CPI Card Group Inc. (PMTS) Q1 2018 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen and welcome to the quarter one 2018 CPI Card Group earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. William Maina. Mr. Maina, you may begin.

Thank you and good afternoon everyone. Welcome to the CPI Card Group first 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 would 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 website. Please note there is also a presentation that accompanies this conference call and is also accessible in the IR section of our 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 that reflects 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, adjusted 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. Now I would like to turn over the call to Scott Scheirman, President and Chief Executive Officer. Scott?

Thanks Will and good afternoon everyone. Thank you for joining us on our first quarter 2018 conference call. As you know, we pre-announced preliminary results last Wednesday, May 2, as part of our press release announcing Lillian's transition. Our fully reported first quarter results are consistent with our preannouncement. We had a good start to 2018 with operating results in line with our expectations and progress against our strategies and plans. I will begin by briefly summarizing our first quarter financial results, I will then discuss our ongoing strategies to drive growth and deliver shareholder value while also providing you with a few business and product updates. Then I will turn the call over to Lillian who will go through our financials in detail. Now turning to slide four of the presentation. As I mentioned, our first quarter results were in line with our expectations. We generated revenue of $59 million, up 5% year-over-year. Revenue growth was primarily driven by strong year-over-year growth in our U.S. prepaid debit segment and momentum in our emerging solutions, including Card@Once. CPI On-Demand and CPI Metals. Our first quarter topline performance was partially offset by continued softness in U.S. credit and debit card market and weaker than expected U.K. Limited results. We recorded a GAAP net loss of approximately $7 million in the first quarter and adjusted net loss of approximately $5 million. We posted adjusted EBITDA of approximately $3 million and we ended the first quarter with $40 million of total liquidity comprised of $20 million of cash on our balance sheet and $20 million available on our revolving credit facility. Now turning to slide five. As we discussed with you on our last earnings call, our goal at CPI is to be the partner of choice by providing market-leading quality products and customer service with a market competitive business model. We are doing this by focusing on four strategic priorities including, first, a deep customer focus, second, market-leading quality products and customer service, third, a market competitive business model and fourth, continuous innovation. Moving now to the next two slides, I would like to update you on our progress. Moving to slide six. With regard to our first priority, we are very focused on delighting our customers every day by leveraging are end to end suite of products and solutions and by providing the highest levels of customer service. As a result of our efforts, I am happy to highlight two recent portfolio wins. The first win is with is InComm, a highly valued and long-standing customer of CPI. After acquiring the distribution rights to program manage and process the prepaid reloadable and gift card products in the U.S. of a major U.S. prepaid card issuer, InComm turned to CPI to produce the prepaid cards for their newly acquired business, given our fast onboarding and ability to scale with exceptional service. The second is with Sharetec System, a provider of both in-house and service bureau core solutions to provide Sharetec credit unions the ability to print ATM and debit cards in-house with our Card@Once instant issuance solution and helping them to deliver exceptional customer experiences. I believe these two stories help illustrate not only our strong position in the market, but also importantly our ability to win new business by putting the customer first and intensifying our focus on providing market-leading quality products and customer service. I also mentioned to you last quarter that we recently completed a realignment of our U.S. business units by product. The goal of the realignment was to better serve our customers and address their needs by leveraging our employee strengths and talents, facilitating innovation, fostering a culture of teamwork, accountability and excellence and delivering outstanding results for our customers and our shareholders. Since initiating this realignment, I am pleased to say that we are delivering improved levels of service and quality to our customers. Turning to our second priority, market-leading quality products and customer service. While I already covered the InComm story with you, I think it bears repeating that this competitive win was directly to CPI's strengths related to providing outstanding quality and service. For our Card@Once instant issuance solution, we continue to deliver growth in the quarter driven by solid customer demand and recognition that we offer a market-leading and differentiated solution. We ended the first quarter of 2018 with approximately 7,700 Card@Once installations, up from approximately 7,400 installations in the prior quarter and an increase of 28% from approximately 6,000 installations in the first quarter 2017. We are pleased with our first quarter Card@Once performance and we see continued opportunities to grow this business. The recent expansion of our Card@Once business with First Financial Bank of Ohio is another great example of our ability to deliver on this priority. First Financial, who has used the Card@Once solution for over three years, recently began upgrading their previous model instant issuance printers with our new premium precision printers across their bank branch footprint. In addition, after recently completing the acquisition of another bank, First Financial is deploying our precision printers in these newly acquired branches. In addition to some good success with our customers, we are also being recognized by other industry participants for our market-leading quality products. For example, I am proud to highlight that CPI recently received awards at the International Card Manufacturers Association 2018 Elan Awards for card manufacturing