Good day, ladies and gentlemen and welcome to the CPI Card Group Second Quarter 2016 Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions] As a reminder this conference is being recorded. I would now like to introduce your host for today conference, William Maina, sir, you may begin.

Thank you operator and good afternoon everyone. Welcome to the CPI Card Group second quarter 2016 earnings conference call. Participating on today's call from CPI Card Group are Steve Montross, President and Chief Executive Officer; and David Brush, Chief Financial Officer. Before we begin, I'd like to remind everyone that this call may contain forward-looking statements as they are defined under the Private Securities Litigation Reform Act of 1995. Please refer to the disclosures at the end of the Company's earnings press release for information about forward-looking statements that they may be made or discussed on this call. The earnings press release is posted on CPI's website. Please review the information along with our filings with the SEC and on SEDAR for a disclosure of factors that may impact subjects discussed on this call. All forward-looking statements made today reflect our current expectations only and we undertake no obligation to update any statements to reflect the events that occur after this call. Also during the course of today's call, the Company may be discussing one or more non-GAAP financial measures including EBITDA, adjusted EBITDA, adjust EBITDA margin, adjusted net income from continuing operations, adjusted diluted earnings per share from continuing operations, free cash flow and constant currency. Please see the earnings press release on the CPI's website for all disclosures required by the SEC including reconciliations to the most comparable GAAP numbers. And now I'd like to turn the call over to Steve Montross, President and Chief Executive Officer.

Thanks Will and thank everyone for joining us today on our second quarter 2016 earnings conference call. Before beginning my discussion of our second quarter results, I want to address our announcement today that Dave Brush will be stepping down as CFO at the end of this year. After a successful career spanning more than 25 years, Dave has decided it's time to spend more time with his family. Dave has been a strong partner during this time with us and his contributions to CPI have been very valuable, especially his leadership during our IPO process last year. On behalf of the entire CPI family and the Board of Directors I wish Dave the very best. I'm happy to say that Dave will stay engaged with CPI after he officially steps down on December 31 and make himself available as a consultant to help with the transition of his responsibilities through June 30 of 2017. We will begin immediately the search for a permanent CFO and will update the market as soon as we have something further to announce. Now onto the second quarter, the second quarter played out right along the lines that we discussed in our prior earnings call. The market experienced a meaningful drop in EMV card demand due to inventory overstocking at the large issuers and processors. And while EMV activity was increasing with a small to midsized issuers, the EMV conversion delays at the processor level caused delays and dampened the growth in the EMV conversions and issuances by these small to midsized issuers. As we anticipated and foreshadowed in our prior earnings call, our second quarter results reflect these temporary unfavorable industry wide factors. I am pleased though with the consistent strong execution and the focus on service excellence by the entire CPI team…

Thank you and good afternoon everyone. First I wanted to say that I have been enjoyed the last year and half working with Steve and the entire CPI team as we've gotten a lot of things to accomplish. Further as Steve mentioned I will continue my role as CFO through December 31, 2016 when I will officially step down. I will then serve as a consultant through June 30, 2017 to help with the transition of my responsibilities. Now I will begin by summarizing the results of our second quarter 2016, I will then provide our guidance for full-year 2016 before opening the call for questions. Second quarter net sales were $73.7 million down 22.8% from $95.7 million in the second quarter of 2015. Our net sales primarily reflect a 54.9% year over year decrease in the number of EMV chip cards sold this quarter partially offset by continued demand for our customers for value-added services. Product net revenues decreased 40.8% year over year to $40.1 million in the second quarter while services net revenues grew 21.1% year over year to $33.6 million in the second quarter. When you remove the approximately 1 million of revenue related to the closed Petersfield facility, services net revenue actually increased by 25.7% in the second quarter of 2016. Now turning to a review of our segments. US debit and credit segment net sales were $50.8 million for the second quarter, a 30.7% decrease over the prior-year period. Segment income from operations was $9.2 million representing 58.6% decrease and segment EBITDA was $11.4 million, a 52.5% decrease. As we discussed, the decline in revenue, operating income and EBITDA were predominantly driven by the year-over-year decrease in EMV card shipments. Average selling prices were in line with our expectations during the second quarter and on…

[Operator Instructions] Our first question comes from the line of Jim Schneider with Goldman Sachs. Your line is now open.

