Welcome to the CPI Card Group Q2 2017 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference may be recorded. I would now like to turn the conference over to your host, Mr. Will Maina, Investor Relations. Sir, you may begin.

Thank you and good morning, everyone -- good afternoon, everyone. Welcome to the CPI Card Group Second Quarter 2017 Earnings Conference Call. Participating on today's call from CPI Card Group are Steve Montross, President and Chief Executive Officer; and Lillian Etzkorn, 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 disclosure at the end of the company's earnings press release for information about forward-looking statements that may be made or discussed on this call. The earnings press release is posted on CPI's website. Please note there is also a presentation that accompanies this conference call and is also accessible in the IR section on our 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 statement 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, adjusted EBITDA margin, adjusted net income and loss and diluted earnings and loss per share, free cash flow and constant currency. Please see the earnings press release on CPI's website for all the disclosures required by the SEC, including reconciliations to the most comparable GAAP measures. And now I'd like to turn over the call to Steve Montross, President and Chief Executive Officer.

Thanks, Will and good afternoon, everyone. Thank you for joining us on today's call. I will begin with an overview of our second quarter results and highlights, discuss the factors impacting our 2017 outlook, then cover current market conditions and close with some recent developments. Beginning on Slide 4. We have a summary of our second quarter 2017 results. Total net sales were $65.8 million, we generated breakeven adjusted net income in the second quarter. Adjusted EBITDA was $8.7 million and free cash flow was a negative $5.8 million. Now I'd like to give you some more specific updates on the second quarter and our outlook for business trends for the second half of 2017 on Slide 5. Beginning with the second quarter, our reported results reflect the sequential improvement over first quarter 2017 results, with net sales up 17.6% over the first quarter and adjusted EBITDA up $4.8 million from $3.9 million in the first quarter of 2017. Product net sales for the second quarter were $33.8 million, down 15.6% year-over-year. Similar to our first quarter, the decline in product net sales compared to the prior year period was predominantly driven by a decrease in our EMV card production volume. We produced 18.8 million EMV cards in the second quarter of 2017, down from 22.5 million in the prior year period, with the decrease again driven primarily by lower sales to large issuers. Partially offsetting this impact were increased revenues in the second quarter, from a contactless RFID loyalty card program for Tesco which is the largest supermarket in the U.K. and has the UK's largest loyalty card program. Tesco is a long-standing customer of CPI and we're very pleased to partner with them to relaunch their club card in the U.K. Average selling prices or ASPs, for our…

Thanks, Steve and good afternoon, everyone. Turning to Slide 10, you will see an overview of our second quarter results. Second quarter net sales were $65.8 million, down 10.7% from $73.7 million in the second quarter of 2016. Product net sales decreased $6.3 million from the prior-year period, primarily driven by a 16.2% year-over-year decrease in the number of U.S. debit and credit EMV chip cards sold, partially offset by the RFID loyalty card order from Tesco in the U.K. Services net sales decreased approximately $1.6 million or 4.8% year-over-year to $32 million, primarily driven by a decrease in card personalization and fulfillment sales, partially offset by growth in our U.S. Prepaid Debit segment. Gross profit for the second quarter was $19.3 million, a decrease of 15.1% year-over-year and representing a gross margin of 29.3% compared with a gross margin of 30.8% in the second quarter of 2016. Income from operations in the second quarter of 2017 was $2 million compared with $4.5 million in the prior year period. The year-over-year change in gross profit and income from operation primarily reflects the decline in our revenue, partially offset by our previously announced cost reduction actions and efficiency initiatives. We reported a net loss of $2.2 million or a loss of $0.04 per diluted share in the second quarter of 2017, compared with a net loss of $0.3 million or a loss of $0.01 per diluted share in the prior year period. We recorded a tax benefit of $0.8 million in the second quarter compared to a tax benefit of $0.2 million in the prior-year period. Our effective tax rate was 28.2% in the second quarter. Turning to our non-GAAP measures. Adjusted EBITDA for the second quarter of 2017 was $8.7 million compared with $12 million for the second quarter of…

[Operator Instructions]. Our first question comes from Brad Berning of Craig-Hallum.

