GPGI, Inc. (GPGI) Q3 2022 Earnings Report, Transcript and Summary

Good day, and thank you for standing by. Welcome to the CompoSecure Q3 2022 Earnings Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Sean Mansouri. Sir, please go ahead.

Thank you, Justin. On our call today, we have the CEO of CompoSecure, John Wilk as well as the company's CFO, Tim Fitzsimmons. Please note that the discussion on today's call includes certain non-GAAP financial measures as defined by the SEC, including EBITDA, adjusted EBITDA, adjusted net income and adjusted EPS. The company believes these non-GAAP financial measures provide useful information to management and investors regarding certain financial and business trends impacting the company's financial condition and results of operations. These non-GAAP financial measures should not be considered as an alternative to net income or any other performance measures derived in accordance with U.S. GAAP and may be different from similarly titled non-GAAP measures used by other companies. A reconciliation of GAAP to non-GAAP measures is available in our press release and earnings presentation available on the Investor Relations section of our website. Due to the forward-looking nature of the adjusted EBITDA guidance we will provide on this call, specific quantifications of the charges excluded from forward-looking adjusted EBITDA, including with respect to depreciation, amortization, interest and tax rate that would be required to reconcile the non-GAAP financial measures included in such guidance to GAAP measures are not available. So it is not feasible to provide accurate forecasted non-GAAP reconciliations without unreasonable efforts. As a result, no disclosure of estimated comparable GAAP measures is provided and no reconciliation of the forward-looking non-GAAP financial measures is provided. Thank you. And with that, let me turn the call over to Jon to discuss our third quarter results. Jon?

