Good day ladies and gentlemen, and welcome to the Q3 2017 CPI Card Group Inc. Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Will Maina. You may begin.

Thank you and good afternoon everyone. Welcome to the CPI Card Group third quarter 2017 earnings conference call. Participating on today's call from CPI Card Group are Scott Scheirman, 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 disclosures 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 web site. Please note there is also a presentation that accompanies this conference call and is also available on the IR section of our web site. Please refer to 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, adjusted diluted earnings per share, free cash flow and currency. Please see the earnings press release on CPI's web site for all disclosures required by the SEC, including reconciliations to the most comparable GAAP measures. And now I'd like to turn over the call to Scott Scheirman, President and Chief Executive Officer.

Thanks Will and good afternoon everyone. Thank you for joining us on our third quarter 2017 conference call. Beginning on slide 4, I'd like to start the call by sharing with you how excited I am to be CPI's President and Chief Executive Officer. I am impressed by CPI's position in the market as one of the leading providers of financial payment card products, and value-added solutions. The CPI team is both talented and energetic, and since joining the company, I have seen a culture of collaboration and steadfast focus on delivering superior solutions and customer service. We remain confident in the long term opportunities ahead of us. CPI is a leader in a large addressable market, with solid long term secular tailwinds. Our market position, diverse suite of products and differentiated solutions, passionate employees and a commitment to providing the highest levels of customer service position us well, to capitalize on this opportunity. And while we are confident we can achieve long term success, we believe that our areas where we need to improve, in order to realize our full potential. Similar to other market leading organizations, we need to be working towards continuous improvement. For example, we believe we have opportunities to improve our business, to ensure that our level of execution, quality, product delivery and cost structure are optimized. We also believe that we need to sharpen our focus on changing market trends, to more quickly maneuver and capitalize on new opportunities and provide our customers with new and innovative solutions. As a result, we recently commenced a comprehensive review of our business to assess our strategies and market opportunities, both from a short term perspective, as we continue to navigate a challenging U.S. card market, and from a longer term perspective. The objective of this review,…

Thanks Scott and good afternoon everyone. Turning to slide 10; you will see an overview of our third quarter results. As Scott referenced earlier, we continue to operate in a challenging U.S. card manufacturing market, which is impacting our performance, as well as the entire domestic card manufacturing industry. Third quarter net sales were $68 million, down 16.2% from $81.2 million in the third quarter of 2016. Product net sales decreased by $6.1 million or 16.2% from the prior year, primarily driven by a 13.6% year-over-year decrease in the number of U.S. debit and credit EMV chip cards sold, and lower EMV card average selling prices. Services net sales decreased approximately $7.1 million or 16.2% year-over-year to $36.6 million, primarily driven by a decrease in card personalization and fulfillment sales and lower U.S. Prepaid Debit segment revenue. Gross profit for the third quarter was $21 million, representing a gross margin of 30.8%, down from 35.8% in the third quarter of 2016, and up sequentially from 29.3% in the second quarter of 2017. Income from operations in the third quarter of 2017 was $3.5 million, compared with operating income of $11.7 million from the prior year period. The year-over-year change in gross profit and income from operations, 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 $700,000 or a $0.01 loss per diluted share in the third quarter of 2017. This compared with the net income of $4 million or $0.07 per diluted share in the prior year period. Now turning to our non-GAAP metrics; adjusted EBITDA for the third quarter of 2017 was $9.6 million, compared with $17.8 million for the third quarter of 2016. Adjusted EBITDA margin was 14.1%, up from 13.2% in…

[Operator Instructions]. And our first question is from [indiscernible] from BMO Capital Markets. Your line is now open.

Hi. This is Paulo Ribeiro from BMO.

Hi Paulo.

Hey, how are you? Well so much to say, Scott, welcome. I mean, you have a challenge ahead of you. So let me ask right off the bat, do you think if this is a turnaround situation? Do you think it's -- CPI has -- I don't know. I used to think that, with the market problem, challenging position in the market, I am sure to think it's a CPI specific problem. Are you guys -- again, in a turnaround situation, are you guys losing market share? Is your product not up to par? Anything you can comment? Sorry to put you on the spot, but just very frustrating.

