there’s a lot of history there. And it doesn’t represent that we think there’s a shift to that model or anything elsewhere, but it’s certainly another tool in our arsenal and one we’ll continue to look at.
Operator
Our next question is from Adam Goldstein, [ph] a private investor. Please state your question.
Unidentified Analyst
Congratulations on the revenue growth this quarter. That was excellent.
Would you say that kind of momentum is continuing into the fourth quarter, or not?
Ryan Pape
Yes, I think what visibility we have into the future that we have. So as we know, we don’t have supply agreements generally.
We have to earn our business every month. But I think that the revenue growth in second quarter was strong.
It was strong in third quarter, and we expect the strong revenue growth to continue.
Unidentified Analyst
Okay. I got a question about how the accounting works for Protex before they were acquired.
You mentioned rebates. Were the rebates accounted as a decrease in net revenue for XPEL?
Or were they accounted for as an increase in COGS?
Barry Wood
Adam, this is Barry. They were accounted for as an increase in COGS for us.
Unidentified Analyst
Okay. So it would seem that as Ryan mentioned, it seems like that would cause an improvement in gross margin.
But you were saying the revenue stream is immaterial, so I guess, we really shouldn’t see an effect on gross margin then?
Ryan Pape
No. I think as you’ve stated, Adam, with the accounting, the net effect of that rebate and the consolidation, there will be a net effect to COGS on that.
I mean, relative to -- or a positive effect rather. So relative to the overall picture, that’s not insignificant, but you’re still in a low Canadian dollar environment.
You have these other factors, which drive it, too. But the net effect is that over the next year and into the future, that will be a positive contributor there because the cost and SG&A that you pick up with Protex is more fixed than the rebate we pay, which scales directly with revenue.
So as that operation has grown over time, they’ve been able to pick up the efficiency of more fixed SG&A but increasing revenue in the form of the royalty from us and the rebate -- or I’m sorry, the rebate from us and the royalty from franchisees. So our expectation would be that we get the benefit of that going forward now and fully expect to.
Unidentified Analyst
Okay, great. My last two, I guess they’re kind of requests.
I wonder if you’d consider improving the disclosure a bit on a couple of things? Like for one, we can’t see how the revenue is changing in Asia or any of the -- you have sort of lumped into U.S.
revenue a bunch of into the U.S. segment a bunch of stuff that’s non-U.
S. Is there any chance you guys could start breaking out rest of the world separately so we could understand the business a little better?
Ryan Pape
Yes, that’s something that’s under review now for next year.
Unidentified Analyst
Okay, great. One more thing on disclosure.
Especially as you guys continue to do acquisitions of installers, it would be interesting to see how XPEL’s business breaks down in terms of installation business versus the wholesale product sales, you know what I mean?
Ryan Pape
Sure. Yes, I think -- so I think you’ve kind of -- the two issues you brought up are kind of related.
So as we look at how we look at the business and then how we think others should look at the business, you have a lot of competing things, because you now have a service revenue and associated cost from the installation side. But then, you have this geographic component.
So it needs to be the proper metric for dissemination and reporting needs to be developed. But it also say that a focus on service revenue versus product revenue, while it’s important and we look at it every day, it’s not the most important thing.
So if our acquisition in Boise, and I would not expect this, but if that ended up where we did no installation revenue there but it turned into a tremendous success on the product side because we were able to unlock the market and bring on a lot of new customers, I wouldn’t be unhappy with that. So from that standpoint, when we’re looking at it, we’re increasingly looking at it as a P&L by market for the folks we have managing it.
So our direction to our team for the Boise market, same as the Las Vegas market or Houston market, is that we want you to drive performance of this market using everything we have at our disposal, which is service revenue and product revenue. But ultimately, we’re not sort of internally bias to how that should be.
The reality is it does intend to go one way or the other it will end up as a mix, so I think that looking at the service revenue component going forward probably does make sense. But ultimately, what we’re trying to do is create geographic centered accountability for our team operating, whether it’s a region or a local market, and giving them the sort of tools and some of the autonomy they need to run that market best based on the type of customers and the setup.