Good afternoon. Thanks for taking my question. I guess it was helpful commentary to hear kind of what's changed from May versus today, is that fully 100% in terms of the guidance, the lower end of the range, the result of the large issuer push-out, can you give us a sense for how many months of inventory you think remain at the large issues and do you think -- do you have confidence now that that inventory situation is going to be fully normalized, exiting the calendar year?

Yes. Jim, what we’re seeing right now and it varies by issuer, but generally the large issuers still have inventories in the 6 to 9 month range and in our discussions with the large issuers, they want to get those inventories down more in the 3 to 6 month range. And so, in general, what -- the information we’re getting from the large issuers is, there is still about three months of excess inventory or so on average that they are sitting on. And so they want to burn through that inventory before they get to what we would expect the more normal buying patterns. And so what we’re expecting is that by the beginning of 2017, they will have burned through that excess inventory and start reverting to more normal buying patterns.

That's helpful. Thanks. And then maybe, just as a follow-up, one bright spot in the quarter was the services business up above 20%, I think you said it was, can you give us a sense of whether that was any different from what you had planned last quarter, and whether that level of growth is sustainable in services going forward and over the next few?

Yes. No, we think it is sustainable, it's reflective of a couple of things. One, our personalization fulfilment business is really performing well. We continue to see growth in that business, just in volumes, but also the uplift from EMV conversions is impacting that business as well, having a positive impact on it. So we’re seeing that, so both growth in volumes and then the uplift from EMV and then also we continue to see strong results from instant issuance in those services. And so overall, we feel really good about our service offering and where it’s headed. So we believe it is sustainable, Jim.

Thank you very much.

Our next question comes from the line of Bob Napoli with William Blair. Your line is now open.

Thank you. Good afternoon. Historically, Steve, you guys get a ramp up in the prepaid business going into holidays, the third quarter in the last couple of years has been a big ramp. In order to hit your guidance, you need to have, I think, you need to have average revenue in the back half of the year at around the 90 million per quarter level. So in order to get there, I think you need to have ramp probably and prepaid, as -- are you going to get that ramp that you've had, and how confident are you in being able to get that ramp and increase the average revenue in the back half versus the front half?

Yeah. We are confident that our prepaid business is going to be stronger in the second half than the first half and we also believe that our prepaid business is going to be up year-over-year, Bob, but we are confident that our prepaid business, we are going to get a ramp and it’s going to be stronger in the second half than the first half.

So I'm sorry, you said you are confident it will be up year-over-year in the back half?

Yes, in the second half, we believe it's going to be up year-over-year and also, we’re confident it's going to be up in the second half versus the first half.

Okay, just something that's been out in the market the last week or so, fraud on chip cards as the fraudsters are finding ways to trick the chip cards and being -- not being able to be used and they can still get data off the magnetic stripe, are you getting a feedback in the market on that issue and I mean how well are you aware of that?

Yes. No, we haven't been getting any feedback on that issue in terms of some tricking of the chips. So I don't have anything to share in that regard, Bob. The one area that we continue to hear a lot about fraud is, well, a couple of different areas. One area is just for the people that haven't -- for the merchants that haven't converted over, their charge back, the charge backs in the market have just skyrocketed, and so that’s ongoing and while there continues to be a lot of focus on making these conversions happening and get to chip on chip transactions and then the other area of fraud is just with prepaid cards. The Fraudsters continue to attack prepaid cards, and because they are magnetic stripe and so we've seen increased desire to really look at what are some fraud prevention measures, including continued focus on temporary and packaging, and that is -- the fraud issues are particularly queued in Canada with prepaid. So those are the two areas that we continue to have a lot of discussion about but haven't heard anything or haven't had any discussion around tricking the chip and seeing fraud as a result of that.

