CPI Card Group Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Unaudited consolidated results. CPI provides financial payment cards and related personalization, fulfillment, and card services across the U.S., Canada, and U.K.
Financial performance
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $68.0m | $81.2m | $189.9m | $241.3m |
| Gross profit / margin | $21.0m / 30.8% | $29.1m / 35.8% | $56.4m / 29.7% | $81.5m / 33.8% |
| Operating income / margin | $3.5m / 5.1% | $11.7m / 14.4% | $3.7m / 1.9% | $29.9m / 12.4% |
| Net income (loss) | ($0.7m) | $4.0m | ($7.4m) | $9.4m |
| Basic and diluted EPS | ($0.01) | $0.07 | ($0.13) | $0.17 |
| Net interest expense | $5.3m | $5.0m | $15.5m | $15.1m |
For the nine months, operating cash flow was negative $6.9m, versus positive $39.8m a year earlier. Capital expenditures were $7.8m, cash used in financing was $7.9m, and cash declined $22.1m to $14.8m. The company attributed the operating cash-flow decline to the net loss and working-capital movements, particularly receivables and income taxes.
At September 30, cash was $14.8m, including $1.8m held outside the U.S. Long-term debt had a $312.5m principal balance and $303.4m carrying value; the term-loan rate was 5.96%. The $40m revolving facility had no borrowings, with approximately $20.0m available at quarter-end, subject to borrowing conditions. Total liabilities were $357.1m, exceeding total assets of $251.5m; stockholders’ deficit was $105.6m.
Material changes and drivers
- Q3 sales fell 16.2%; nine-month sales fell 21.3%. U.S. Debit and Credit was the principal source of decline, with nine-month segment sales down 26.7%, largely from weaker EMV card demand and reduced personalization and fulfillment activity.
- EMV card volumes and average selling prices both declined: Q3 volume was 19.5m cards at $0.86 versus 22.6m at $0.96; nine-month volume was 56.6m at $0.85 versus 86.5m at $0.94. Management cited continued softness among large issuers and processors and competitive pricing pressure.
- U.S. Prepaid Debit sales declined 11.1% for nine months, including a delayed packaging-design refresh for a large customer and lower average prices. CPI on Demand ramp-up costs also weighed on margins.
- U.K. Limited nine-month sales rose 8.0%, helped by a large RFID loyalty-card order; reported sales were reduced by $2.2m from foreign-exchange movements. Q3 U.K. sales declined following a prior-year loyalty-card project that did not recur.
- Nine-month gross margin contracted 4.1 percentage points and operating margin 10.5 points. Management cited lower volumes and overhead absorption, product mix, pricing pressure, and CPI on Demand ramp-up costs. Operating expenses rose 2.2%, including higher legal costs.
Outlook, management commentary, risks, and unusual items
- No numeric revenue, earnings, or margin guidance was provided. Management said it expects operating cash flows, existing cash, and available borrowing capacity to fund debt service, operations, capital expenditures, leases, and working capital for at least the next 12 months, while noting there can be no assurance.
- In August, CPI discontinued its quarterly $0.045-per-share dividend. Management said retaining the cash would support reinvestment, growth initiatives, debt reduction, and financial flexibility; estimated annual savings were approximately $10m.
- The company was in compliance with credit-facility covenants and did not expect an excess-cash-flow payment for 2017. The term loan matures in 2022 and the revolver in 2020. The facility restricts certain actions, including dividends and additional indebtedness.
- Gemalto litigation was settled in September for a $0.75m payment due in Q4 2017, resolving two patent lawsuits with dismissal with prejudice and an 18-month mutual covenant not to sue. CPI reduced its previously accrued contingency by $0.25m in Q3.
- A securities class action related to the 2015 IPO remained pending; the court denied CPI’s motion to dismiss on October 30, 2017. CPI said it would defend the claims; potential loss was not probable or estimable, and no accrual was recorded. CPI also reported ongoing patent and trade-secret litigation involving Multi Packaging Solutions.
- CEO Scott Scheirman became effective October 5, 2017, succeeding Steven Montross. The company reported effective disclosure controls as of September 30, 2017 and no material change in internal control over financial reporting during the quarter.
- Key risks cited include continued EMV softness, competition and price erosion, customer concentration and retention, demand forecasting, cybersecurity and production interruptions, substantial indebtedness, and U.K./foreign-exchange exposures. The filing identifies no material change to previously disclosed risk factors.
Important facts for investors to verify
- Whether EMV card demand, volumes, and selling prices stabilize, particularly among large issuer and processor customers.
- Whether operating cash flow recovers from the nine-month use of $6.9m and supports debt service and working-capital needs.
- Actual revolver availability and covenant capacity, given the term-loan balance, restrictions, and borrowing conditions.
- Progress and financial impact of CPI on Demand, the dividend suspension, and planned reinvestment and debt reduction.
- Developments and potential costs in the IPO securities litigation and the remaining patent and trade-secret matters.
- Effects of the new CEO transition, large-customer activity, and U.K. currency movements on future performance.