Good day, ladies and gentlemen and welcome to the Q3 2016 CPI Card Group, Inc Earnings Conference. 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 turn the call over to your host Ms. Molly Carol [ph]. Ms. Carol, you may begin.

Thank you, operator and good afternoon, ladies and gentlemen. Welcome to the CPI Card Group’s third 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 maybe 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 the 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 will 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, Molly, and thank you everyone for joining us today on our third quarter 2016 earnings conference call. I would like to share some highlights from the third quarter with you. Net sales were $81.2 million representing a decrease of 24.6% year-over-year predominantly driven by fewer EMV chip cards sold in the third quarter of 2016 compared to the same quarter last year, partially offset by continued strong growth of value added services and better than expected EMV pricing. On a GAAP basis, net income from continuing operations was $4 million or $0.07 per share in the third quarter of 2016 compared with $0.19 per share after preferred dividends in the third quarter of 2015. Adjusted net income from continuing operations was $6 million or $0.11 per share. Adjusted EBITDA was $17.8 million compared with $32.5 million in the prior year period, and we returned $2.5 million to stockholders through dividends in the third quarter of 2016. Our third quarter results were below expectations primarily due to continued softness in demand for EMV chip cards on favorable foreign currency exchange rates which impacted the quarter by $1.4 million and delays in the operational startup of our new Print on Demand offering for the U.S. prepaid debt segment. Despite the lower than expected sales, I was pleased with our performance at both gross margin and adjusted EBITDA margin performance in the third quarter compared to the second quarter. The sequential improvement in margins was driven by the combination of the expected seasonal increase in the prepaid debit segment, benefits from cost saving actions we initiated earlier this year, and higher selling prices in the EMV cards resulting from improved customer mix. The long-term growth opportunities for CPI remain positive, driven by our broad product offering for the financial payment card markets,…

Thanks Steve. I will first provide you with a review of our third quarter results and then update you on our financial outlook for 2016 as well as providing some comments on 2017. Third quarter net sales were $81.2 million down 24.6% from $107.7 million in the third quarter of 2015. The decline in our net sales primarily reflects a 45.1% year-over-year decrease in the number of EMV chip cards sold in Q3 of 2016. Products and net revenue decreased 42.8% year-over-year to $37.5 million in the third quarter while services net revenue grew 3.8% year-over-year to $43.7 million. Turning to our segments, U.S. debit and credit segment net sales were $49.2 million for the third quarter a 32.5% decrease from the prior year period. Segment income from operations was $10.8 million compared with $21.6 million in the prior year and segment EBITDA was $12.9 million, a 44.7% decrease over prior year. The decline in our U.S. debit and credit segment results were predominantly driven by the year-over-year decrease in EMV card shipments, as Steve discussed average selling prices exceeded our expectations during the third quarter and on a weighted average basis were $0.96 compared with $0.94 in the second quarter of 2016 and $0.94 in Q1 of 2016. In our card personalization and fulfillment business, we generated a $4.3 million year-over-year increase in net sales during the third quarter, which partially offset the decline in product net sales. U.S. debit and credit segment net sales were $23.1 million in Q3 down 2.4% year-over-year. Segment income from operations was $8 million, a decrease of 15.3% and segment EBITDA decreased 13.8% year-over-year to $8.6 million. The year-over-year decline of U.S. prepaid debit segment net sales was primarily reflecting lower prices partially offset by increased volumes from sales activity. Finally, our UK…

[Operator Instructions]. Our first question comes from Jim Schneider of Goldman Sachs.

Good afternoon. This is Claire [ph] stepping in for Jim today. Just a couple of questions. Could you give us an update on the current inventory levels at the large issuers, I think on the last call you said that 6 to 9 months and kind of where that’s trended now, and where you expect it to trend by the end of the year and then also just in terms of your 2017 revenue outlook, could you maybe explain some of the drivers there and how it delves up to that net sales level, and kind of the mix between pricing and volumes in the different sub segments applies? Thanks.

Sure, this is Steve and I will address the first part in terms of the inventory levels and then I will ask Dave to talk about the buildup of the revenues for 2017. But overall, the revenue level or the inventory levels for the large issuers have continued to come down. As we’ve talked about before, there were excess inventories all through the year and we had indicated previously. We didn’t expect that those -- that issue was going to be going away until we got into 2017 and that’s still our outlook that inventory levels continue to do be consumed and continue to decline, and we expect that the large issuers are going to get to what their desired inventory levels are as we get into 2017. So our outlook around that really hasn’t changed, and I will ask Dave to please comment on the build-up of revenues for 2017 with the main – she was asking the main drivers.