And last question, the services business. As you look into 2017 and ‘18, do you expect that to continue to be a double digit topline growth business?

We do, yes, we do.

And what parts of that business are you most confident in that services business?

I would say around personalization fulfilment, we expect that we are going to continue to see strong growth there and then also with our instant issuance business, that continues to grow well. So we expect that we’ll see good growth there. And then in the prepaid segment, as we moved into -- we talked about the new -- basically new offerings to really attack and go after and take advantage of the high growth areas of prepaid, those niches of prepaid where we have a new offering to take advantage of those areas, we expect that we’re going to see really good traction there, based on the discussions with our customers and most of the people right now that we’re engaged with are existing customers, we are expanding that with some new customers that we’re talking to on our new offering, but a lot of it is our existing customer base and we think that we are going to see really good growth from that as well.

Thank you, appreciate it.

Our next question comes from the line of Stephanie Price with CIBC. Your line is now open.

Good afternoon. You mentioned visibility still isn't where you would like, can you talk about your comfort on the full-year guidance and looking out into 2017?

Yes. So the visibility is not as much as we would like, and, I think, we've got a better handle overall on inventory levels. I think where we're still lacking the visibility is the order cycle is still very short and so we’re not getting forecast, for instance, out over the next six months and so those order cycles are short, although we have better information about inventory levels, it's still short cycles and so don't have as much specificity to the future as we like, and so that’s goes to our comments around, not having as much visibility as what we’d really like. We feel good about the guidance that we gave in terms of where we are and where we see things developing. As Dave mentioned, we here tightened up the top end of the range because we just weren't seeking the large issuers coming back above really the expectations that we had that we set in the second quarter when we reestablished our guidance, we weren't seeing them or don't anticipate that they are going to come back at levels above kind of those prior expectations that would get us up to the upper end of the previous guidance range. And so we've tightened the guidance rangers as Dave talked about, but overall we feel good about where the estimates are that are out there in terms of the business and so hopefully that is response to what you are looking for.

Yes, that's great. Thank you. And then can you talk about share buybacks as well, sounds like you did a bit in the quarter and what’s your thinking on share buybacks at this point?

Yes, Stephanie. This is Dave. I think what we did in the second quarter is we took advantage of the ability to buy a couple of blocks and really like the pricing where we were able to buy CPI’s stock at the average of $4.17. I think that being said, we have 1.4 million shares left to buy over the, I guess the authorization is for the next year and I would expect this to continue to use the program to buy CPI’s stock at the level that it trades at today.

Okay, great. Thank you.

Our next question comes from the line of Paulo Ribeiro with BMO. Your line is now open.

Thank you. Good afternoon. First, Dave, it's been great working with you, thanks for your support on all this time through the IPO and all. My first question is about pace of sales for the rest of the year and piggybacking on Bob’s question about the uptick that you get in prepaid and typically in the third quarter, so is about 90 million on average of revenue per quarter for the next to meet your guidance, but that's not what's going to happen, right, do you think that third quarter is stronger than the quarter or vice versa?

Yes. Paulo, this is Dave. Thanks for your kind words. What I would tell you is that the third quarter will be driven by the normal seasonal build in prepaid that we've described to you and this year, when you put the third quarter against the first and the second quarter, it will be even a more dramatic build when you compare it against those, but likely in line with where we have seen it historically as a percent of the overall year. What I think then tenders that a little bit in the third quarter is the softness of the EMV markets and so I think if you use sort of Bob’s on average 90 million, I would suggest that the third quarter probably is a bit below the 90 million, the 90 million level and then you get the recovery of the EMV card volumes starting to begin in the fourth quarter, which helps that piece of the revenue and I do think as Steve mentioned, I think we would expect to see a nice third quarter, nice fourth quarter also in the prepaid business as we begin to bring on some of this new volume, coupled with just other programs that we have line of sight to with existing customers.