excellence. These prestigious awards recognize the best of design innovation, security and technical achievements in the global card manufacturing industry. We received the first place award in the loyalty, promotional and gift cards category for our sophisticated metal card crafted for a prominent brand partner of our client, Alliance Data. Additionally, our Uber card produced for Barclays and designed to reflect the Uber brand identity and a bridge between digital and physical worlds was named first finalist in the best secure payment card category. We are thrilled to receive these awards in recognition of the products created in collaboration with our customers. Onto our third priority, which can be found on slide seven, a market competitive business model. We are on track with the consolidation of our personalization sites from three sites to two and expect to complete this initiative by the summer. The benefits to our cost structure from the site consolidation will primarily be in 2019. We also remain laser focused on our initiatives to drive additional productivity and efficiency improvements through the business which Lillian will discuss in more detail in her remarks. Lastly, with respect to our fourth priority, continuous innovation, I would like to provide you with some updates. Beginning with prepaid, NetSpend, a leader in the prepaid industry selected CPI to develop a completely new and unique generation packaging protocol for their prepaid cards based on our relationship and reputation for packaging innovation. CPI worked closely with NetSpend to design and manufacture the updated prepaid card portfolio which successfully launched the first quarter of 2018. For CPI Metals, we continue to see interest from our customers extending beyond traditional financial institutions into retail as well as some new and nontraditional verticals for us. As I mentioned on our last call, it's still early days for CPI Metals and I look forward to updating you on our progress with this premium product. For our CPI On-Demand solution, the momentum we began building in 2017 has continued into the first quarter of 2018. We continue to deliver on our CPI On-Demand solution to new business verticals outside of traditional financial institutions, including areas such as transportation and healthcare. Lastly on dual interface EMV cards, we continue to view the potential migration of the U.S. market to dual interface cards as an attractive long-term opportunity. We are in active conversations with customers regarding their dual interface product roadmaps and how we can play a role in fulfilling their future needs. But at this time, we are not factoring dual interface into our 2018 plans in a meaningful way. In summary, our first quarter results were in line with our expectations. We won new business with our existing customers, added new customers and capitalized on opportunities to deliver our products and solutions to new client verticals. Our initiatives which are aimed at better serving our customers by providing market-leading quality products and customer service with a competitive business model is resulting in good growth across several parts of our business. While we still have work to do, we believe our efforts position CPI well in the current market and will further benefit us as the demand environment for U.S. debit and credit cards begins to improve. Before turning the call over, I would like to thank Lillian for her leadership of our finance organization and positive contributions she has made during her tenure. On behalf of the entire company, I wish Lillian the very best in her future endeavors. I will now turn the call over to Lillian to review our detailed financial and operating results for the first quarter. Lillian?

Thanks Scott and good afternoon everyone. Turning to slide 10, you will see an overview of our first quarter 2018 results. First quarter net sales were $59.1 million, an increase of 5.5% from $56 million in the first quarter of 2017. Product net sales decreased 7.4% year-over-year to $27.6 million in the first quarter, primarily reflecting an 8.2% decline in the number of U.S. debit and credit EMV chip cards sold and lower EMV card average selling prices. EMV volume was up 22.6% from the fourth quarter of 2017 to 16.8 million. Services net sales increased 20% year-over-year to $31.5 million, primarily driven by growth in our U.S. prepaid debit segment. Gross profit for the first quarter was $14.4 million, representing a gross margin of 24.4% compared with 28.7% in the first quarter of 2017. Loss from operations in the first quarter of 2018 was $4 million compared with an operating loss of $1.8 million in the prior-year period. Included in our loss from operations during the first quarter of 2018 are $300,000 of restructuring charges and an $800,000 accelerated depreciation charge related to the consolidation of our personalization site. The year-over-year changes in our gross profit margin and income from operations for the first quarter of 2018 primarily reflect our topline growth and ongoing cost reduction actions and efficiency initiatives, offset primarily by the negative impact of absorption of overhead costs from lower volumes, weaker than expected results in our U.K. Limited segment and investments in our business to enhance our products, solutions and go-to-market strategy. As we discussed with you on our last call, we continue to seek ways to improve our cost efficiencies, enabling us to be market competitive. Increased efficiencies will help our ability to improve profitability, drive cash flow and build a stronger foundation for growth and innovation. Our key cost initiatives for 2018 remain process improvements and efficiencies, a continued focus on direct and indirect procurement savings and an optimized footprint. We recorded a GAAP net loss of $7.3 million or $0.65 loss per diluted share in the first quarter of 2018. This is compared with a net loss of $4.5 million or $0.40 loss per diluted share in the prior year period. As a reminder, all per share amounts have been retroactively adjusted to reflect the one-for-five reverse stock split that went into effect in December 2017. Now turning to our non-GAAP metrics. Adjusted EBITDA for the first quarter of 2018 was $2.7 million compared with $3.9 million for the first quarter of 2017. Adjusted EBITDA margin was 4.5% compared with 6.9% in the prior-year period. The year-over-year changes in our adjusted EBITDA and EBITDA margin primarily reflect the same factors which