CPI Card Group Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Dollar amounts below are in millions unless stated otherwise. CPI designs, manufactures, personalizes, packages and fulfills payment cards and related products and services in the U.S. and Canada.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $61.5 | $54.8 | $116.3 | $105.3 |
| Gross profit | $19.9 | $16.7 | $34.3 | $31.3 |
| Gross margin | 32.3% | 30.4% | 29.5% | 29.8% |
| Operating income (loss) | $2.7 | $0.7 | $0.3 | $(1.2) |
| Continuing-operations net loss | $(0.8) | $(3.3) | $(6.5) | $(7.9) |
| Total net loss, including discontinued operation | $(16.7) | $(2.2) | $(24.0) | $(6.7) |
- Q2 sales increased 12.1%; first-half sales rose 10.5%. Product sales grew to $31.5 million in Q2 and $56.2 million in the first half; services sales were $30.0 million and $60.1 million, respectively.
- Q2 operating improvement reflected higher sales, more favorable mix and overhead absorption. First-half gross margin dipped as accelerated depreciation from facility consolidation weighed on U.S. Debit and Credit results.
- Interest expense was $5.6 million in Q2 and $11.1 million for the first half, up from the comparable periods, primarily because of a higher average term-loan rate. The reported tax benefit was $2.6 million for Q2 and $4.6 million for the first half.
Cash flow, debt and liquidity
- Cash and equivalents were $17.8 million at June 30, down from $23.2 million at year-end 2017. Continuing-operations operating cash use was $1.4 million in the first half; discontinued-operation operating cash use was $1.2 million.
- Continuing-operations capital expenditures were $2.1 million in the first half, compared with $4.3 million a year earlier. Financing cash use was $0.3 million, primarily capital-lease payments; the company paid no dividends in the period.
- Term-loan principal was $312.5 million (balance-sheet carrying amount $304.8 million); the June 30 interest rate was 6.36%. The $40.0 million revolving facility had $19.95 million available, with no amount drawn. Term-loan and revolver maturities are August 2022 and August 2020, respectively.
- CPI reported compliance with its credit covenants and no expected excess-cash-flow prepayment for 2018. Management said cash, operating cash flow and borrowing capacity should be adequate for debt service and operating needs, while noting there can be no assurance.
Material changes, outlook and risks
- U.K. business sale: CPI classified U.K. Limited as discontinued operations and completed its sale on August 3, 2018, after quarter-end. The sale consideration was approximately $4.5 million; expected net cash proceeds were approximately $0.3 million after repayment of associated liabilities, excluding tax benefits. U.K. Limited’s Q2 results included $7.6 million of impairment charges and a $7.2 million loss on classification as held for sale, contributing to a $15.9 million discontinued-operation net loss.
- U.S. facility consolidation: The company decided to consolidate three personalization operations into two facilities. First-half charges included $2.1 million of accelerated depreciation and $0.6 million of severance; Q2 also included a $0.4 million lease-termination charge.
- Segment trends: Q2 U.S. Prepaid Debit sales rose 25.9%, supported by a new portfolio win and sales timing. First-half sales rose 42.2%, primarily from portfolio wins with two existing customers. U.S. Debit and Credit first-half sales fell 1.4%; lower EMV and other card sales and pricing were partly offset by growth in emerging products, including Card@Once and metal cards. EMV card average selling price declined year over year.
- Accounting change: CPI adopted the customer-revenue standard on January 1, 2018 using the modified retrospective method. Certain card-production revenue is now recognized over time, affecting timing and comparability with prior-year figures, which were not restated.
- Legal matters: The IPO securities class action reached an agreement in principle to settle on July 31, 2018, subject to final documentation and court approval; CPI recorded a non-material estimated liability at June 30. A related derivative suit is stayed pending the class action. Separate patent and trade-secret litigation involving Multi Packaging Solutions remains ongoing.
- No financial guidance was provided in the supplied filing text. Key stated risks include substantial indebtedness and interest costs, card-industry pricing and competition, customer demand and concentration-related exposure, operational and cybersecurity risks, and required Payment Card Brand certifications. Management reported disclosure controls were effective as of June 30, 2018.
Investor verification points
- Confirm final closing adjustments, proceeds received, and any tax effects from the U.K. sale.
- Track the class-action settlement’s definitive terms, funding and court approval, and developments in the derivative and other litigation.
- Assess whether growth in prepaid debit and emerging products can offset lower EMV pricing and weaker U.S. Debit and Credit trends.
- Monitor cash conversion, working-capital needs, interest expense, revolver availability and covenant headroom given the debt load.
- Separate recurring operating performance from consolidation costs, U.K. disposal losses and the effects of the new revenue-recognition standard.