So I definitely understand your point, and I think that folds in with the geographic reporting. And it’s certainly, I think, a challenge even for us with access to all the information because we’ve got a lot of competing things and a lot of different ways to win.
But certainly, I understand your point.
Unidentified Analyst
Okay. Well, just one last kind of follow on.
I guess it’s my impression, although I don’t really have the numbers, my impression was that the service revenue is higher-margin than the product revenue. So like if -- I’m just thinking like if a customer comes into an installer and has there -- wants a paint protection film added to their car, the total amount of dollars they spend -- I guess, I’m guessing that the fraction of those dollars that go to the product is kind of small compared to the overall paint protection.
Ryan Pape
Yes, I think what you’re saying is that for us in aggregate on the service revenue of installing the product, we have a higher gross margin on that and higher revenue dollars per car both than we do when we sell the product. So I think that’s accurate.
Now the difference in those type of operations is you’ve got facilities, you’ve got different personnel expense. So you have a higher fixed cost probably for that incremental revenue, too.
So if you were a marginal operation or a marginal time of year or bad month or whatever you say, you still got a hurdle rate to go through for your fixed cost. So the dynamic there is a little bit different.
But overall, I think you’re correct that we see higher gross margin from the installation business than we do product sales business and higher revenue per vehicle. That’s correct.
Unidentified Analyst
Okay. All right.
So great. So it does -- I mean, that is a great reason than to sort of disclose that better so that we can see those two types of revenues.
But all right, that should do it.
Operator
Our next question is from Max Poleski [ph], a private investor.
Unidentified Analyst
Ryan, as you know, I’m a long-term shareholder, and I appreciate the primary focus to increase sales and decrease cost of goods. My question, I’ve got two questions.
One, are either of these two purchases involving stock? Are you paying in stock for any of these?
Ryan Pape
No, these are cash, and they tend to have a significant seller-financed component over a number of years.
Unidentified Analyst
Okay. So I was -- I asked that in anticipation of my second question.
I find that your website is absolutely atrocious. I hate to say that.
It’s -- I cannot -- if you go to your website, I cannot find who the corporate officers are, corporate directors. And I think that being the first thing that somebody would look at your company, needs vast improvement.
And I’m just wondering if you’re going to take a look at it. I don’t know how potential investors would look at this company when they can’t get information.
And it’s been frustrating. I’ve asked this question many times.
Three or four years ago, I asked if you guys are going to go to the U.S. market.
Do you have any plans in that regard to get off the Canadian market? I think it’ll be a benefit to you to improve the share price significantly if you told the story much better.
So I don’t know if that’s a question or a comment.
Ryan Pape
Yes. Well, I think all the feedback is good.
I think as far as I know, last I checked, the management team and director should be listed on the website. So if that’s not there, we’ll certainly take a look at that.
I think that first thing -- first story I want to tell on the website is about the product, not about the company. So understand that’s me operating from a different perspective than you are.
But your point’s well taken, so I think we can look at that and probably dress that up substantially. I think that -- we’ve talked about it before, and long term for this company, it makes sense to list in the U.S.
and make the transition. Agree with that 100%.
I think everyone involved does. It’s just simply a matter of slotting that in and getting the resources to do it, along with a thousand other things and stacking that up with all the competing priorities that we need to make the business better and grow the business and all the other things.
But I think there is a unanimous agreement that, that’s in our future and that we’re going to do that.
Operator
Our next question is from James Barnby with DKAM. Please state your question.
James Barnby
My question’s just about you made the Protex acquisition, you’re streamlining the SKUs, and obviously, this is going to be fairly different business kind of in the near future here going forward. And in order to make those decisions that you made, you must have some view on what this is going to do incrementally to gross margin.
So I was wondering if you have a view of where gross margins go from here for 2018, 2019. Yes, that’s my question.
