CPI Card Group Inc. — FY 2016 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2016; fourth-quarter figures are also noted below. CPI provides payment cards, personalization, packaging and fulfillment services, primarily in the U.S., with operations in Canada and the U.K. Its reporting segments are U.S. Debit and Credit, U.S. Prepaid Debit, and U.K. Limited.
Key financial metrics
| Metric | FY 2016 | FY 2015 | Change |
|---|---|---|---|
| Net sales | $308.7 million | $374.1 million | Down 17.5% |
| Gross profit / margin | $101.9 million / 33.0% | $135.8 million / 36.3% | Margin down 3.3 percentage points |
| Operating income / margin | $29.0 million / 9.4% | $67.7 million / 18.1% | Income down 57.2% |
| Net income from continuing operations | $5.4 million; $0.10 per diluted share | $31.3 million | Down 82.7% |
| Adjusted EBITDA | $57.2 million | $96.2 million | Down 40.6% |
| Cash from operating activities | $60.0 million | $43.9 million | Up $16.0 million |
| Capital expenditures / free cash flow | $14.3 million / $45.7 million | $18.7 million / $25.3 million | Free cash flow increased |
| Cash and cash equivalents | $37.0 million | $13.6 million | Up $23.3 million |
| Total debt | $312.5 million principal; $301.9 million carrying value | $312.5 million principal, plus $9.0 million seller note | Seller note repaid in 2016 |
Working capital was $57.1 million, compared with $59.0 million a year earlier. The company reported $40.0 million of revolving-credit availability and no revolver borrowings at year-end. The balance sheet showed a $95.3 million stockholders’ deficit. Interest expense was $20.0 million; the term loan carried a 5.50% floating rate at year-end, reset to 5.83% in January 2017. A 0.25 percentage-point rate change would affect annual term-loan interest expense by approximately $0.8 million.
Material changes versus the prior comparable period
- U.S. Debit and Credit sales fell 20.8% to $208.8 million. EMV card sales declined to 104.5 million from 154.7 million, while card personalization, fulfillment and other services grew.
- Products revenue declined 30.3%; services revenue increased 5.8%. Company-wide sales weakness reflected continued softness in EMV demand, especially among large issuers and processors.
- U.S. Prepaid Debit revenue fell 8.8% to $60.1 million, driven by lower volumes and lower average prices for tamper-evident packaging. A large customer shifted some business to a competitor.
- U.K. Limited sales declined 13.6%, including a $4.0 million adverse foreign-exchange effect. The 2015 closure of the Petersfield, U.K. facility also reduced sales in “Other.”
- Gross margin contracted as lower card volumes weakened overhead absorption; prepaid margins also faced lower packaging prices and higher fourth-quarter labor and ramp-up costs.
- Operating expenses rose 7.1% to $72.9 million, including $5.5 million of public-company costs, $3.5 million of litigation-related charges and a $2.7 million trademark impairment. Lower stock-based compensation versus 2015 partly offset these increases.
Outlook, risks, contingencies and unusual items
- Outlook: No specific numerical revenue or earnings guidance is provided in the filing. Management expected U.S. EMV conversion to continue over the following years and cited opportunities in dual-interface cards, prepaid, instant issuance, Print on Demand, and cross-selling services. These are expectations, not guaranteed results.
- Fourth quarter: Sales declined 28.0% year over year; U.S. Debit and Credit sales fell 35.2%. CPI recorded a $0.9 million operating loss versus $10.0 million of operating income in Q4 2015, and a $4.0 million net loss. The quarter included the $2.7 million trademark impairment.
- Debt and liquidity: The $312.5 million floating-rate term loan matures in August 2022; the $40 million revolving facility matures in August 2020. The credit agreement restricts dividends, additional debt and other actions, and provides for excess-cash-flow repayments. CPI reported compliance with covenants at year-end.
- Litigation: Securities class actions relating to the 2015 IPO and two Gemalto patent suits remained unresolved. CPI said the securities claims were without merit; no loss accrual was recorded because the potential loss was not estimable. Gemalto matters could entail material legal costs, and adverse outcomes could not be ruled out. CPI also sued Multi Packaging Solutions over an alleged patent infringement.
- Other risks: Major risks include EMV demand and card-replacement cycles, price competition, customer concentration (the top five customers represented 29.4% of sales), cybersecurity and certification failures, reliance on a concentrated group of EMV-chip suppliers, floating interest rates, foreign exchange, and potential substitution of physical cards by digital payments. Brexit-related uncertainty could affect U.K. operations.
- Other notable items: CPI repurchased 1.44 million shares for $6.0 million and paid $7.5 million in common dividends during 2016. A $20 million repurchase authorization had $14.0 million remaining at year-end, subject to a share limit and expiration in May 2017. Management reported effective disclosure controls and internal control over financial reporting; the auditor did not provide an internal-control attestation under the applicable transition relief.
Important facts for investors to verify
- Whether EMV card volumes stabilize and whether growth in personalization and other services can offset lower card-production revenue.
- Cash generation, working-capital trends, capital needs, and capacity to service floating-rate debt while funding dividends and repurchases.
- Current status and possible financial exposure from the securities and patent litigation; the filing provides no estimable loss range for key cases.
- Customer retention and the effect of the large prepaid customer’s business shift, along with continued customer concentration.
- Progress and returns from Print on Demand, instant issuance and dual-interface products, and any material changes to management’s outlook.
- Effects of subsequent interest-rate changes, foreign-exchange movements, and new revenue-recognition and lease accounting standards.