Perfect, thanks. In this prepaid, so this is a new revenue stream, new product, but the investments you made and you highlighted some are already in place, is that correct, so this is on top of service ready provides not substitutes to what, on the upgrades to what you provide, right?

Yeah. No, we really like it, because as you know, we've been the dominant provider in what we would call retail prepaid in that area of prepaid. This really expands the offering that we have in the -- what we would call the enterprise or the B2B and B2C areas of prepaid and those are also high-growth areas. We talked about before where it’s rewards, it’s also for instance, payroll benefits, healthcare, and so we're really excited about it because it is an expansion into that segment where we've been we believed under penetrated. Those are also high-growth segments. And where we are right now is, we’re bringing that online in September that capability online and we've had discussions with customers, discussions have gone very well, they are excited about the capability and we believe that once we bring that online, really demonstrate the execution, then we’re going to see a lot more traction of sales at that point. And so we expect that we’re going to see impact from that in the fourth quarter as Dave mentioned, but we think that we’re really going to see bigger impact, get more traction in 2017.

Perfect. One last question before I get it back on the line, but the adjusted diluted earnings per share guidance for the year, does it incorporate the repurchase the 1.4 million that you still have left?

I don't think we’ve forecasted the guidance at that level of precision. So I think within the range of guidance that we've given you, if we were to do the remaining 1.4 million, you would still sit inside of that range, Paulo.

Okay, great. Thank you.

[Operator Instructions] Our next question comes from the line of Dave Koning with Robert W. Baird. Your line is now open.

Yes. Hey, guys. Thanks for taking my question. And so, I guess first of all year-to-date, the number of cards, the cards sent is down and I know you’ve mentioned kind of the reason and everything, do you think for the full year that the number of cards will be down and I guess the second part of the question is do you think the overall market is still up. I guess I'm just wondering if you think you’re losing share this year and then how you kind of catch that back up maybe next year.

Yeah. So, let's just go directly to market share and then we can talk about the overall market. So, in the first quarter, we felt our market share was actually above our long-term historical averages, and in the second quarter, we believed that our market share is right at what our long-term historical numbers have been. So we don't see any loss of market share. Overall, what we are seeing in the market, Dave, is that the number of cards in circulation are not changing, it’s going up a little bit, but it’s not changing. And the issuances are perhaps down a little bit this year from what they were last year by the financial institutions. But as we've talked about before, in the second quarter and then also today, we talked about it as well is just card purchases and I’m talking specifically about EMV card purchases are definitely down year-over-year, reflecting that carryover of excess inventories. So overall card production and hard demand for EMV cards is down this year and will be down year-over-year. Card issuances, we think, are going to be for the year probably relatively flat, maybe down a little bit and cards in circulation, though, are remaining the same or going up a little bit.

Okay, that was pretty helpful. That’s great. Thank you. And then I guess the second thing is, in 2017, my guess is your expectation is that revenue is going to grow and so do you think, a, that we can get back to the 2015 level of revenue and then, b, if that is the case, our margins, do you think margins can be in a place where you would generate a similar EPS as you generated in 2015 if that was the case?

Yes. I think look, 2015 total revenue of 374 million. I think when you look at where we would expect issuance next year as the market returns to what we will call some more normalcy when you look at the continued migration of the remaining EMV cards which it's going to be driven by debit, which becomes a proxy for the small issuers where we have a nice position and then we just look at sort of any other further penetrations and things like dual interface and ongoing movements on prepaid, then for sure without going out on a big limb here that yes, I think she would be well above the 2015 revenue as we would predict our 2017 sitting here to date. I mean, if you just, I think as we, if you look at what underpinned the EMV cards that we issued in 2015, it was 154 million cards, as we reported it out. I think if you look at what we've issued this year, year-to-date with the second quarter being at 22 million cards and we were at around 41 million cards, if my memory is right on the first quarter. So 63 million cards in the first half, for sure we will see that number building, but I don't think our guidance has predicted getting back to even the 154 million level that we saw in ‘15 for card production. So again, just the ongoing conversions and the return to normalcy will be helpful for sure to that top line.