Ryan Pape
Yes. So I think that the hardest area for us to forecast is where is the growth and where do we see the growth.
So the reality is that if you look at this year, we have Canada growing very nicely, unlike the previous year where it was growing slower. We have Europe growing nicely and we have Asia and China growing very nicely.
They are all three growing faster than the U.S. in the past several quarters.
So if that continues or the rate of growth there continues, you obviously see lower margin contribution than you would in the U.S. business aside from the ability to raise prices in those markets or get the benefit of currency.
So I think that the sense is though that when you look at your Q2 gross margin, you look at the Q3 gross margin, and certainly, the Q3 adjusted gross margin, which looks a lot like Q2, we’re trying to get to the point that, that’s the absolute floor and we’re moving in the opposite direction. So our sense is that through the pricing adjustments and some of the contractual adjustments we are doing, the changes with Protex, a variety of these things, that absent maybe a further degradation in the FX position where we’re exposed, but it’s been relatively stable the past six months, that we’re going to be in a position to see gross margins begin to increase into end of this year, beginning of next year.
And that’s not just from pricing and mix in Protex. It’s from things like optimizing our production costs, which is the changes that we’ve made there may be worth half or a point of COGS for the year if they were annualized.
So there’s lots of ways that impact that. So to say where is it going to be for 2018?
I can’t tell you what it’s going to be. I do know for given customers and given regions, that we’re making improvements there where it was and where it will be.
But I don’t know the mix -- what the mix is going to be next year between U.S. growth and China growth.
I’d love to be able to forecast it, but we get very limited information to be able to do that, but that’s going to be the ultimate driver of the consolidated gross margin.
James Barnby
So do you guys have an internal target that you use to make decisions, like where you think...
Ryan Pape
Yes. We have targets by segment.
So I have a target for Europe, I have a target for Canada, I have a target for China and I have a target for the U.S. But what I don’t know I have a guess on the mix, right?
But ultimately, I don’t get to choose the mix. And the reality is that to pick on China, say, if China grows at double the rate we expected and they have a lower margin than the U.S., I’m certainly going to take the sales even as it reduced my overall gross margin, while simultaneously figuring out how to increase the margin for that segment.
So I appreciate the question, but in practice, it’s saying what is our market price? What is our sales price in Canada need to be relative to the market, relative to the competition.
What is our price through distribution need to be to China to be competitive and allow our distributor to make a margin. Those are the things we can control.
How well each of those perform relative to one another, we can make a guess at it, but to a certain extent, we’re along for the ride.
James Barnby
Okay. I don’t want to beat this too much, but I’m going to ask just another part on gross margins here.
Do you think it’s more reasonable to expect the gross margins that we experienced in Q3 here? Or do you think it’s more reasonable to expect something closer to what was observed in 2016?
Ryan Pape
No. I don’t think Q3 as a go forward is what we’re expecting.
We’re expecting to move back to sort of 2016 and hopefully beyond that as we work through all these initiatives.
James Barnby
Okay, perfect. And then my last question kind of relates to your response to my first question, and you mentioned again that your priority has continued to be -- like the top priority is revenue growth.
And I’m wondering if you could just outline again why you see that as your top priority? And then if you ever see yourself shifting to be more conscious of margins and having that as a top priority.
Ryan Pape
Well, I think that focusing on growth to be a growing company and grow a company to a certain scale is certainly a well-understood concept. I mean, we could maximize our gross and net profitability as a $50 million year company and hop along like that, but that certainly doesn’t come close to satisfying my vision for this company nor I think what all shareholders can realize if we grow.
So yes, you have gross margins and the incremental gross margin on a given sale and what that does to your aggregate, but you still have the net margin of the business, which even at low gross margin sale, theoretically contributes to that net margin as your overhead costs are fixed. I could tell you my salary hasn’t increased with sales from 3 million in 2009; wish it had.
