CPI Card Group Inc. — Q1 2016 Form 10-Q
Business context and reporting period. CPI supplies financial payment cards and related personalization, fulfillment and software services, primarily in North America. This unaudited report covers the three months ended March 31, 2016, compared with Q1 2015. Unless noted otherwise, amounts below are in millions of dollars.
Financial results and liquidity
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Net sales | $86.4 | $77.3 |
| Gross profit / margin | $29.7 / 34.4% | $25.5 / 33.0% |
| Operating income / margin | $13.7 / 15.8% | $11.7 / 15.1% |
| Net income | $5.7 | $6.2 |
| Net income from continuing operations | $5.7 | $6.0 |
| Basic and diluted EPS | $0.10 | $(0.15) |
| Cash provided by operating activities | $16.8 | $12.7 |
| Capital expenditures | $3.8 | $5.7 |
- Product sales rose 22.1% to $55.0 million; service sales declined 2.7% to $31.4 million.
- Segment sales: U.S. Debit and Credit increased 30.0% to $65.1 million; U.S. Prepaid Debit fell 29.2% to $12.3 million; U.K. Limited was essentially flat at $6.2 million.
- Segment EBITDA, a company-defined measure, was $17.7 million versus $15.9 million. U.S. Debit and Credit EBITDA increased to $18.9 million from $12.6 million, while U.S. Prepaid Debit declined to $3.3 million from $6.0 million.
- Cash and equivalents were $26.9 million at March 31, up from $13.6 million at year-end. Working-capital changes contributed to operating cash flow; receivables and inventories declined.
- Debt principal included $312.5 million under the First Lien Term Loan and a $9.0 million Sellers Note. Reported debt, net of discounts and financing costs, was $309.5 million, including $9.0 million current. The $40 million revolving facility had no borrowings; $39.9 million remained available after letters of credit.
- Net interest expense increased to $5.0 million from $1.9 million, principally reflecting the 2015 term loan. The company reported a 33.0% effective tax rate, compared with 39.9%.
Material changes and management commentary
- Sales growth was led by EMV card adoption: U.S. Debit and Credit EMV revenue increased $13.7 million. CPI sold 41.4 million EMV cards at an average selling price of $0.94, versus 24.9 million at $1.00 in Q1 2015; management attributed the lower price to product mix.
- Higher EMV volumes and personalization services supported improved overall gross margin and U.S. Debit and Credit profitability. Higher chip-material, overhead and labor costs partly offset the benefit.
- U.S. Prepaid Debit comparisons were affected by a large customer packaging refresh in Q1 2015 that did not recur at the same level; the segment’s gross margin fell to 33.0% from 38.4%.
- Q1 2015 included the Nevada operation’s discontinued results and sale gain; the Nevada business was sold in January 2015. Q1 2016 had no discontinued-operation result.
- The company said cash, operating cash flow and available borrowing capacity should be sufficient for debt service, operations, capital spending, lease obligations and working capital for at least the next 12 months. It provided no quantified forward revenue or earnings guidance in this filing.
Risks, contingencies and other notable items
- Controls: Management concluded disclosure controls were ineffective at March 31, 2016 because of an unremediated material weakness in financial reporting controls, related to insufficient finance expertise for complex or non-routine accounting. Remediation efforts included formalizing policies and processes and hiring finance personnel; management said the financial statements fairly present results in all material respects.
- Patent litigation: Gemalto’s October 2015 suit alleges infringement involving microchips in CPI products. CPI disputes the claims and has asserted counterclaims; discovery was ongoing and the company said potential liability could not yet be reliably determined. A second Gemalto patent suit was filed May 3, 2016, after quarter-end. No accrual was recorded.
- Capital returns: A $0.045-per-share dividend approved in February was paid April 7. On May 11, the board approved another $0.045 dividend and a $20 million share repurchase authorization, limited to 2,827,105 shares over the following 12 months.
- The first-lien facility is secured by substantially all company assets and contains customary covenants; CPI reported compliance at March 31. The Sellers Note’s $9 million principal was due by September 2, 2016, absent earlier specified events.
- The filing reported no material changes in market risks or contractual obligations from the 2015 Form 10-K and no off-balance-sheet arrangements.
Important facts for investors to verify
- Whether EMV-driven U.S. Debit and Credit growth and margin gains persist, and how card volumes and average selling prices evolve.
- Whether prepaid-card sales normalize after the prior-year customer refresh and whether segment margins recover.
- Debt-service capacity given the debt balance and higher interest expense; confirm repayment or refinancing of the Sellers Note.
- Progress and effectiveness of internal-control remediation, including whether the material weakness is formally deemed remediated.
- Developments, potential exposure and any indemnification outcomes in both Gemalto patent cases.
- Execution and funding of the announced dividends and $20 million repurchase program, and any effect on liquidity.