Thanks, Sean. Good evening, everyone, and thank you for joining us for our third quarter 2022 earnings call. We're excited to announce that we have achieved another record quarter and continue to build upon our momentum from the first half of the year. Before we share some of our highlights, I want to recognize our more than 800 team members, who delivered an outstanding quarter for our shareholders. Now on to our results on Slide 2. For the third quarter, we achieved net sales of $103 million, which was up 56% versus last year as we continue to see strong demand for premium metal card products both domestically and internationally, and we capitalized on this through strong sales execution, deep customer relationships and partner channels. We also reported net income of $22 million, up 17% year-over-year, and adjusted EBITDA was higher than expected at $33 million for the quarter up 33% year-over-year due to a combination of our ability to drive significant economies of scale, our focus on operational excellence and efficiency and managing investments based on the Arculus ramp-up expectations and timing. Our growth trajectory is supported by positive card issuer trends including high consumer and business demand for premium cards and spending in such areas as travel, entertainment and services and growth in new customer card acquisitions for card issuers. I'll provide some additional detail on this in a few slides. It's important to note that as of today, we have not seen any major impact from larger economic issues. However, we're closely monitoring our customers, the market and macroeconomic factors. If economic indicators evolve, we believe we are well equipped to respond similar to how we executed throughout the pandemic when we grew both top and bottom line despite a challenged economy overall, and in particular challenges in the credit card market. Moving on to Arculus progress. We are announcing a number of new partnerships and continued progress with names previously mentioned, and we believe the Arculus platform is well positioned to support today's growing security, payment, and authentication needs across a variety of industries. That said, the overall ramp-up remains slower than expected with the continued uncertainty in the digital asset market, and we are managing our spend accordingly and have increased our focus on executing our B2B sales and marketing efforts, which we believe can deliver greater scale at a lower cost. To be more specific, going into 2022, we shared that our projected full year net impact from Arculus was forecasted to be around $33 million negative, which encompassed total anticipated net sales minus expected operating and marketing expenses. Based on our strategic business decisions and spending discipline driven by uncertainty in the market, we now anticipate the net impact for the full year to be more in the range of $20 million to $22 million negative, which has a positive impact on our adjusted EBITDA for the year. Coming back to our overall outlook for the year and based on the outperformance in the metal payment card business, we are updating the 2022 net sales range to the high end of our previously announced guidance and now expect net sales for the year between $370 million and $380 million. We are also raising our 2022 adjusted EBITDA guidance and now expect it to be in the range of $130 million to $137 million, given our continued margin expansion, profitability and spending discipline. The adjusted EBITDA guidance is up nearly $20 million from the midpoint of last quarter's guidance and up nearly $30 million from the midpoint of our guidance issued last December. Now moving to Slide 3. We have seen strong growth in the payment card business including new clients across banking, gaming, entertainment, fintech and exchanges. For example, we've seen cards launched this year from Venmo and PayPal. While owned by the same company, they've launched distinct metal card programs. We've also launched programs with additional fintechs, including Vital, Mercury and BHG, which target different aspects of the fintech landscape. On the gaming side, we have Mana, which is a neo banking platform designed for video gamers and is offering a metal debit card, so gamers can earn rewards for purchases in gameplay. We've got continued expansion with eToro, a social investment and multi-asset brokerage company that offers a debit card tied directly to an eToro money cash accounts. Last, we have a unique innovation we're bringing to market with U.S. Bank, where we're piloting an LED metal payment card. The card is truly distinct with the bank logo on the face and it card lights up when a contactless transaction is initiated, once again highlighting CompoSecure's card form factor innovations. I also want to highlight some of the progress we're seeing on the Arculus side. CoinZoom, which announced a partnership with Visa in June is a U.S.-based crypto exchange that can leverage their Visa partnership to deliver crypto to eligible customers in 194 countries. They plan to combine their current metal payment card, which we provide with FIDO2 authentication capabilities starting early next year. Legacy Vault app is a cloud-based platform that delivers security for managing and preserving valuable information related to legal and financial family planning. With an Arculus FIDO2-enabled metal card they expect to deliver enhanced device level security. We mentioned InBestGo last quarter. We're excited about our progress, which includes a premium metal card plus Arculus digital authentication and separately, white labeling our Arculus cold storage wallet. We are tracking well and anticipate a launch in the first half of 2023. Chainge also mentioned last quarter as a DeFi app with 0.5 million users that empower people to become their own digital bank, and they are working to offer the Arculus cold storage solution for their mobile wallet. Finally, as I mentioned earlier, we're increasing our focus on executing B2B sales and marketing. We had a strong showing at Money 20/20, and we're encouraged by the conversations we had with potential and current customers. As I mentioned earlier, we're increasing our focus on executing our B2B sales and marketing, strong showing at Money 20/20, encouraged by the conversations with customers across a variety of industries such as gaming, gambling, entertainment, et cetera. We also expanded our B2C distribution in the third quarter and the Arculus cold storage wallet is now available for sale on Walmart.com and NewEgg. Turning to Slide 4. I'm excited by our customer progress, and we are encouraged by the positive card issuer market trends that we're seeing. On the left hand of Slide 4, we are showing our largest customers purchase volume growth based on publicly available data, which remains well above pandemic levels. Despite general mixed signals within the broader economy, we continue to hear positive messages from our clients. Card issuers are experiencing record spending levels by their customers, supported by travel, entertainment and goods and services. For example, Amex stated that Millennials and Gen Z spending was up 39% year-over-year in the quarter, and that U.S. SME spending grew 17% in the quarter. They also noted that offline spending was back above pre-pandemic levels highlighting that consumers are out shopping and spending, which takes me to the right side of the chart, as you can see, tap to pay with cards, is the fastest-growing method of in-store transactions for consumers and remains well above digital wallets and growing at a much faster trajectory. A positive indicator for our market that reinforces the demand and usage of card products as well as the ability to enable premium brand experiences for our clients. On Slide 5, you can see that American Express reported strong card acquisition numbers for the quarter. They added 3.3 million new proprietary cards during the quarter, an all-time high for quarterly card acquisitions. At the same time, they are tracking well for their planned investment for marketing and business development growth. American Express recently referenced the marketing portion of the spend for the third quarter, which was $1.5 billion, on track with their expectation to spend over $5 billion in 2022. They also stated that investments to drive customer engagement, acquisitions and retention continue to generate results with card member spending at near record levels in the quarter, and highlighted the fact that the strength of the rebound in travel spending has exceeded expectations throughout the year, and total T&E spending was up 57% in the third quarter from a year earlier. This is all publicly available information, and we update this chart every quarter to try and give some additional insight and understanding based on our customers' guidance. Regarding the Arculus platform, I'd like to take an opportunity to dive deeper into Arculus and share the diversity and strength of the platform. Each time we've talked about Arculus, I've highlighted that it is a security and authentication platform with opportunities across a variety of verticals and will continue to frame that for you. On the right side, we have our direct-to-consumer Arculus cold storage product, which was the first vertical application for our platform. On the left side, we're showing our B2B solutions that deliver security, authentication, identity verification and/or cold storage across a variety of verticals, including financial institutions, fintech, gaming, gambling, telecom, crypto exchanges, et cetera. When we talk about secure authentication, this helps better protect the login process, whether it's for banking and investment accounts, gaming or gambling, this is our direct response to the password problem. And Arculus allows for the use of 2 or 3-factor authentication to support enhanced security. As we move to Slide 7, I want to provide a little more context for the massive scale of the password problem. You can see that over 90% of Internet users worry about getting their passwords hacked. And that 57% of people, who have been scanned don't change their passwords. This is a burgeoning security crisis, and many organizations are trying to move beyond passwords, and we believe that Arculus is the ideal solution. On Slide 8, you can see how the Arculus portfolio can turn a metal credit or debit card into a physical security token, which reduces reliance on passwords and combat fraud. It is also something that you carry with you everywhere and are used to using multiple times a day already. With Arculus, we can also add step-up authentication for such actions as high-value transactions, customer service or authenticating a device. Moving to Slide 9. I spoke to the uncertainty in the digital asset market in general, and how we're better timing our Arculus investment. As you can see, hacks and thefts in the crypto market persists. Year-to-date, the industry has seen more than $3 billion worth of cryptocurrency stolen in hacks from various services. In addition, we are seeing exchanges still freeze customers' digital assets due to liquidity challenges for some of these platforms. While this uncertainty persists, these challenges continue to drive greater consumer awareness and are encouraging and exchanges are encouraging offering solutions to protect customer assets such as cold storage and authentication. We see strong interest in Arculus cold storage, and we are encouraged by the positive conversations we're having with many platforms and exchanges across the world. This climate actually drives an increased need for consumers to control the private keys to their digital assets. This is what the Arculus cold storage wallet in our offering was made for and we believe will benefit from this market turbulence in the medium and long term. You can see a few screenshots of the Arculus cold storage wallet, which shows our advanced 3-factor authentication, how we leverage NFC to better security as opposed to Bluetooth or plugging and dongle into your computer, and we provided added layer of authentication when sending or receiving digital assets. In addition, businesses can white label our cold storage offering and provide it to their customers as a better way for them to secure their digital assets. As I mentioned, we're already working with several exchanges and platforms. We are still on track to deliver all-in-one capability of payment card, as authentication and cold storage early next year. With that, let me hand it over to Tim for a deeper discussion on our financials.