But so all of those things are opportunity and really depends what kind of company do you want to become? And for me, we can become a much larger company, which ultimately generates a lot more net operating margin.
And if that means we accept lower margin sales to China or lower margin sales to Canada due to FX in the meantime, I think that’s great because all of that pays dividends over the long term as you raise prices, lower cost and keep your operating expenses, expense growth constrained.
Operator
Our next question is from Jason Hirschman, [ph] private investor.
Unidentified Analyst
Ryan, Barry, thanks for providing some clarity around the restructuring charge and all those changes going on in XPEL. It’s impossible to keep up, practically.
I’ve got one question for you on margins, and then I’ll move on to a wholly different topic. So you mentioned in your commentary that there’s some pricing contractual agreements for overseas markets, or I think you said rolling off in the next few months.
Are they going to be set to a new level? Or are you implementing a completely new pricing approach for those contractual agreements?
Ryan Pape
No. I mean, put simply, there are some key customers internationally that are receiving price increases where the pricing was either held or reduced in 2015 or 2016 either due to currency impact that may have been impacting them if they were purchasing in U.S.
dollars? Or concessions that were made in 2016 due to limited inventory availability when we had our supply issues.
So with some of those key accounts, it’s pretty simple. The price is going up and they tend to be low-margin accounts, so -- low-margin sales.
So those have sort of an outsized impact for the customer base.
Unidentified Analyst
Okay. I know the recent installer acquisitions in Las Vegas, in Dallas, in Houston, and these are profitable business at the time of purchase.
Are you increasing expenses and investments in these installers that are temporarily driving down profitability or even all the way to breakeven and so that you can sort of spur them for faster growth?
Ryan Pape
Well, I wouldn’t say that’s true on a location-by-location basis, but it’s sure true just with the aggregate investment we’re making in the business. So I mean we’ve -- so if we bought the Protex business, for example, and then simultaneously, we’ve established the window film training center.
That’s got people dedicated to it. So that has a net effect of probably muting the net contribution from that acquisition as an example.
So I don’t think that the investment that you speak to is necessarily happening at that installation center level, but it’s happening sort of contemporaneously with other things we’re doing. And the reality, not speaking to Protex, but if we were to acquire an installation center that might do $500,000 a year in revenue, you don’t have to have a lot of other initiatives like a window film training center to eat up any incremental margin from that business directly.
So I think it’s not tied to that, but tied to just the other initiatives and things we’re doing.
Unidentified Analyst
So it looks to me, just looking at the numbers, that the gross margin issues are just purely because of mix between different geographic regions, mostly whether it’s China is lower margin, let’s say. But the SG&A investments -- or higher SG&A is because of investments in Europe and in the United States, sort of like direct markets.
Is that a fair characterization?
Ryan Pape
Yes, I think that’s accurate. When you look at the installation businesses as well, if we were to acquire and then consolidate the installation business, there’s a portion of that is cost of goods, be it labor required to install the products, that’s cost of goods.
But then you have really businesses that per revenue dollar versus selling a roll of film. You’ll have a higher SG&A component per revenue dollar than selling a roll of film does also.
So be it a facility, an electric bill, things related to facilities and premises. So that results in higher SG&A expense for those facilities, but that really should be offset with higher gross margins from the installation business.
But I think you’re right in that, as Barry talked about, close to 30% of our SG&A increase in Q3 is related to the European operation. That’s huge and that substantial.
And we’ve made a major investment there, and that business continues to develop. But that business, by itself, like us overall, they’ve got to go through that cost structure.
And they’re growing through that cost structure in an environment of the bad FX condition, too. So you feel that, but you do that and you do a few other moves investing in the U.S.
business or the corporate side, and that’s where that SG&A growth is driven from.
Unidentified Analyst
Now you just introduced a brand new PPF film in China called -- and I’m going to try and say this on emphasis, Zeus. Also an improved Ultimate plus in North America.
