CPI Card Group Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; comparisons are to Q1 2017 unless otherwise noted. CPI designs, produces, personalizes, packages and fulfills payment cards in the U.S. and Canada, and gift and loyalty cards primarily in Europe and Canada. Amounts below are in U.S. dollars; financial-statement amounts are in thousands unless stated otherwise.
Financial performance and liquidity
| Metric | Q1 2018 | Q1 2017 / comparison |
|---|---|---|
| Net sales | $59.1 million | $56.0 million; up 5.5% |
| Product sales | $27.6 million | $29.8 million; down 7.4% |
| Services sales | $31.5 million | $26.2 million; up 20.1% |
| Gross profit / margin | $14.4 million / 24.4% | $16.1 million / 28.7% |
| Operating loss / margin | $(4.0) million / (6.7)% | $(1.8) million / (3.2)% |
| Net loss / loss per share | $(7.3) million / $(0.65) | $(4.5) million / $(0.40) |
| Segment EBITDA | $1.5 million | $2.8 million |
| Cash used in operating activities | $1.8 million | $5.0 million |
Net interest expense was $5.5 million, versus $5.1 million, reflecting a higher average term-loan rate. Income tax benefit was $2.0 million, compared with $2.3 million; the reported effective tax rate was 21.4%, versus 33.7%.
Cash and cash equivalents were $20.2 million at March 31, 2018, down from $23.2 million at year-end 2017. Current assets were $84.3 million and current liabilities $31.4 million. Long-term debt, net of unamortized discount and financing costs, was $304.4 million; term-loan principal was $312.5 million, at a 6.36% interest rate. No revolver borrowings were outstanding; $19.95 million was available, with additional borrowing subject to facility terms and leverage limits. CPI reported compliance with debt covenants and did not expect a required 2018 excess-cash-flow payment. The term loan matures in August 2022 and the revolving facility in August 2020.
Investing cash outflow was $1.2 million, primarily capital expenditures. CPI also entered into $3.7 million of machinery and equipment capital leases. Financing cash outflow was $0.1 million for capital-lease principal payments. The company discontinued its quarterly dividend in August 2017.
Material changes and business developments
- Sales increased overall, led by U.S. Prepaid Debit, while product sales declined. U.S. Debit and Credit revenue fell 6.5%, partly because of lower EMV sales: 16.8 million cards at an average selling price of $0.79, compared with 18.3 million at $0.84. The filing attributes lower volume primarily to customer-order timing and lower average price to pricing and customer mix.
- U.S. Prepaid Debit revenue rose 63.3% to $15.5 million, driven by additional sales from a new portfolio with an existing customer. U.K. Limited revenue fell 24.6% to $4.2 million amid U.K. retail softness and lower sales from certain customers.
- Gross profit fell 10.3%, and gross margin declined 4.3 percentage points. Management cited lower sales and overhead absorption in U.S. Debit and Credit, pricing and mix, and sharply lower U.K. sales. U.S. Prepaid Debit gross profit and margin improved with higher volume and favorable overhead absorption.
- In February 2018, CPI decided to consolidate three U.S. personalization operations into two facilities. It recorded $0.8 million of accelerated depreciation and $0.3 million of severance charges in Q1.
- CPI adopted the new revenue standard (ASC 606) on January 1, 2018 using the modified retrospective method; prior-year results were not restated. Certain card-production revenue is now recognized over time as products are made, rather than at shipment or delivery. Adoption increased opening accumulated earnings by $2.8 million and changed reported Q1 2018 revenue and gross profit; without the standard, Q1 sales would have been $58.9 million and gross profit $14.6 million, versus reported $59.1 million and $14.4 million.
Outlook, risks and contingencies
The filing provides no quantified revenue, earnings or cash-flow guidance. Management stated that operating cash flow, existing cash and available borrowing capacity were expected to be adequate for debt service, operations, capital expenditures, leases and working capital, while noting there can be no assurance. It did not expect a required 2018 excess-cash-flow debt payment. No material changes to contractual obligations, market-risk disclosures or previously reported risk factors were identified for the quarter.
- Key disclosed business risks include substantial indebtedness and debt-service needs; pricing pressure and competition; customer demand and order timing; production, quality, IT, cybersecurity and data-protection disruptions; reliance on certified facilities, suppliers and payment-card brands; and regulatory, technology and U.K./economic uncertainty.
- The securities class action concerning the 2015 IPO remained pending; the court had denied CPI’s motion to dismiss, and the lead plaintiff moved for class certification in March 2018. CPI disputes the claims; potential loss was not considered probable or estimable, and no liability was recorded.
- A related shareholder derivative suit was stayed pending the class action. CPI’s patent and trade-secret litigation involving Multi Packaging Solutions remained ongoing. The two Gemalto cases had been settled in 2017 for a $0.75 million payment and dismissed with prejudice.
- CPI reported effective disclosure controls as of March 31, 2018. It noted that controls provide reasonable, not absolute, assurance.
Important facts for investors to verify
- Whether the Q1 revenue and gross-margin trends—particularly EMV pricing and volume, prepaid growth, and U.K. weakness—continued in later periods.
- The realized savings, execution costs and operational effects of consolidating personalization facilities.
- Debt principal, interest-rate exposure, revolver availability under leverage conditions, covenant compliance and cash generation relative to debt service.
- The effect of ASC 606 on reported results and working-capital balances, given that comparative periods were not restated.
- Developments and potential exposure in the securities class action, derivative suit and ongoing MPS litigation; no loss estimate was provided for the first two matters.