Okay. And then do you think if you did generate a similar amount that margins can get back to a similar level, so you can drive EPS kind of around the same level as 15 or above?

Yes. I think what we've learned in the last quarter or two is that volume matters, and so I mean I think as we've looked at the cost shaping programs that we’ve been working to try to take out some of the variable labor, but ultimately when volumes come back with the absorption of the fixed cost, it has a meaningful impact. And so I think when we start to talk about the more normal volumes on the EMV side, from an EBITDA return perspective, I think in ‘17, we would return back to that 26% sort of average number to the bottom line. And with that, you continue then to sort of enjoy gross margins in that 35% to 37% range. And I think as we've said right along, as we see the average pricing mix change for us, which is beneficial, meaning that as the small and mid-size customers become more significant for our overall portfolio, it actually helps offset that decline that we've talked about in the large issuers space, pretty good reference point was $0.94 held flat for us as the mix improved in the second quarter of this year, coupled with the fact that we do continue to see declines in the underlying chip costs itself. So when we put all of those things together, with the sort of normalized volume, we would expect the metrics, both the gross margin and EBITDA margins to get back to those normal levels and if we’re able to get a bit more aggressive on some of these cost programs, then that just works in our favor.

Yes, got you. All right, thank you.

We have a follow-up from the line of Paulo Ribeiro with BMO. Your line is now open.

Hi, thanks. Just back to the instance issuance, you used some numbers there, on the number of machines, I missed out, but could you just repeat and also talk about on this pick up in revenues from personalization, and in terms of instance issuance, was it driven by machine sales, by service, a mix of both?

Yes. It was a mix of both, Paulo. In terms of the numbers, it was 4775 installations. So that’s units that are installed and online versus 4230 at the end of the first quarter and so we saw a good pickup, so sales have continued, installations have continued at a really healthy level and so as a result, we’re seeing increased revenues from that, but then also, now, we are building up the installed base and so we’re seeing increased revenues from the sale of supply, from the quick fees that are generated through that ongoing service if you will. And so we’re now starting to see that have an impact. So overall, instance issuance is, it was with the increase around that it was a combination of new sales plus the installed base generating higher revenues for us.

Perfect, thanks. Last question, magnetic stripe. What are the some of the numbers that are in terms of production and average selling price in this quarter and how they compare versus last, how much you made step change already?

Yes. I would say that magnetic stripe volumes were definitely down, the substitution continues in debit and credit and in prepaid, actually, our volumes are not down. We still haven't seen any kind of, in the US versus Canada, where we've seen really an uptake now of prepaid chip cards, not seeing that in the US, so it's all magnetic stripes. So the magnetic stripe volumes for prepaid are holding steady, up a little bit and so that's overall -- in terms of overall volumes, that’s what we’re seeing in terms of pricing, we’re seeing pricing relatively stable for magnetic stripe cards.

Great, thank you very much.

We have another follow-up from the line of Bob Napoli with William Blair. Your line is now open.

Hi. Just quickly on the services revenue, I forget. Did you break that out by segment, how much of the services revenue was in debit and credit and prepaid question?

Bob, we don't, just sort of help you a little bit, but won't give you the exact answer you're looking for. The prepaid business that we show as a segment all goes to services. And then the part of US debit and credit is our personalization and fulfilment business that a good share of it goes into the services line and then we have a rough number, it’s about half of the UK business and half of the revenue that gets generated out of the other segment, which is Canada, goes between services and product.

Okay. So all of the prepaid you said goes into --

Yeah. All of the prepaid.

Okay, great. Thank you. I appreciate it.

At this time, I'm showing no further questions. I would like to turn the call back over to Steve Montross for any closing remarks.

Okay. Well, thank you. Thanks everyone for participating in our earnings call and we look forward to speaking to you next quarter.