Thanks, Jon, and good evening, everyone. I'll provide a more detailed overview of our third quarter 2022 financial performance and turn it back to Jon before we open the call for questions. Unless stated otherwise, all of the various commentary is on a year-over-year basis. Third quarter 2022 net sales grew 56% to $103 million compared to $66 million last year. The increase was driven by strong domestic and international growth of our metal card business for both new and existing customers. Gross margins for the quarter increased to 60% versus 55% in the third quarter of 2021. We are benefiting from higher card issuance volumes as well as operating efficiencies. Despite the challenge of managing global chip and metal supply chain issues. Net income for the quarter of -- third quarter of 2022 was up 17% to $22 million. This includes a $1 million benefit from fair value adjustments associated with the mark-to-market of warrants and earn-out as well as a $10 million charge from a completed arbitration in the quarter. This arbitration contingency has been disclosed in our financial reporting year-to-date. Adjusted EBITDA for the quarter was $33 million, up 33% compared to Q3 2021. This was driven by strong growth on the top line, gross margin expansion and lower than planned spend at Arculus. Similar to last quarter, the Arculus revenue and investment resulted in a net impact of approximately minus $5 million in the third quarter. And as Jon said earlier, we now expect the full year net impact investment in Arculus to be in the negative $20 million to $22 million range. We add back noncash fair value adjustments to arrive at adjusted EBITDA of $33 million. Note that this includes the impact of the onetime arbitration charge of $10 million, I referenced a moment ago. Excluding the onetime charge, our adjusted EBITDA margin would have been up 400 basis points to 41%. Let's turn to our performance through 9 months of the year. Net sales were up 48% to $285 million, driven by momentum in our premium metal card business across banking, gaming, fintech entertainment and exchanges in the U.S. and internationally. Adjusted EBITDA through 9 months of the year was up 30% to $106 million, which excludes the $38 million benefit from fair value adjustments. However, it does include the impact of the $10 million for the arbitration charge. Taking a closer look at our net sales trends, you can see that we are generating strong growth both in the U.S. and internationally, with each up 62% and 35%, respectively. U.S. growth was driven by the strength of our sales execution and favorable industry trends, while international was up due to the expansion of our international sales team, continued distributor growth and strong customer demand. Year-to-date, international net sales is up 79% versus the prior year and represents 24% of the total net sales. Before I turn to EPS, let me take a few moments to discuss our cash flow and balance sheet, which can be found in the appendix of the presentation. Looking at our cash flow statement year-to-date, we had operating cash flow of $91 million versus $48 million during the same period of 2021. As of September 30, we had secured debt of $243 million. That was made up of $233 million of a term loan plus $10 million of our revolver, an unsecured convertible debt of $130 million. We had cash of approximately $15 million on the balance sheet, resulting in a total net debt of $358 million. We are pleased that our leverage ratio is now 2.92 based on $123 million in trailing 12-month adjusted EBITDA calculated as per our bank agreement. This ratio was down from 3.29 on $180 million in trailing 12-month adjusted EBITDA from last quarter. This was achieved through a combination of paying down debt and growing EBITDA and is consistent with our stated strategy. The secured debt facility provides a revolving loan of up to $60 million with $10 million drawn as of September 30, 2022. We believe our cash balance, cash flow generation and debt facilities provide adequate working capital to fund our growth plans. I want to turn now to earnings per share. As I mentioned last quarter, we have adopted an alternative method under GAAP for calculating basic and diluted EPS. This method allows us to allocate changes in fair value adjustments of mark-to-market instruments among the public company and the operating subsidiaries to better reflect the actual economic impact of the conversion of such instruments on our net income on a per share basis. The reason we are doing this is that we believe this method better reflects the economic impact for shareholders. Our Q2 and Q3 EPS numbers as reported, are consistently calculated under this GAAP measure. Having said that, let me run through our EPS calculations. Basic GAAP earnings per share for the quarter was $0.18 for basic and diluted shares. Basic GAAP earnings per share for the 9 months ended September 30, 2022, was $1.03 per basic (sic) [ $1.02 per basic ] and $0.94 per diluted share. You can read through the footnotes on the slides that take you through the complexities of the allocation of net income due to the Up-C structure and the shares that are included in the basic and diluted calculations. Note that the fair value adjustments in the quarter and the year-to-date have been allocated among the operating companies to come to pre-allocation net income. On Slide 13 and in our MD&A, we are also providing an adjusted net income and EPS that takes out the impact of the noncash fair value adjustments, stock-based compensation and the effect of the Up-C structure. We believe that this provides a clearer picture of the economics of the company's operating results. With that background, our non-GAAP earnings per share for the quarter was $0.26 per basic share and $0.22 per diluted share. For the 9 months of 2022, our non-GAAP earnings per share was $0.86 per basic share and $0.74 per diluted share. In the appendix, you'll find a reconciliation between the GAAP and non-GAAP net income used in these calculations. I will now hand it back over to John to address our updated guidance and for a final summary before we take questions.