As I said in my comments, you know, I think we are still in the process of finalizing the 2017 plans, but I think I also mentioned that the influencing factor perhaps from what the model has suggested previously is really driven by lower conversion rate of financial debit cards to EMV during 2017, and that that sort of expected 90 plus percent conversion rate that had originally been expected to take place in 2017 has now been really spread over 2017 and 2018, so that part of the impact is probably the single biggest factor, I think then when we look underneath of the other components, you know, I think as I have said, we see the EMV markets and overall credit card issuance markets stabilizing as we move into 2017, but more or less on a volume base slightly up from 2016 but not getting back to the 2015 levels. Then the last piece to that is really in our services business, which includes both our personalization fulfillment and the prepaid businesses, you know, we see above market rate growth for those businesses in 2017.

And included in Dave’s comments on the services businesses that we expect that Print on Demand which is the new offering that we’re bringing to the market or have brought to the market, we expect that we are going to see some meaningful growth from that in 2017, so we should get a good boost from that product offering.

Thank you. Our next question comes from Dave Koning of Baird.

Hi guys, I have got a – I guess a few questions. The first one, I think our models which kind of matched your guidance had Q4 revenue previously in the kind of low 90s range, and now you are saying kind of the more low 60s range, so you know, it’s pretty significant reduction like you know whatever the 35% reduction or so. Is it, I guess two questions here, one is, is it just that hard to forecast which makes 2017 also hard to forecast; and then B, maybe you can just give, is there a base level recurring revenue that kind of no matter what, there is kind of a level of revenue that it can’t go below?

Yes, in terms above the fourth quarter, Dave, as you look at the fourth quarter, I think we were anticipating when we gave the previous guidance back in May, we were really anticipating that in the second half of the year, but sequentially greater from the third to the fourth quarter, we were going to see an uptick in EMV buying levels and that has not materialized, it was off a bit in the third quarter, and we see that in our lower than expected results in the third quarter, but really is also manifesting itself in the fourth quarter what our expectations are for the fourth quarter, and so that’s part of it, it’s just slower volume levels and part of it is also as we mentioned FX has a small – on the margin small impact, and also we have expected that we are going to be getting in the fourth quarter about $4 million of revenues from Print on Demand and with the delay in the operational start up of Print on Demand that’s not going to be there except in the small amount for the fourth quarter. So it was really the expected uptick in EMV buying just did not materialize, we did not see in it, market continues to be soft and migrations while progressing are progressing more slowly than expected.

Okay and I guess that second question, the base level, is there like a base level across your segments of like maybe some of the services work or some of the debit issuing work, is there a base level of like say $50 million of revenue that that each quarter that is very sticky and highly recurring, and it’s really that next level that’s really hard to predict between maybe 10 million and 50 million it’s just because the card revenues bounce all over the place, but you know could you give us some confidence in like just a base level recurring business?

Yes, we think, as we look, and I think Dave expressed, we believe the market is really stabilized at a slower rate of migrations and at lower level of buying than what was previously anticipated but we do believe that the EMV market in particular stabilized and so as we look to 2017, we took that into consideration as we thought about what our guidance is, is what is, where is the market now, where do we think the market is going to be based upon discussions with the issuers and so that’s what really drove the guidance that we had around the debt and credit business and we continue to see good strength in our personalization and fulfillment business and as Dave mentioned, we expect that to grow at higher than market rates which is consistent with what our experience has been and then we expect our prepaid businesses going to show good growth in 2017 based upon business in hand and also discussions we are having with customers around prepaid particularly around Print on Demand. So we really feel that the guidance that we put out there those reflect a level of activity that is consistent with the level of activity that we’re experiencing now with growth coming from again the services business which is consistent with the growth that we have been achieving.

Got it, okay. And then my last one, that was helpful on that. The last one is just the EBITDA margins, you know obviously coming down this year and it’s hard, I get it’s hard to manage when if revenue is lower and you have a cost base somewhat fixed you know it becomes a little difficult to manage the margins, can, if you grow next year, you know, is there a good incremental margin kind of on the bounce back in revenue next year and, you know it’s somewhere higher than 16 but less than 15, I think that may be what you were saying on the last question too.

I think that’s right, Dave and I think if you look at you know, where we were at in 2015 at a 26% EBITDA adjusted sort of return level and with the – what I would say a drop in second quarter this year that was in the 16% range but then seeing that raise back up to 21.5% in the third quarter that as we look at 2017, I think it would be, you know, looking to probably at the volume levels that we’re predicting for 2017, hard to get back to the 2015 level but in the 20s is still where our line of sights are and so, you know, I think as volume comes back it’s scalable. I think when we look at the things that we can’t control and Steve talked about them, it’s continuing to look at our cost base whether it’s in the SG&A side of things or it’s in the manufacturing cost, those are things that we’ve now I suppose become more focused and have undertaken as an ongoing process to try to balance those against the volumes that we’re predicting.

