CPI Card Group Inc. — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017; filed March 2018. Amounts are in U.S. dollars unless noted. CPI provides payment-card products and services, with U.S. Debit and Credit, U.S. Prepaid Debit, and U.K. Limited as its reportable segments.
Financial performance
| Metric | 2017 | 2016 |
|---|---|---|
| Net sales | $254.9 million | $308.7 million |
| Gross profit / margin | $75.0 million / 29.4% | $101.9 million / 33.0% |
| Operating income (loss) / margin | ($18.1 million) / (7.1%) | $29.0 million / 9.4% |
| Net income (loss) | ($22.0 million) | $5.4 million |
| Operating cash flow | $2.4 million | $60.0 million |
| Capital expenditures | $8.8 million | $14.3 million |
- Revenue mix and segments: Product sales fell 25.6% to $125.3 million; services sales fell 7.6% to $129.6 million. U.S. Debit and Credit sales declined 23.9% to $158.9 million, while U.S. Prepaid Debit increased 1.8% to $61.1 million and U.K. Limited increased 4.8% to $31.1 million.
- Margins and EMV cards: U.S. Debit and Credit sold 70.3 million EMV cards at an average $0.86 each, versus 104.5 million at $0.95 in 2016. Management cited weaker demand, price erosion, and market-share losses. Consolidated gross margin declined 3.6 percentage points.
- Impairment and taxes: Operating expenses included $19.1 million of goodwill impairment: $17.2 million in U.S. Debit and Credit and $1.9 million in Other. The company recorded a $16.4 million income-tax benefit; the 2017 effective tax rate was 42.7%.
- Cash and liquidity: Year-end cash was $23.2 million, down from $37.0 million. Working capital was $54.8 million. Operating cash flow dropped sharply, primarily due to working-capital movements, including accounts receivable and income taxes, and the net loss.
- Debt: First Lien Term Loan principal was $312.5 million; carrying value, net of discount and financing costs, was $303.9 million. The term loan matures in August 2022; the $40 million revolving facility matures in August 2020. CPI reported $20 million of revolver capacity available at year-end because of leverage restrictions. The term-loan rate was 5.96% at year-end and reset to 6.36% in January 2018. CPI reported covenant compliance at year-end.
Material changes and unusual items
- Sales declined 17.4% year over year, driven mainly by a 23.9% decline in U.S. Debit and Credit. The segment’s operating income fell to $2.7 million from $43.8 million.
- Fourth-quarter sales were $65.0 million, down 3.6% year over year; the quarter’s net loss was $14.6 million. A $19.1 million goodwill impairment contributed to the fourth-quarter operating loss of $21.8 million.
- CPI paid $750,000 in 2017 to settle two Gemalto patent cases. Separate securities and shareholder derivative litigation remained pending; the company said potential losses were not estimable and recorded no accrual for those cases.
- CPI discontinued its quarterly dividend in August 2017, citing reinvestment, debt reduction, and an expected annual cash saving of approximately $10 million. It completed no share repurchases in 2017; the prior repurchase authorization expired in May.
- In February 2018, CPI decided to consolidate three U.S. personalization operations into two, with the transition expected to be substantially complete in the third quarter of 2018.
Outlook, risks, and other disclosures
- The filing provides no quantified revenue or earnings guidance. Management described priorities of restoring sustainable profitable growth, improving cost efficiency and quality, investing in innovation, and strengthening the balance sheet.
- Key risks include substantial floating-rate debt and restricted borrowing capacity; continued EMV demand weakness and card-price pressure; customer and supplier concentration; cybersecurity and data-protection exposure; operational and production risks; and maintaining Payment Card Brand and PCI certifications.
- Tax reform enacted in December 2017 reduced the federal corporate rate and changed interest-expense deductibility, among other provisions. CPI said it was still evaluating potential effects; its accounting included a $7.1 million tax benefit from remeasuring deferred tax liabilities.
- CPI adopted the new revenue-recognition standard on January 1, 2018. It expected a $3–$4 million increase to accumulated earnings on adoption and earlier recognition for certain customized products; it did not expect a material effect on the income statement.
- KPMG gave an unqualified opinion on the consolidated financial statements. Management concluded disclosure controls and internal control over financial reporting were effective as of December 31, 2017; the auditor did not provide an internal-control attestation.
Important facts for investors to verify
- Whether EMV card volumes, average selling prices, and U.S. Debit and Credit market share stabilize or continue to decline.
- Whether operating cash flow improves and CPI can service its debt while maintaining sufficient liquidity; confirm current revolver availability and leverage-covenant calculations.
- Progress, costs, and expected savings from the U.S. facility consolidation, and whether prepaid and on-demand services can offset weakness in core card sales.
- Final effects of the revenue-recognition transition and tax reform, including interest deductibility and any tax adjustments.
- Developments in the pending securities and derivative litigation and other contingencies, for which potential losses were not estimable in this filing.