CPI Card Group Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Unless otherwise stated, amounts below are in millions of dollars. The company designs, manufactures, personalizes, packages and fulfills financial payment cards, with U.S. Debit and Credit and U.S. Prepaid Debit as its principal segments.
Financial performance
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Net sales | $66.9 | $61.5 | $133.8 | $116.3 |
| Gross profit / margin | $22.4 / 33.5% | $19.9 / 32.3% | $43.9 / 32.8% | $34.3 / 29.5% |
| Income from operations / margin | $10.1 / 15.1% | $2.7 / 4.3% | $13.7 / 10.2% | $0.3 / 0.3% |
| Income (loss) from continuing operations | $1.6 | ($0.8) | ($1.5) | ($6.5) |
| Net income (loss), including discontinued operations | $1.5 | ($16.7) | ($1.5) | ($24.0) |
| Segment EBITDA | $13.0 | $7.2 | $20.9 | $9.9 |
- Q2 sales rose 8.9%; first-half sales rose 15.0%. Services revenue grew to $33.8 million in Q2 from $30.0 million, while products revenue grew to $33.1 million from $31.5 million.
- Growth was led by U.S. Debit and Credit, where Q2 sales increased 16.5% and first-half sales increased 23.5%, reflecting higher EMV and dual-interface card volumes and personalization and fulfillment activity. U.S. Prepaid Debit sales increased 3.5% in Q2 and 5.7% in the first half.
- Gross margin improved year over year, particularly in the first half, with higher volumes, favorable cost absorption and lower depreciation after prior-year facility consolidation contributing. Q2 U.S. Debit and Credit margin eased to 31.1% from 31.6% as card-material costs and product mix weighed on results; U.S. Prepaid Debit margin increased to 40.8% from 34.4%.
- Reported operating income includes a $6.0 million litigation settlement gain. Excluding that gain, operating income was approximately $4.1 million in Q2 and $7.7 million in the first half; the corresponding margins were approximately 6.1% and 5.7%.
- Interest expense was $6.4 million in Q2 and $12.8 million in the first half, up from $5.6 million and $11.1 million, respectively, primarily due to higher average term-loan interest rates. Q2 foreign-currency loss was $1.3 million, including a $1.329 million translation adjustment recognized upon the Canadian subsidiary disposition.
Cash flow, debt and liquidity
- Cash and cash equivalents were $17.5 million at June 30, down from $20.3 million at December 31, 2018. Current assets were $84.0 million and current liabilities $35.6 million.
- First-half operating cash flow from continuing operations was negative $1.0 million, compared with negative $1.4 million in the prior-year period. Inventory increased by $5.0 million, and accrued expenses declined by $6.2 million. Capital expenditures were $2.7 million; the company also received $1.5 million from the Canadian subsidiary sale.
- Long-term debt carried a $306.8 million balance-sheet value; the First Lien Term Loan principal was $312.5 million, at a 7.35% interest rate. No revolving-credit borrowings were outstanding at period end. The company reported $19.95 million available under the revolver, while additional borrowing up to the $40 million facility limit is subject to a leverage condition.
- Net leverage was 9.8 times Adjusted EBITDA. The company reported compliance with credit-facility covenants at June 30, 2019. The term loan matures August 2022 and the revolver August 2020. Management believes operating cash flows, cash on hand and available borrowing capacity will be adequate for debt service and operating needs, but gave no assurance.
- Stockholders’ deficit was $149.5 million. The filing reports no material off-balance-sheet arrangements.
Material changes, outlook and risks
- A $6.0 million cash settlement in a trade-secret and employment-related lawsuit was recorded as a gain in Q2 operating income. The case was dismissed with prejudice on July 12, 2019.
- The Canadian subsidiary sale closed April 1, 2019 for $1.451 million in gross proceeds; management said it had no significant net cash impact or significant gain or loss. Canadian financial-payment-card activity migrated to U.S. operations or other providers. The U.K. business sale was completed in August 2018, and its prior-period results are presented as discontinued operations.
- The prior-year comparison includes substantial U.K. discontinued-operation losses: $15.9 million for Q2 and $17.5 million for the first half of 2018, including impairment and disposal-classification losses. This explains much of the improvement in consolidated net loss year over year.
- The company adopted lease accounting standard ASC 842 on January 1, 2019, recording $8.0 million of operating right-of-use assets and $8.8 million of operating lease liabilities at adoption. At June 30, operating lease liabilities totaled $8.4 million and finance lease liabilities $4.3 million.
- No specific financial guidance or quantified forward outlook is provided. Management cited substantial indebtedness and refinancing risk, cybersecurity and data-protection exposure, production and supply-chain disruptions, customer retention and competition, intellectual-property and litigation matters, and the need to maintain payment-card brand certifications among relevant risks.
- A shareholder derivative suit remains ongoing; the company said potential loss was not probable or estimable and recorded no liability. Separately, the company appealed a patent-review decision finding its patent claims unpatentable; the related infringement suit is administratively dismissed pending the validity determination.
- Management reported disclosure controls were effective as of June 30, 2019, and no material changes in internal control over financial reporting during Q2.
Important facts for investors to verify
- How much of reported operating improvement is sustainable after excluding the one-time $6.0 million settlement gain?
- Whether higher card-material costs and product mix continue to affect U.S. Debit and Credit margins, and whether growth in dual-interface cards and services persists.
- Cash conversion and working-capital needs, particularly inventory growth, alongside cash interest payments and capital expenditure requirements.
- Debt-service capacity and refinancing options given $312.5 million of term-loan principal, 9.8x reported net leverage and the revolver’s leverage-based borrowing restrictions.
- Developments in the derivative litigation and patent appeal, and the continuing financial or operational effects of the Canadian and U.K. dispositions.