Okay, great. Well thank you.

Thank you, our next question comes from Chris Kennedy with William Blair.

Hi guys, thanks for taking the question. Can you talk about your market share and how we get confidence that CPI is maintaining its market share?

Yes the – in terms of our market share, Chris, we believe that our market share continues to be consistent with what we’ve experienced in the past and as we’ve talked about before at a point in time we could see some movement on that because there are puts and takes with business for instance this year there was – it was recently that there was an RFP for a customer that we lost and so that business that was lost business to us and then we’re gaining business in other areas, so there is always ebbs and flows but overall, our market shares is consistent with what we’ve had in the past and what we would, what we’ve discussed with you. So we don’t, the market share that we’re looking at is also as we determine our market share, we continue to look at what are the issuers doing? Have discussions with them about it and then look at our own production to come up with where we think we are and so our view of our market position hasn’t changed and again at a point in time, it could fluctuate a bit but over the long term, our view of our market position, where we are and what our market share is hasn’t changed, Chris.

Okay great, and then the Print on Demand service, I think you mentioned you were expecting $4 million of revenues in the fourth quarter, is that kind of an annualized run rate as we look into 2017, you know 15 million to 16 million or…

It, I would say that, that would be annualized run rate. It just – for clarification that business was contracted business that we had, so with business in hand it was just an operational delay that we had both on our side and the customer side that push that out but in terms of a run rate that we would expecting, yes, that’s neighborhood of a run rate we would be expecting as we get into 2017.

Okay great, and then just, on the penetration of EMV cards, I think initially you were looking for 90% exiting 2017, you said, you reduce that expectation, where is it, what’s your expectation today?

And it was, I would say, our expectation driven also were influenced by the expectation of a lot of people in the marketplace that whether it was the card brands or it was third party consulting firms. I think everybody was anticipating or projecting that the market was going to be 90% plus converted to EMV by 2017. We don’t think we get to that until towards the end of 2018 maybe in to 2019, but we don’t think we get to that level then based upon the current pace of migrations to EMV, we think that next year at the end of 2017, it’s probably more in the range of 80% and then getting up to 90% plus as you get into the end of 2018 beginning of 2019.

Yes, I think, Steve, just to sort of add to that a little bit, you can dissect it I think back through the transcript but I think you have within the 90 plus percent, we refer to that as the combination of both debt and credit for the financial payment space. I still think, yes, that the credit part of that is certainly well ahead of debit. And so when we look at exiting this year, I think you see a more – a number that’s closer to the 90% for credit and the debit is still in the 30% range. And so the step up between ‘17 through ‘18 is really influenced by the debit component of debit and credit cards.

Okay, great. Just one last one, any update on the CFO search?

Yes, we have – as we talked about, I think we talked about the last time, we had engaged with the national search firm. We have met with some excellent candidates and so we are very, very excited about the people that we have met with and we continue to – we will continue to meet with a couple others, but that process is moving along as expected, but we are really encouraged by the caliber of people that we are talking to.

Great. Thanks a lot.

Sure.

Thank you. Our next question comes from Stephanie Price of CIBC.

Good afternoon.

Hey, Stephanie.

I am just working through this lower Q4 volumes versus Q3 and Q2 and trying to translate that into sort of the outlook for 2017, can you kind of walk through where you are expecting the pickup in EMV volumes to occur, is it going to be at the beginning of 2017 or how are you kind of thinking about that year?

Yes. Usually, if we look at the patterns in the past, the patterns have been that Q4 is generally a lower quarter. Quarters two and three are stronger quarters and there is a – then there is a slowdown in Q4 that then carries over into Q1 and then there is a pickup after that as we get into the year. In terms of exactly how we see that sequence out in 2017, we are still working on our operating plans, Stephanie. So, can’t give you that kind of precision right now around how we see exactly that sequencing in 2017. Overall, as we talked about we think the market had stabilized, we think that the expectations around EMV for 2017 as a whole should be consistent with what we have experienced in 2016 and that’s our view as we look at our guidance and as we look for 2017.

Okay. And then in terms of leverage, can you talk a bit about where you are comfortable with and how you are thinking about leverage right now?

We continue to – leverage is something that we continue to be focused on making sure that we are managing and over the long-term we want to be reducing our leverage. That’s always been a long-term goal of ours. Right now, we have a debt facility that is very favorable to us. We know we have interest payments on it, but we have no principal payments on that debt for a number of years. And so the capital structure that we have I think is favorable and we will continue to really monitor what our leverage levels are. And over the long-term, we are absolutely committed to getting our coverage ratios up and our leverage ratios down, but we believe that the debt facility – well, the debt facility doesn’t provide or it doesn’t constrain us in anyway and we don’t expect that it’s going to.

