CPI Card Group Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Dollar figures are in millions unless otherwise noted.
Business context
CPI provides financial payment cards and related personalization, fulfillment, and software services. Its reportable segments are U.S. Debit and Credit, U.S. Prepaid Debit, and U.K. Limited. The filing attributes the sharp downturn primarily to softer EMV card demand among large U.S. issuers and processors.
Financial results
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Net sales | $65.8 | $73.7 | $121.9 | $160.1 |
| Gross profit | $19.3 | $22.7 | $35.4 | $52.4 |
| Gross margin | 29.3% | 30.8% | 29.0% | 32.7% |
| Operating income | $2.0 | $4.5 | $0.2 | $18.2 |
| Net income (loss) | $(2.2) | $(0.3) | $(6.7) | $5.4 |
| Segment EBITDA | $6.8 | $8.8 | $9.6 | $26.4 |
- First-half product sales fell to $63.6 million from $95.1 million; services sales were $58.3 million versus $65.1 million.
- First-half operating cash flow was $(8.3) million, compared with $33.2 million generated in the prior-year period. Capital expenditures were $5.8 million, versus $7.0 million.
- Cash declined to $17.9 million from $37.0 million at year-end 2016. At June 30, long-term debt had a carrying value of $302.9 million and $312.5 million principal outstanding. The term-loan rate was 5.83%; it reset to 5.96% in July.
- The company reported a $105.8 million stockholders’ deficit. It had $35.9 million of current liabilities and $85.8 million of current assets.
Changes and operating drivers
- Q2 sales declined 10.7% year over year; first-half sales declined 23.9%. First-half U.S. Debit and Credit sales fell 29.5%, principally from a $28.6 million decline in EMV-related revenue.
- First-half EMV card volume fell to 37.1 million cards from 63.9 million; average selling price declined to $0.85 from $0.94. Q2 volume was 18.8 million versus 22.5 million, with average selling price of $0.86 versus $0.94.
- U.S. Prepaid Debit first-half sales declined 8.7%, including a delay in a large customer’s packaging redesign rollout and costs to ramp Print on Demand capabilities.
- U.K. Limited first-half sales rose 16.7%, helped by a large RFID loyalty-card order; unfavorable currency movements reduced reported sales by $2.2 million.
- First-half operating expenses increased 3.0%, including higher legal and software costs. Operating income fell to $0.2 million from $18.2 million, reflecting reduced sales and gross profit.
Liquidity, outlook, risks, and unusual items
- Management said cash, operating cash flows, and borrowing capacity should be adequate for debt service, capital expenditures, leases, working capital, and ongoing operations. The $40 million revolver had no borrowings and approximately $20 million available; additional availability is subject to leverage conditions. The company was in covenant compliance and did not expect an excess-cash-flow payment for 2017.
- The company discontinued its recurring quarterly dividend of $0.045 per share to retain cash for business investment and debt reduction, estimating approximately $10 million in annual savings. A previously approved $0.045-per-share dividend was payable July 7, 2017.
- No specific revenue or earnings guidance was provided. Management’s stated priorities include strategic investment, returning to sustainable profitable growth, strengthening the balance sheet, and maintaining financial flexibility.
- Key stated risks include continued weak or slower EMV adoption, pricing pressure and competition, customer concentration and retention, demand forecasting, cyber and data-security incidents, production or software defects, substantial indebtedness, foreign exchange, and U.K./EU-related uncertainty.
- Gemalto patent litigation remains ongoing; CPI recorded a $1.0 million loss-contingency accrual. The company said the reserve could increase materially and legal expenses may be significant. A separate IPO-related securities class action remained stayed pending a motion to dismiss; no loss was accrued because the potential loss was not considered probable or estimable.
- The company is also pursuing patent litigation against Multi Packaging Solutions; motions and an opposing IPR petition were pending. The filing does not provide a quantified potential recovery or loss for that case.
- The IRS notified CPI that it would examine the 2014 federal tax return; the company said it had not been notified of disputed items. Disclosure controls were assessed as effective, and no material change in internal control was reported.
Important facts for investors to verify
- Whether EMV demand, card volumes, and selling prices stabilize, and how much of the sales decline reflects market softness versus customer timing.
- Whether margins recover as production volumes change and Print on Demand ramp costs develop.
- Cash generation, working-capital needs, revolver availability, covenant headroom, and the ability to service substantial debt.
- Whether the $1.0 million Gemalto litigation accrual changes, and the status and potential costs of all material legal proceedings.
- Execution of the dividend discontinuation and the use of retained cash for investment and debt reduction.