I think these films are modestly higher-priced than ULTIMATE in China or ULTIMATE in North America, right? And secondly, how are they doing?
Ryan Pape
No. So yes.
So we’ve got an additional product in China that is higher-priced. That’s really a couple of months into that.
That’s doing well. That’s contributing to sales growth there.
You’re correct in that is a higher-margin product that was added. Then the Ultimate plus in the U.S.
is really the next-generation of the ULTIMATE film and now coincide with some pricing adjustments there. We think it’s actually quite an improved product in terms of installation characteristics.
It’s important when you think about the product everyone thinks about what does a consumer think of the product. That’s very important.
But consumers think about how does the product look and how durable is it. And that’s really, as a consumer, the only thing you care about.
But the reality is that product’s got to get from our shelves to be installed on the vehicle. So if we can make it easier to install, that has an outsized impact on the installer, and in many respects, sometimes the consumers are the ones demanding the product, and sometimes, the installers are telling the consumer what product.
So if you can bring a solid win to the installer, that’s tremendous. And so that’s what the Ultimate Plus and the changes we’ve made to make it easier to install, that’s really who that’s geared towards.
Unidentified Analyst
And finally, any initial thoughts or reflections on the flat glass business? Is this going to become like a window tint size business?
Or is there any guidance you can give us just about the quality...
Ryan Pape
Yes. So just to recap so that everyone knows what you’re talking about, but a component of the window film business that we’ve launched is a flat glass for commercial and residential film business.
And this is attractive to us for a couple of reasons. In terms of addressable market size, it’s very large.
It gives us overtime exposure beyond automotive, which has always been a sort of tertiary priority for the business. And then we have a built-in ready-made way to access that additional line via some of our existing customers.
So that product line is brand-new for us. We’ve just started some of the initial announcements in sales of that.
And we certainly, over time, have very high expectations for that. And if you look at our 10-plus percent of revenue as window film today, the vast, vast, vast majority of that 95% plus is automotive film.
So to expect that over time, on the commercial and residential side, we can build a substantial business there. That’s what we expect.
Operator
Our next question is from Meredith Brill with Brill Capital [ph]. Please state your question.
Unidentified Analyst
I just wanted to touch on the Ultimate Plus product. And I was wondering if you could give information about the timelines of the rollout in the U.S.
Ryan Pape
So the Ultimate plus product is very similar to the ULTIMATE product as we’ve been selling it for the past few years. We’ve made some rolling enhancements to the ULTIMATE product over this past year, and then this -- a final change which adjust the installation characteristics.
That’s sort of the more substantial change to the installer. Some of the other changes benefit installer and consumer alike.
So we’ve started selling that product to select customers over the past 60 days. And then in December and into January, we’re going to be pushing hard to roll that out and work towards moving many or most of the customer base in the U.S.
over to that product.
Unidentified Analyst
And Canada as well?
Ryan Pape
And Canada as well, yes.
Unidentified Analyst
And is that concurrent with some sort of price adjustments, or?
Ryan Pape
Yes. Yes.
So that will be, for most customers, at a higher price, which will increase the margin on that product for us.
Unidentified Analyst
And you’re going to keep, I’m assuming, the ULTIMATE just as a back up until everyone sort of migrates?
Ryan Pape
Yes, we are. And it will be somewhat based on customer feedback, how that co-exists and what the timeframe is.
We’ve got a real initiative to simplify the number of SKUs. There’s the ULTIMATE product, which we all talk about.
But then we’ve got essentially four or five other products that we sell different places in the world for different things. So we want to simplify.
So we’ll have to take a real hard look at that. And we’ve -- as the other caller mentioned, we’ve added additional product in China, which is even a further different product, so we have to be real mindful of that.
So the goal is to probably transition that completely at some point. But we’ll wait and work with the customers and see how that goes over the first couple of months of next year.
Operator
Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to turn the call back to management for closing remarks.
Ryan Pape
Thanks, everybody, for the questions and for your participations. We’ll talk to you next quarter.