Okay, great.

Thank you. Our next question comes from Paulo Ribeiro of BMO.

Good afternoon. Thanks for taking my questions. I have couple of questions. First is the mix of chip to mag stripe, because you guys talked about the chip volumes are coming lower than you expected? Is it – how about mag stripe, what’s going on in that market? Is it also weaker or are we seeing less overall we faced them in volumes or issuance rather from financial institutions or that is holding up and it’s more the conversion is being slower. Can you talk a little bit about the trends in mag?

Yes. Paulo, in terms of the volume levels, as we look tomorrow…

Overall parts, yes.

Yes, yes. As we look at the buying levels overall from financial payment card combined levels are lower than anticipated, lower than what we have had expected when we had provided previous guidance. And so I would say overall buying levels for all of financial payment cards are lower and that specifically includes EMV which we know has larger impact given the difference in price.

Right.

Yes.

And the second question is regarding cost you mentioned some cost savings if I got it right $6 million annualized for this year from $2 million in cost savings in the second half. And then did you say some additional $4 million from cost initiatives that you started in 3Q ‘16? I am trying to….

Yes.

Okay. So in total, we are talking about $10 million in cost savings for ‘17 and what is the basis that – how should I think about it is like – is that based on which year and what is the cost of sales and what is OpEx?

Yes. Most of the $10 million is going to be in cost of sales.

Okay.

Okay. And that will be $10 million impact to the bottom line, so that will flow through.

Okay. So, if I have, let’s say, a cost of sales $200 million for ‘16 it’s $10 million less?

Yes.

No, so you already had some savings flowing through third quarter…

We already have some savings, yes.

So, you had already some 4, 5 in the second half of the year?

Yes. We have $2 million in the second half of the year and then we expect that, that’s going to grow on an annualized basis and that’s going to grow to $6 million for the full year in 2017 and then there is going to be an additional $4 million of savings that we will generate in the full year 2017.

Okay. So, you have a little bit of that in this year, but most of it the $4 million, the full $4 million is next year?

Yes.

Okay, great. And how about the buyback, last question on buyback, how are you guys thinking about that, how much you still have left, if you can remind us?

Yes. In terms of the total buyback I believe its 1.6 million shares that we have left.

1.4.

1.4. Okay, 1.4 million shares. And the way we are looking at it Paulo is we continue to evaluate that, but one of the things that we are always weighing in is, what are the other uses of capital that we have, for instance, in the third quarter as Dave mentioned. We have reduced our debt by $9 million when we paid off that promissory note. And so that was important to us for using that cash for debt reduction and managing that leverage. And also we want to make sure that we are maintaining liquidity that we are maintaining a strong balance sheet. So, those are things that are really important to us. And so we are going to continue to balance what we do and we will – we have the flexibility to be buying more shares in the future if that looks like the right decision for us. And so that’s something that we can do, but we are constantly weighing in terms of the importance in the use of capital for us.

Great, thank you.

Thank you. And our final question comes from Carl Norberg of Craig-Hallum.

Hey, guys. Thanks for taking my questions. Just want to get your thoughts on sort of the longer term post EMV, how should we be thinking about like annualized car production, EMV car production runway front rates, is that like a $200 million number or $300 million number just kind of want to get your thoughts on sort of longer term here?

Carl, just to make sure I heard the question right, Steve, are you asking what is for CPI or for the market in terms of…

For CPI?

In terms of total card units?

Total cards units sold per year, yes?

And what we have – I am sorry, Carl, you are asking what we have got in 2017.

What sort of a run-rate – just sort of a run-rate post EMV once EMV is fully converted, how many cards you guys would be selling per year?

I think it’s going to – now taking out prepaid cards, so I think the question is in and around what’s the normal run-rate just so that I am very clear for financial debit and credit cards and that is after you sort of get through the full mix issue between what’s magnetic stripe and what’s EMV. And I think based on what we have historically done I would say a normal runway if we just based it on a no growth, but just normal run-rate would be somewhere in the range of 180 million to 200 million cards would be the normal run-rate.

Got it. Thanks, guys.

Thank you. I am showing no further questions at this time. I will turn the call back over to your Mr. Montross for closing remarks.

Okay, thank you. Thanks everyone for participating in the earnings call and we look forward to speaking with all of you next quarter.

Thank you. Ladies and gentlemen, this concludes today’s conference. Thank you for your participation. You may all disconnect and have a wonderful day.