Lillian, I was wondering if you could touch base a little bit more specific on free cash flow needs for the second half of the year, when you commented about the full year comment? And what kind of revenue run rate do you need to get to in early '18, to start to make sure that you are seeing positive free cash flow? I think given the change in guidance here, just people want to make sure we know what your expectation is on that? Secondly, now that you've been here a couple of quarters, help us walk through the process that you think is in place to help provide some increased confidence that the outlook is based upon expectations that are more likely realistically to be hit, given just that there's been a series of cuts for a couple of years almost, at this point. Just kind of help us walk through that process and help investors have some confidence in the numbers going forward?

Sure. Thanks for the questions, Brad. So the cash flow perspective from operating cash flow. Yes, as I mentioned, we're changing our projection for that to be a negative outlook for this year. And a lot of that, quite candidly, is a reflection of what we've experienced in the first half which has been a fairly significant move, both reflecting the overall net loss and also the use from working capital as we talked about before. As we start progressing through the year and as we start going into the second half and generating the business that we're expecting to generate, we'll continue -- we'll begin to continue to generate positive cash from the operations. But we will still continue to have some modest expenditures from a CapEx perspective to continue to build the portfolio, support the growth initiatives that we do have. So there will be some capital requirements, there will be some working capital as we move through the year, but we'll continue to improve overall generation of cash in the business as the revenue in the business continues to deliver. So I expect as we look first half to second half, the second half becomes more positive. However, just given the significant negative use in the first half, we're not going to overcome that. So as we move into 2018, I fully expect us to be in a positive cash generating mode with what we're seeing. And in terms of your second question, in terms of the increased confidence. I have a lot of confidence in where we're with the revised guidance. I think this has been a bumpy time, it's been a bumpy time for the company, for probably the past year and a half, quite candidly. We came into this year with certain expectations of…

One quick follow up is, as you take a look at 2014, 2015 EMV card issuance and you look at the expiration dates on both what you know from your partners but also the ones the ones that you supply stock to, where you don't have the reissuance dates on and you've been able to study that more. As of right now, what are your expectations for industry card EMV issuance in '18 versus '17? Are you in a position to not necessarily comment on what your share is going to be about, but at least help understand that those are expiration dates on the cards they don't change. So do you feel like you have a good grasp on what that number should be expected to be?

Yes, Brad, we -- as we mentioned in our prepared remarks, the EMV migration began in earnest really in '14 and '15 and our expectation is that we're going to see an increase in the issuance volumes as those cards expire, that we're going to see an increase in the issuance volumes in '18 and '19. The exact timing and the magnitude of that is something that we don't have good clarity on at this point. But through third parties and also some consulting firms that we have spoken to, the consensus is from those third-party sources that we -- that the industry should be seeing an uplift in reissuances in the '18, '19 time frame as those cards expire. And then based upon just a portion of our businesses, we start running through the EMV cards through our personalization fulfillment operations, the expectation is that we'll see increased reissuances of that work that was done back in '14 and '15, we'll see that coming in '18 and '19.

Our next question comes from Paulo Ribeiro of BMO Capital Markets.

Well where to start? Let's go through market share, you guys last quarter said you believe market share was fairly stable for you guys. And now we -- are you guys talking about modest? Can you walk us through a little bit how you got to that? And if possible, quantify market share or the impact they had? And then I'll have a follow-up.

Sure. As we discussed before, very -- there's not one industry source that we can go to, Paulo, for volumes. And so it's very difficult to pick what is the market share, because we don't have an accurate picture of the total industry volumes for everything. We know ours, we don't know what they are for the total industry. That being said, we believe that our market share has fluctuated over a period of time, we've talked about that before. And where we're right now is we think that we have seen some market share erosion. Business in late 2016, business -- some business was lost due to price, we expected we were going to see growth from other customers in 2017, it was going to make up for that business lost. And that growth hasn't materialized as we expected. So at this point in time, we think that our share is down a bit from what it's been historically.

