CPI Card Group Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020. CPI provides payment cards, card personalization and related services. Amounts below are in millions of dollars except per-share data.
Financial performance
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Net sales | $74.0 | $66.9 | +10.6% |
| Gross profit / margin | $25.7 / 34.8% | $21.5 / 32.2% | +$4.2; +2.6 percentage points |
| Operating income / margin | $7.7 / 10.4% | $3.6 / 5.3% | +$4.1 |
| Interest expense, net | $6.1 | $6.3 | -$0.2 |
| Income from continuing operations | $2.4 | Loss of $3.1 | Improved |
| Net income (loss), including discontinued operations | $2.4 | Loss of $3.1 | Improved |
| Diluted earnings (loss) per share | $0.21 | -$0.27 | Improved |
| Cash from continuing operating activities | $3.2 | Use of $10.2 | Improved by $13.4 |
| Capital expenditures | $0.9 | $2.1 | -$1.2 |
Sales growth was led by Debit and Credit, up 22.3% to $59.8, on higher dual-interface EMV card volumes and sales of Second Wave cards, as well as increased personalization. Prepaid Debit sales fell 13.2% to $14.5 amid lower volumes and an unfavorable mix. Debit and Credit gross margin improved to 34.2%; Prepaid Debit gross margin declined to 36.0% from 37.9%.
Operating cash flow improved with the return to net income and working-capital benefits, particularly from inventories and accrued expenses. Cash and cash equivalents were $46.9 at March 31, versus $18.7 at year-end; financing activities included $29.1 of net proceeds from the new credit facility. Current assets were $120.0 and current liabilities $35.4. Stockholders’ deficit was $150.0.
Debt, liquidity and capital structure
- At March 31, gross principal debt comprised $312.5 under the First Lien Term Loan and $30.0 under a new super-senior facility. Debt carrying value, net of discounts and issuance costs, was $333.9.
- The $30.0 facility was entered into March 6, 2020, bears 9.5% interest at quarter-end, ranks senior to the term loan, and matures May 17, 2022. The First Lien Term Loan matures August 17, 2022 and bore 6.38% at quarter-end. The prior revolving facility was terminated with no balance outstanding.
- Reported net leverage was 7.2 times Adjusted EBITDA. The new facility requires at least $25.0 of trailing-four-quarter Adjusted EBITDA beginning with the quarter ended March 31, 2020. CPI reported covenant compliance at quarter-end.
- Management stated that cash and operating cash flows should be adequate for debt service and ongoing needs, while noting there can be no assurance. The facilities impose restrictive covenants and are secured by substantially all company assets.
Material changes, outlook and risks
- Operating income more than doubled year over year, mainly reflecting stronger Debit and Credit sales, pricing and mix. Prepaid Debit profitability weakened with lower sales and unfavorable cost absorption.
- The Q1 income tax benefit was $0.9 on $1.5 of pretax income, substantially affected by estimated CARES Act benefits, including NOL carrybacks and increased interest-deduction limits. CPI also recorded a partial valuation allowance. The resulting effective tax rate was negative 62.9%; this is an unusual, potentially non-recurring comparison factor.
- COVID-19 had not materially affected reported Q1 results, but management said the impact would be more fully reflected in future periods. Operations remained open and were considered essential. Potential supply constraints, reduced customer demand, facility disruptions, employee availability, higher transportation costs and reduced access to capital markets could materially harm results and liquidity.
- The company gave no quantitative revenue, earnings or cash-flow guidance. It said it was supporting customers, executing its strategic plan and managing spending, but could not assure these measures would mitigate pandemic effects. COVID-19-related deterioration could also trigger a goodwill impairment; $47.2 of goodwill was reported in Debit and Credit, with no impairment trigger identified as of March 31.
- On April 1, 2020, a derivative lawsuit settlement received final court approval. Claims were discharged, CPI agreed to corporate-governance reforms, and its insurer agreed to pay plaintiff counsel fees and a nominal service award; CPI recorded no settlement liability at March 31. Separately, a federal appellate court affirmed the invalidation of CPI’s patent in a dispute with Multi Packaging Solutions; CPI did not appeal, and the infringement suit was administratively dismissed.
Important facts for investors to verify
- Whether pandemic-related demand, production and supply-chain impacts emerge in subsequent quarters, and whether customers defer or reduce orders.
- Whether operating cash generation and available cash can support debt service, working capital and capital spending under the high-leverage capital structure.
- Compliance with the new facility’s $25.0 Adjusted EBITDA covenant and other debt covenants as results change.
- The durability of Q1 Debit and Credit growth and margin gains, alongside continued weakness in Prepaid Debit.
- The final tax and cash-refund effects of CARES Act provisions, and whether COVID-19 developments require goodwill impairment testing.