No, no. Thank you for your question. I am sure, your question is on the mind of others too. So Paulo, thank you for the question. First, I am very excited to be here. Are there things that we need to turn around? Absolutely. But what I will say -- what I have been very impressed with is, we have a strong foundation for growth. We are an industry later, in a large addressable market that have growth opportunities, and we have breadths and depths of our products and solutions. The management team here is very strong. We have very engaged employees and so forth. To your point Paulo, the U.S. card manufacturing environment has been challenging, not only for us, but for our competitors too from that standpoint. But with that said, I do believe there is things we need to get better at, like most companies. We need to continuously improve around our execution and our quality and our product delivery. We need to take a hard look at our process and our business to optimize, to get to a lower cost structure. And then just continue to sharpen our focus on changing market trends, just to ensure that we quickly capitalize on new opportunities and provide customers with new solutions and innovative products from that standpoint. But with that said, Paulo, I really see a lot of opportunity here. The EMV transition will continue. Later in the prepaid space, I visited the Minneapolis, Minnesota facility, a couple of weeks ago. I was very impressed, what I saw there with the team and the talent. Dual interface, maybe not a near term opportunity in 2018, but longer term opportunity. And then, as I mentioned on the call, Card@Once, we've got 6,700 installations. I believe we have got a lot of room to grow there. Metal cards, we are positioned well. I don't think that's a matter of if, but when. We know our customers have long marketing cycles or lead time, but we shipped our first cards and we are doing some things in the digital area. So all-in-all, I am optimistic about our future. I believe we have got a number of long term growth opportunities here. Are there some near term bumps we have got to work through? Absolutely. But I feel like we have got a really good foundation for growth, a great management team, and I believe ultimately, we are going to win in the marketplace long term.

So let me follow-up, [indiscernible]. Have you had a chance to talk to some of your large clients? And did they express [indiscernible] comment, any -- they complain about your product or your process or some things, one. As you review the business, are you also reviewing personnel and might be able to make some change to implement your vision? And third, just getting more granular here on this quarter, prepaid, I thought 3Q is seasonally stronger, and there was a point made here in prepaid, based on top of [indiscernible] areas that we should be worried about [indiscernible]?

It's okay, that's okay. Let me first start with card customers, Paulo. One of my first goals as the CEO is and continues to be is, to go listen to the voice of the employee and the voice of the customer. And I have had a number of meetings, face-to-face and over the phone with customers, and I have received a warm reception. They very much value the partnership or the relationship with CPI, and many of these have been longstanding relationships, and I believe they will continue to be longstanding relationships on a go forward basis, and they see the value we bring. We have had some good candid discussions around where are opportunities to improve, and at some points, I touched upon in my prepared remarks. But opportunities around this continues to improve with our level of execution, our quality and our product delivery, but our customers, have been very warm and welcoming and in spirit of partnership, want to continue to work with CPI. On your second question, as far as personnel and so forth, again, I would say that we are in the early days of reviewing our strategies, our business plan. We want to do a comprehensive and robust review, and I look forward to sharing that with everybody in early 2018. I feel like overall, we have got a really strong management team. We have got passionate employees. But I'd say like, every company, you are always looking to add talent, as you can find talent, because at the end of the day, what makes almost every company work, is having the best and the brightest employees and that will be our focus. But overall, I am pleased with the talent, that there is always opportunities to improve all facets of your business.

And I guess -- Paulo, this is Lillian. So in terms of your question around the prepaid performance. You are very right in pointing out, that that has lagged on a year-over-year basis when we compare to last year, and Q3 is typically the highest quarter, which it has been thus far this year. But really, the overhang that we have been dealing with, in terms of the prepaid, has been in overhang for most of the year, and it has really been around -- the indecision around the CFPP regulations and coming out with kind of firm guidelines. That what we have been experiencing with our clients is, that they have been pushing out some of the orders that we might typically have seen this year, as they have been waiting for some of those decisions. So as we are looking forward into the coming months and into 2018, we are expecting more certainty on that front. We are starting to see more encouragement, I guess you say, from the clients to progress, as they feel that there is more conclusions there. At least, in stuff that would impact their form. So the outside security packaging for these secured prepaid cards. And the other thing that we are finding as well, quite happily, is that we are gaining new business in this area, and we are offering some very innovative solutions for our clients, and we are winning new business that we don't presently have on the books and are excited to be onboarding, as we move into 2018.

Thank you. I will get back in the queue. Thanks.

Thanks Paulo.

Thanks Paulo.