So trailing on that, so historically should we still think -- you talked before around the ideal time, 1/3 market share? Or that's not the perimeter, it's by the end of '15 or end of '16 it was already down. If you'd maybe quantify where you think you are? And second, if you could -- this loss in share that you price was, I assume and correct me, it's largely among large issuers? And if that's the case, where are you with smaller issuers and where is the demand from that?

Yes, so I'll start with your -- the last question first and then work back. Yes, where we're seeing the market share erosion is with large issuers. And large issuers have multiple sources of supply. And so that's -- and depending on the RFPs that are out there and winning or losing those RFPs market shares will fluctuate in that large issuer segment. And that's where we've seen some erosion, is around the large issuers. And our business with the small- and mid-sized issuers continues to be, I believe, relatively steady in that business. One of the things we don't -- we also don't -- we're not able to calculate precisely, Paulo, is again we don't have precise information is exactly the impact that the overall industry drop in volume is having or industry demand drop is having. But nevertheless, we think that we've seen market share loss in the large issuer segment. And then going back to the time of the IPO, we had said at that time that we thought that our market share based on publishing information from First Annapolis, a consulting firm, if their information was correct and looking at our volumes we believe that our market share ranged from about 30% to 35% of the financial cards, with 30% for the large issuer and 35% for the small- and mid-sized issuers. So we had put it in those ranges. So we think that our large issuer market share, again, we don't know precisely what it is because we don't have any industry figures. But we think that we've seen some erosion in that large issuer segment.

Okay, so one last step. Can you give us an update on that product refresh in prepaid and large prepaid customers that impact last quarter results? Where we stand on that? And if that's included in your '17 guidance?

Yes, the assumption cause flowing in -so it's -- our assumption at this stage is that it's going to still come through by the end of the year and that's assumed in our guidance. It still hasn't been scheduled, but it is something that we're looking to see by the end of the year.

[Operator Instructions]. Our next question comes from James Schneider of Goldman Sachs.

This is Julie on the line for Jim. I was wondering in terms of pricing, is [indiscernible] going to be the new normal? Or are you expecting to see more pricing pressure in 2018?

Yes. We think that in the large issuer segment, as we have said before, we think we'll continue to see pricing pressure in the large issuer segment. And that's where we're seeing most of the pricing pressure in that segment. And so we expect -- and that is also something that we have talked about before and that our outlook was continued pricing pressure in that segment.

When do you think metal and dual interface cards will begin to alleviate some of that pressure?

Well metal cards, as we talked about before, metal cards, we're seeing strong interest. We believe we're going to be generating a modest amount -- a small amount of revenues this year, with some of what we expected happening this year moving into 2018, just given some delays on the part of the customers. So we believe that, that's starting to get some traction. And then dual interface, we're not seeing any clear cut plans for dual interface issuance. There's really 2 issuers so far or two issuances, One was around the Costco card and another one is an issuer does it when they're being asked. But there's no definitive plans that we've seen so far by large issuers that start going to dual interface. So unclear exactly what the timing of that would be. We believe that dual interface is a great customer convenience, it's been taken up by all the other major markets around the world as an important product. So we think that the value proposition is strong for the consumer. But no definitive plans right now, so we can't tell you what the timing is.

I'm showing no further questions at this time. I'll turn the call back over to Steve Montross for any closing remarks.

Okay. Well thank you, Valerie. I would like to thank all of our CPI employees for their contributions and commitment to serving our customers and also want to thank our valued customers who depend and trust on us -- trust us to serve their business. Thank you, everyone, for participating in our earnings call. We look forward to speaking with you next quarter. Have a good afternoon.

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