impacted our reported income from operations. Adjusted net loss was $5.2 million in the first quarter of 2018, or a $0.47 loss per diluted share, compared with adjusted net loss of $3 million or a loss of $0.26 per diluted share in the first quarter of 2017. Now to a review of our segments for the first quarter of 2018. Before I begin, I would like to note that we have changed the way we report our CPI On-Demand business. Beginning with the first quarter of 2018, we are reporting the CPI On-Demand business with in our U.S. debit and credit segment versus our prepaid debit segment as previously reported. We realigned CPI On-Demand to be consistent with the other related personalization operations and to correspond with our decision-making process regarding the allocation of resources. We restated our first quarter 2017 segment information to be consistent with our new alignment. This restatement was not material. So now turning to the results on slide 11. U.S. debit and credit segment net sales were $37.1 million for the first quarter, a 6.5% decrease from the prior-year period. The corresponding segment EBITDA was $5.7 million, compared with $7.4 million in the prior-year period. The year-over-year decline in our U.S. debit and credit segment result was predominantly driven by a decrease in cards sold as well as lower average selling prices. CPI sold 16.8 million EMV cards in the first quarter of 2018, down from 18.3 million cards in the first quarter of 2017, but up 3.1 million cards from the fourth quarter of 2017. The year-over-year decrease in EMV cards sold was primarily due to timing of certain customer orders. On a weighted average basis, average selling prices were down approximately 6% from the first quarter of 2017 and down approximately 12% sequentially from the fourth quarter of 2017. The year-over-year decrease in average selling prices in the first quarter was primarily due to lower prices experienced across our customer base and our customer mix. In our traditional U.S. card personalization and fulfillment business, net sales decreased $1.7 million versus the first quarter of 2017, primarily due to the reduced EMV card production. U.S. prepaid debit segment net sales were $15.5 million in the first quarter, up $6 million dollars or 63.3% year-over-year. The increase in revenue was primarily driven by additional volumes from recent client portfolio wins which Scott mentioned earlier. Please note that the revenue attributable to the new portfolio wins was recognized primarily in the fourth quarter of 2017 and the first quarter of 2018. Beginning in the second quarter, we currently anticipate that our prepaid business will start to resemble revenue trends similar to past years with lower revenues in Q2. For the full year 2018, consistent with what we shared with you previously, we continue to expect that we will participate in the prepaid industry's modest growth this year. Prepaid debit segment EBITDA was $4.8 million, up from $2 million recorded in the prior-year period. Finally, our U.K. Limited segment net sales were $4.2 million in the first quarter, representing a decrease of 24.6% from the prior-year period. The lower net sales resulted from softness in the U.K. retail sector and a decline in sales related to certain customers. U.K. Limited segment EBITDA was a $1.1 million loss, compared with a positive $325,000 in the prior-year period. Now turning to our cash flow overview on slide 12. Cash used in operations for the first quarter was $1.8 million compared with cash used in operations of $5 million in the prior year period. Capital expenditures in the first quarter of 2018 were $1.2 million, down from $3.3 million in the prior-year period, yielding first quarter 2018 negative free cash flow of $2.9 million, which is an improvement of over $5 million from the first quarter of 2017. Turning to slide 13. Our ending cash balance as of March 31, 2018 was $20.2 million compared with $23.2 million at the end of 2017. We ended the quarter with total debt principal outstanding of $312.5 million and a net debt balance of $292.3 million. Netting the deferred financing costs and discounts, our recorded total debt balance was $304.4 million. At March 31, 2018, our net debt leverage ratio was at 12.2 times. As of March 31, 2018, we had an undrawn $40 million revolving credit facility, of which $20 million was available for borrowing. Our term loan has no financial covenants and does not mature until August 2022. Total available liquidity was $40.2 million as of March 31, 2018. I would now like to recap the current industry trends that we expect will continue to impact our 2018 results on slide 14. Overall, the market conditions are consistent with what we discussed with you on our last earnings call in March. We continue to expect that U.S. industry card manufacturing volume will be essentially flat in 2018 versus 2017 levels and then return to growth in 2019. In addition, we anticipate that the average selling prices will continue to decline in the market during the course of this year, similar to 2017. For card personalization and fulfillment, our expectation is for more modest levels of demand in 2018, driven by steady-state new card issuance, expiration and lost or stolen replacement activity. For U.S. prepaid, we continue to expect that CPI will participate in the prepaid industry's modest growth this year. As a reminder, I would also like to highlight that our business segment results do fluctuate from quarter-to-quarter based on several factors including ordering patterns of our customers and seasonality. Lastly, we believe that we have adequate cash and liquidity to support our business plan. Our ongoing focus is on driving profitable growth, returning to consistent positive cash flow generation and delivering shareholder value. Finally, before opening the call for questions, I would like to say that I have truly enjoyed working with the entire CPI team and I am very thankful for the time I spent working directly with Scott. This was not an easy decision for me, but ultimately I made the choice to accept a role closer to my home and family in Detroit. I will be working with the transition of my responsibilities over the next couple of months. So with that Madison, please open the call for questions.

Madison, thank you. Everyone, thank you for participating on our earnings call today and we continue to look forward to updating you in the future with our strategies and our progress as we move forward. Madison, you can now end the call. Thank you.