Thank you. Our next question is from James Schneider from Goldman Sachs. Your line is now open.

Hi, this is Julie on for Jim Schneider.

Hi Julie.

So we are wondering, are you going to incur any additional cost, as a part of your strategic review?

It's really too early to determine that. We are literally just, Julie, weeks into that process, and we are looking at a broad range of strategies, and really have not concluded on anything at this point in time. But the goal of the review is to enhance our strategies, our business plan, develop key initiatives and action plans, all with an aim to improve the business performance in simple terms. So we will have more to share with you on that in early 2018. But hope we can appreciate, we are just in the early days of that review and need to continue through that process. But we will come back to you in early 2018 to give you our thoughts in where we are heading and what we are doing.

Okay, great. Thanks.

Thanks Julie.

Thank you. [Operator Instructions]. And our next question is from Dave Koning from Baird. Your line is now open.

Oh yeah. Hey guys, thank you.

Hey Dave.

And I guess, first of all, it seems like in the core U.S. debit and credit business, you have kind of been hovering right around $40 million of revenue. Some of your competitors have actually been calling out the -- really the toughest comps are hitting this quarter, and that it's just a tough environment. Actually, you are kind of holding pretty steady in that. Is this kind of normalized, or does it start to feel like a pretty normal cadence of business to kind of hold around $40 million, or is it too premature to kind of say, that we couldn't get some pretty extreme lumpiness in the future? So --

Thanks for the question, Dave. I think, it's a little bit hard to tell quite candidly. I mean, the market is definitely soft. We are hearing that from others in the industry, and I think, we still feel that we are experiencing that. That said, I think you are pointing out something very fair that, it seems to have kind of tapered off through some consistency in terms of the EMV cards that we are producing. We are not seeing continued sequential declines, which I think was the concern that the marketplace had for some time. So is this where we are going to hover? I am not sure. I mean, we definitely feel soft at this stage, and I think there is still a lot of opportunity, as Scott referenced in some of his comments during the earlier part of the call that, as the industry goes into, what I'd characterize as a more normalized reissuance cadence, once we start approaching expiration dates, which I think is longer term, we should see some recoveries and some improvements overall broadly for the marketplace. I think it's more of the timing that the industry is still grappling with.

Got you. Okay. And then I guess, just the second thing, just on operating expenses; they have been very steady now, right around $17 million, $17.5 million, $18 million, very steady for a while. Is this sort of a bare bones operating expense? Like is their limited like ability to cut more from here, and you are kind of operating really lean or can that flex either way still?

I would say, everything is in scope as part of our -- reviewing our strategies and our business plan and those initiatives to enhance our business performance. So I am not taking anything for granted, so to speak. One of our key goals, is really to be a high quality provider, but to also be a low cost structure, if you will. So as we go through this business review, that's something we are going to take a hard look at, and make sure that we have the right resources to serve our customers well. So really more to come on that.

Okay, got you. And just yeah, appreciate how transparent you are being with the tough trends and everything. But I guess the one thing like -- how does the bank? I know you said that you have committed financing through 2022. But yeah, how does the bank deal with such high leverage? I mean, is it just committed, that you guys have that money for now, and there is not really too strict of covenants? How do they deal with that?

Yeah. Well I think that, first to start off, I think nobody wants to see the company operating at these higher net leverage levels, and really, as we look towards the long term for the company, our intention is to get back into, what I'd characterize as more normalized leverage. I think in the past, we have talked about our objective of getting back to three turns net leverage. That being said, the way the term debt has been structured, there are not restrictions in terms of the financial covenants that will trigger any types of repayments. So that debt really is on the books until 2022. In terms of our revolving credit facility, that is where we do have a restriction, and it's a restriction in access. So the facility is approved and stands at $40 million, but to the extent that our net leverage is at 7 turns or greater, what's available to us, is only $20 million. But I should also point out, that once the leverage returns back below 7 turns, the full $40 million is available to the company again. So it's a limited restriction, is how I would characterize it.

Got you. Great. Well thank you guys.

Thank you, Dave.

Thank you.

Thank you. We have a follow-up question from Paulo from BMO Capital Markets. Your line is now open.

Thank you. Could you comment on the smaller financial institutions into the demand? You mentioned in your prepared remarks about the pull forward from the renewals and so forth from the larger financial institutions, and you talked about their impact on pricing. Where are the [indiscernible] in terms of the issuance of EMV, and more broadly if you could talk how you think -- give us an update on the status of EMV migration broadly? Thanks.

