CPI Card Group Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; comparisons are with Q1 2016 unless noted. Amounts are in U.S. dollars; financial statement amounts are in thousands except per-share data. CPI provides payment-card products and services through operations in the U.S., Canada and U.K.
Financial results
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $56.0 million | $86.4 million | Down 35.2% |
| Gross profit / margin | $16.1 million / 28.7% | $29.7 million / 34.4% | Profit down 45.8%; margin down 5.7 points |
| Operating income (loss) / margin | ($1.8 million) / (3.2%) | $13.7 million / 15.8% | Down $15.5 million |
| Net income (loss) | ($4.5 million) | $5.7 million | Turned to loss |
| Diluted EPS | ($0.08) | $0.10 | Turned to loss |
| Segment EBITDA | $2.8 million | $17.7 million | Down 84.2% |
| Cash from (used in) operations | ($5.0 million) | $16.8 million | Down $21.8 million |
| Capital expenditures | $3.3 million | $3.8 million | Down $0.5 million |
Product sales fell to $29.8 million from $55.0 million; services sales declined to $26.2 million from $31.4 million. Operating expenses increased 11.7% to $17.9 million despite the sharp revenue contraction. Net interest expense was $5.1 million, and the effective tax rate was 33.7% (Q1 2016: 33.0%).
Business drivers and material changes
- U.S. Debit and Credit sales decreased 39.3% to $39.5 million, primarily from a $23.5 million decline in EMV-related revenue. The company sold 18.3 million EMV cards at an average selling price of $0.84, versus 41.4 million at $0.94 a year earlier. Management cited continued softness, particularly among large issuers and processors, and customer mix as a factor in lower average price.
- U.S. Prepaid Debit sales fell 20.7% to $9.8 million, mainly because a large customer delayed a packaging-design refresh. Segment gross margin contracted to 22.6% from 33.0%; ramp-up costs for Print on Demand Services also weighed on results.
- U.K. Limited sales declined 10.3% to $5.6 million. Increased activity was more than offset by currency translation, which reduced reported sales by $0.9 million.
- Consolidated gross margin declined as lower volumes reduced overhead absorption, particularly in U.S. Debit and Credit and U.S. Prepaid Debit. Corporate and other operating costs rose, including $0.8 million of additional legal costs, of which $0.6 million related to patent and shareholder litigation and related charges.
Cash, debt and liquidity
Cash and cash equivalents were $25.9 million at March 31, 2017, down from $37.0 million at year-end; $8.9 million was held outside the U.S. Current assets were $90.8 million and current liabilities were $38.7 million. Operating cash use of $5.0 million reflected the net loss and working-capital outflows, including increases in receivables, inventory and income taxes. Cash used in financing was $2.9 million, primarily dividends of $2.5 million.
Term-loan principal was $312.5 million, with a 5.83% interest rate and August 2022 maturity; the balance-sheet carrying value, net of discount and financing costs, was $302.4 million. The $40.0 million revolver had no drawn balance; the filing reports approximately $20.0 million available, with further borrowing subject to leverage conditions. The company said it was compliant with credit-facility covenants. Management believes operating cash flow, cash on hand and borrowing capacity will be adequate for debt service, operations, capital expenditures, dividends, leases and working capital.
The company paid a $0.045-per-share dividend in Q1 and approved additional $0.045-per-share dividends payable in April and July 2017. The share-repurchase authorization had $14.0 million remaining, subject to a share cap, but no shares were repurchased during the quarter.
Outlook, risks and contingencies
The filing provides no quantified revenue, earnings or other financial guidance. Management discussed continued softness in EMV-card demand and warned that actual results may differ materially from forward-looking statements. Cited risks include slower EMV adoption, competition and pricing pressure, customer concentration and retention, demand forecasting, security or production disruptions, technology changes, substantial indebtedness and restrictive credit terms, foreign currency and legal/IP claims.
Shareholder securities litigation concerning alleged IPO registration-statement disclosures was pending; proceedings were stayed while a motion to dismiss was considered. Two Gemalto patent cases were also pending: one litigation remained stayed after patent-review petitions were granted for claims, and a petition in the second case had not yet been decided. The company stated that potential losses were not estimable and recorded no accrual for these matters. It also sued Multi Packaging Solutions over a gift-card-packaging patent; discovery was ongoing. The company intends to defend or pursue the cases vigorously. The IRS notified the company it would examine its 2014 federal tax return; the examination was at an early stage, with no disputed items identified.
Management reported effective disclosure controls as of March 31, 2017, with no material change in internal control over financial reporting during the quarter. No material change in market-risk disclosures or contractual obligations was reported.
Most important facts for investors to verify
- Whether weak EMV demand and lower card volumes persist, and how issuer demand, card pricing and customer mix evolve.
- Whether sales recover in U.S. Prepaid Debit following the delayed customer packaging refresh, and whether Print on Demand ramp-up costs decline.
- Cash conversion and working-capital needs, given Q1 operating cash use and the increase in inventory.
- Debt-service capacity, borrowing availability under leverage restrictions, and compliance with credit-facility covenants.
- Potential financial and operating impacts of the shareholder, Gemalto and MPS litigation and the IRS examination; the filing does not provide clear estimated loss values.
- Sustainability of dividends and any future share repurchases amid the operating loss and substantial debt.