Thanks, Tim. As mentioned, we've updated our guidance. We are narrowing the 2022 net sales range to the high end of our previously announced guidance, we now expect sales for the year between $370 million and $380 million, reflecting an approximate 40% increase from 2021 at the midpoint. We're also raising our 2022 adjusted EBITDA guidance and now expect it to be in the range of $130 million to $137 million representing an increase of approximately 31% from the 2021 midpoint, or at the midpoint. As always, I'd like to share our strategic priorities with this audience, as you can see on Slide 15. We achieved another outstanding quarter that has us set up for a strong finish for 2022. And our strong performance validates our strategic business decisions in particular, our approach to the timing of our Arculus investment has enhanced margins for the quarter and the year and ensures that we are managing investment appropriately in order to drive long-term growth and profitability. We continue to see increased demand for our metal payment card offering from both new and existing customers, driven by strong sales execution, deep customer relationships and market momentum. The Arculus portfolio, we believe, is well positioned to support today's growing security payment and cold storage and authentication needs across a variety of industries, and we are focused on executing our sales and B2B marketing efforts. We are working to better time investment to growth by adjusting the investment timing for Arculus due to the current uncertainty in the marketplace. While we have not seen any major impact from macroeconomic issues as of today, we're monitoring our customers, the market and macroeconomic factors and are well equipped to respond. We're proud of what we have achieved in the last 9 months. And we believe we have differentiated ourselves from many other companies that went public in 2020 and 2021 by delivering strong results with revenue growth 40%, adjusted EBITDA growth north of 30% and EBITDA margins north of 30%. With that, I want to thank you all for taking the time to join us today. We very much appreciate your attention, and we'll now open it up to questions.