Sure Paulo. Thanks for the question. So as you know, the small and medium sized institutions definitely lagged in the migration in comparison to the large financial institution. And I guess, how I would characterize them at this stage is that, they are steadily progressing their conversion. We are not seeing the type of lumpiness, I think that we experienced with the large institutions early in the cycle. So it's steady progression. I think the market is still overall, trending, and our expectation is that market in total is trending to about 100% conversion by the end of 2018, which will be good. We don't have a specific number in terms of measuring the third quarter levels, but things are progressing as we would expect.

Yeah. I don't think I would add -- Paulo, the midyear numbers we had, is we think that the markets and round numbers about 70% converted as of the end of the second quarter. So still a fair amount to go in the next 12, 18, 24 months from that standpoint. And with the small and mid-sized issue, as you are probably well aware, that's one place that we are well positioned and we have really good relationships there.

And if you -- do you have a sense of your market share? And in your prepared remarks, you kept pointing you guys are a leader and one of the things that you guys probably still have, is you have more production capacity than anyone else. You have four facilities, right, I think the closest competitor has a couple or something. Can you give a sense of where that was like -- where is the path of [indiscernible] versus the competition? If it is true, do you still have more? And in terms of market share, if -- in last quarter's call, Steve talked about, finally I guess, that you guys lost some market share, where [indiscernible] the overall market was down. Do you think -- any comments on that?

Sure Paulo, it's Lillian. Why don't I start off, and then I think, Scott will chime in as well. So in terms of -- just talking maybe a little bit about our production facilities, because I think, sometimes there can be some confusion in terms of what we actually have in our footprint here in the U.S.; because what we have is very unique compared to others that participate in the card manufacturing space. And what I mean by that is, we have two facilities that I would characterize as dedicated to card manufacturing. We have a facility here in Colorado, which really focuses more so on the large production runs. Supports more of your large financial institutions, is how I would characterize it. Then we have a sister facility, for a lack of a better way to refer to it, in Indiana, which really specializes in the small and mid-size issuers. Provide some very customizable support, and great customer service for the small and mid-size issuers. Our other two facilities that we have in the U.S., one is in Minnesota, that really is fully geared toward supporting our prepaid market and our CPI on-demand business. And then we have our facility in Tennessee, which focuses on the personalization. That said, I think we recognize and that's part of what Scott was discussing in his remarks, is that we do need to look at the business, and that's part of the business review that we are looking at, to make sure that we are operating as efficiently as we can as an organization. But I think it's important to clarify that, while we do have more facilities than many of our peers, our business footprint and the type of business that we support out of those facilities are very unique. In terms of the market share, quite candidly, that's a really hard number to get at in our industry, just given the lack of what I'd call your system-wide, industry-wide sharing of data, in terms of actual production volume. So while we did discuss in the last call, where we did have a couple of large financial institutions, that were in our portfolio in 2016 that are with us now, it's hard to assess what is the absolute share level, as we look at the business. We have not lost other clients, as we move through 2017, I think that's an important datapoint. But the absolute share metric is real difficult to assess.

But one thing I would add, and not maybe direct with your question. But I think, that's one thing that I like about our business model, and that we are diverse, just beyond -- call it the traditional card manufacturing, but we are in the prepaid space. Dual interface, we think is a long term opportunity. Card@Once, 6,700 installations, more room there. Metal cards, we have got capacity to produce metal cards, and then CPI on-demand and digital solutions. So there is a number of other products and solutions that have allowed us to become, let's say, somewhat more diverse and broaden our product portfolio from that standpoint. But also on a go forward basis, as we think about market share, our goal is to profitably gain market share, because you can't put a card in the bank, you can't put revenue in the bank, but you can put profits in the bank, so to speak, as a proxy for cash flow. So we will be very focused on profitably gaining share, as we move forward, as an objective.

Great. Thank you.

Thanks Paulo.

Thank you. At this time, I am showing no further questions. I would now turn the call back over to Scott Scheirman, CEO, for closing remarks.

Thank you for participating in our earnings call today, and I look forward to speaking with you and meeting with many of you in the months to come, and I look forward to speaking with all of you again during our fourth quarter earnings call, in early 2018. Operator, you may end the call. Thanks everyone for joining us.