CPI Card Group Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Amounts below are in millions of dollars unless stated otherwise. CPI designs, manufactures, personalizes, packages and fulfills payment cards, with U.S. Debit and Credit and U.S. Prepaid Debit as its principal segments.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $71.7 | $71.0 | $205.4 | $187.3 |
| Gross profit | $25.4 | $23.3 | $69.3 | $57.6 |
| Gross margin | 35.5% | 32.8% | 33.7% | 30.8% |
| Operating income | $8.0 | $4.7 | $21.6 | $5.0 |
| Operating margin | 11.1% | 6.6% | 10.5% | 2.7% |
| Net loss | $(0.7) | $(6.1) | $(2.2) | $(30.1) |
| Net loss per share | $(0.06) | $(0.55) | $(0.20) | $(2.70) |
| Segment EBITDA | $12.2 | $9.0 | $33.1 | $18.9 |
- Q3 sales rose 1.0%; nine-month sales grew 9.7%. Services revenue was $37.7 million in Q3 and $105.6 million year to date; product revenue was $34.0 million and $99.8 million, respectively.
- Q3 U.S. Debit and Credit sales increased 7.3% to $51.5 million, supported by personalization and fulfillment, dual-interface EMV cards and Card@Once. U.S. Prepaid Debit sales decreased 3.5% to $20.5 million. Year-to-date U.S. Debit and Credit sales rose 17.5%, while U.S. Prepaid Debit rose 2.0%.
- Margin and operating income improved, particularly in Debit and Credit, with higher volume, favorable overhead absorption and benefits from prior facility consolidation. Prepaid Debit declined in Q3 as lower sales reduced cost absorption.
- Year-to-date operating income included a $6.0 million litigation settlement gain. Excluding the settlement, reported operating income growth was lower; the filing does not provide an adjusted operating-income measure.
Cash flow, balance sheet and debt
- Cash was $14.3 million at September 30, down from $20.3 million at year-end 2018. Total assets were $213.7 million and stockholders’ deficit was $150.1 million.
- Continuing-operations operating cash flow used $3.0 million in the first nine months, versus $1.8 million used in the prior-year period. Inventory investment used $12.3 million of cash; cash interest paid was $17.3 million. Capital expenditures were $3.3 million, and the Canadian subsidiary sale generated $1.5 million. Net cash decreased $6.0 million.
- Long-term debt carrying value was $307.3 million; the First Lien Term Loan principal was $312.5 million, bearing 6.71% interest. The loan matures in August 2022; the revolving facility matures in August 2020. No revolver balance was outstanding at quarter-end, and the filing reports $19.95 million available, subject to facility terms.
- Management reported a 9.0x net leverage ratio and covenant compliance. The facility permits additional revolver borrowing only to the extent the leverage ratio does not exceed 7.0x; investors should verify how that condition affects practical access to stated availability. Management believed cash and operating cash flows would be adequate for debt service and operating needs, while noting there is no assurance.
- Operating and finance lease liabilities totaled $13.5 million at quarter-end. CPI adopted ASC 842 on January 1, 2019, recognizing $8.0 million of operating right-of-use assets and $8.8 million of operating lease liabilities at adoption.
Material changes, outlook and risks
- Q3 continuing-operations net loss narrowed to $0.7 million from $1.1 million. For the nine months, the continuing-operations loss narrowed to $2.2 million from $7.6 million, while interest expense increased to $18.8 million from $17.2 million.
- The effective tax rate was unusually high: 135.3% in Q3 and 247.3% year to date. A $2.6 million partial valuation allowance on U.S. deferred tax assets, related primarily to limits on business-interest deductibility, was a principal driver.
- The Canadian subsidiary was sold on April 1, 2019. The U.K. business had been sold in 2018 and is presented as discontinued operations. The 2019 foreign-currency loss included a $1.3 million reclassification of accumulated translation adjustments related to the Canadian disposition.
- CPI received a $6.0 million cash settlement in June 2019 in its trade-secrets and employee-related litigation against Multi Packaging Solutions; the case was dismissed with prejudice. Separately, the company’s derivative suit remains ongoing, with no loss recorded because a potential loss was not considered probable or estimable. Its patent case is stayed pending appeal of a decision finding the patent claims unpatentable.
- No new or materially changed risk factors were reported. Disclosed risks include substantial debt and refinancing needs, restrictive debt terms, cyber and data-security exposure, operational and supply-chain disruptions, customer retention and competition, product quality, payment-card certification requirements, and litigation. Management gave no specific financial guidance in the provided filing text.
- Disclosure controls were assessed as effective as of September 30, 2019. A senior vice president/general manager stepped down effective October 31, 2019 and was to provide transition assistance through December 13, 2019.
Important facts for investors to verify
- Whether inventory growth and working-capital needs convert into operating cash flow in subsequent periods.
- Actual revolver borrowing capacity given the 9.0x leverage ratio and the facility’s 7.0x condition, as well as refinancing and debt-service plans.
- The sustainability of segment margin gains and the extent to which year-to-date operating results depended on the one-time $6.0 million settlement.
- The basis and future implications of the deferred-tax valuation allowance and unusually high effective tax rate.
- Developments in the derivative suit and patent appeal, and any resulting financial exposure.