[Operator Instructions] And our first question comes from John Todaro from Needham.

Congrats on the quarter, everyone. Two questions here. First off, as we think about gross margin and the expansion you guys have been able to do there, kind of -- can you just give a little bit of maybe you're thinking of upper limit on unlocking efficiencies there kind of as we move longer term in the '23 and then '24? And then I have a follow-up question on SG&A.

So John, thanks for the question. As we think about gross margins, we've guided sort of long term, call it, mid-50s and we've been fortunate in that we have been able to offset rising supply chain costs and labor costs with the efficiencies that Tim outlined. As we look forward, we tend to be conservative around market environment, the potential for competition and a whole series of factors. So I'd say we're comfortable with guidance previously given.

Got it. And then just a quick follow-up to that. I believe the margin profile for Arculus on a gross margin basis is even kind of higher than that 60% level. Can you just be reminded on that? And is it fair to say as Arculus does ramp, that gross margin could expand more?

Yes. That is a fair point that we've made before, and I would agree with that we think our unit economics are perhaps even stronger on the Arculus side. And yes, I think we have the ability to deliver gross margins that would be in line to hire.

And our next question comes from Reggie Smith from JPM.

Congrats on the quarter. Just 2 quick questions for me. I know you guys have a pretty good look ahead in terms of, I guess, advanced orders for payment cards and such. My question is, as you stand here today, how does your backlog look or compared to maybe a year ago? Obviously, things can change. The economy is in question right now, but just curious what you're seeing from a advanced booking perspective? And then I have a follow-up.

Thanks, Reggie. When we look at the backlog it's strong and consistent with my comments, we have not seen impacts from some of the macroeconomic things happening around us, and consistent with messaging that others have delivered in earnings that we're continuing to push forward, intending to and wanting to drive growth and believe that we can -- if that changes, we will adapt. But our backlog as well as communications with customers at this point still give us positive indications.

Got it. And then just a follow-up. It sounds like the payment plus authentication card will be ready sometime in early '23. Just remind us kind of how did new product rollouts occur? And my question is, I guess, what I'm curious about is, have you already like received orders for those? Like how should we think about the initial deployment of that technology kind of occurring and rolling out?

Thanks, Reggie. So just a clarification. So the payment plus authentication is available now. So we can deliver that to the market. We got Visa and Mastercard approval for that. And that is working. That's -- we have the ability to deliver that to the market now. What I -- the comment I have made is our ability to deliver payment plus authentication plus cold storage is something that we would deliver early next year. So the conversations I highlighted, for example, with InBestGo or some of the other potential partners cover that payment plus authentication. So we're essentially selling that now and looking to deliver that. Does that make sense?

And I am showing no further questions. I would now like -- this concludes today's conference call. Thank you for participating. You may now disconnect.