CPI Card Group Inc. (PMTS) Q2 2018 Earnings Report, Transcript and Summary

Welcome to the CPI Card Group Second Quarter 2018 Earnings Conference Call. At this time, all participants will be in listen-only mode. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to William Maina. Investor Relations please go ahead.

Thank you Kate and good afternoon everyone. Welcome to the CPI Card Group second quarter 2018 earnings conference call. Participating on today's call from CPI Card Group are Scott Scheirman, President and Chief Executive Officer and John Lowe, 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 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, adjusted diluted earnings and loss per share, and free cash flow, all reported on a continuing operations basis. Please see the earnings press release on CPI's website for all the disclosures required by the SEC, including reconciliations of the most comparable GAAP measures. Please note that this call will conclude after our prepared remarks. And now I'd like to turn the call over to Scott Scheirman, President and Chief Executive Officer. Scott?

Thanks Will and good afternoon everyone. Thank you for joining us on our second quarter 2018 conference call. Before we begin, I'd like to formally introduce and welcome John Lowe, who joined CPI as our new CFO about eight weeks ago. John joins us from SquareTwo Financial Corporation, a Denver-based financial services company, where he served as Chief Financial Officer. During his eight year tenure at SquareTwo, John helped to nearly double the size of the company before it was acquired in June 2017. We couldn't be more excited to have John as part of the CPI team, and he has already started to make a positive impact during his brief time with us. As you probably read in our press release this morning, we have announced the sale of our U.K. business to SEA Equity. We believe the sale of our U.K. business will strategically enable us to sharpen our focus on executing our key priorities across our core customers, markets and businesses, including secure cards, personalization, instant issuance and prepaid. In summary, we believe this transaction will benefit both organizations, better enabling CPI and the U.K. business to excel in their respective core markets. I'd like to take this opportunity to thank our U.K. colleagues and wish them all well. Now turning to the second quarter. We delivered solid second quarter 2018 results, with operating performance in line with our expectations. A summary of these results can be found on Slide 4 of the presentation. And as a reminder, all of the figures presented reflect our U.K. Limited segment accounted for the discontinued operation as required under U.S. GAAP. We generated revenue of $61.5 million, up 12% year-over-year. We delivered revenue growth across both our U.S. Debit and Credit and Prepaid Debit segments. Prepaid Debit growth in the second quarter was strong, up 26% compared to the year-ago period, reflecting our recent portfolio wins. Our U.S. Debit and Credit segment growth was 3.5% year-over-year, primarily reflecting growth of our emerging solutions, including Card@Once and CPI Metals. We were also pleased to have sequential and year-over-year growth in our EMV cards sold in the second quarter. We reported a GAAP net loss from continuing operations of approximately $800,000 in the second quarter and adjusted net income from continuing operations of approximately $1 million. We posted adjusted EBITDA from continuing operations of approximately $9 million in the second quarter up 24% year-over-year. And finally we ended the second quarter with $37.8 million of total liquidity, comprised of $17.8 million of cash on our balance sheet and $20 million available under our revolving credit facility. Overall, we are pleased with our second quarter results, which reflect good progress against our strategy and plan to get CPI fit for growth. We are tracking in line with our business plan through the first half of 2018. Turning now to Slide 5. I'd like to provide you with a brief reminder of our go-forward strategy and then, over the following several slides, I will provide you with a few examples of how we have continued to execute against this strategy in the second quarter and year-to-date. As we have shared with you on our previous two earnings calls, our overarching plan 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, which we are instilling at every level of the organization. These priorities include: First, deep customer focus; second, market-leading quality products and customer service; third, a market competitive business model; and fourth, continuous innovation. Now turning to Slide 6 and starting with our first priority, deep customer focus. By intensifying our focus and efforts on delighting our customers every day, including the recent reorganization of our U.S. operations to better align our organization structure with the needs of our clients, we are making good strides in strengthening our existing customer partnerships. As a result of our continued efforts, I'm happy to share with you a recent Debit Card portfolio win, which I believe is a good example of our ability to win new business by putting the customer first. This win is with Hancock Whitney Bank, a longstanding customer of CPI, which recently launched a major company-wide rebranding effort. In support of that effort, they partnered with CPI to quickly manufacture the new debit cards to resonate their brand vision. Turning now to our second priority, market-leading quality products and customer service. We remain laser focused on delivering our unique end-to-end suite of financial card products and solutions to the market, combined with the highest levels of quality and customer service. We believe our ongoing efforts in this area will enable us to further expand our wallet with our existing customers and also allow us to win business with new customers. One recent success story I would like to highlight is our collaboration with Commercial Business Systems, a provider of premium software and IT services for credit unions. We partnered with Commercial Business Systems to integrate their credit union accounting and management system with Card@Once. This integrated offering will provide an end-to-end print and activation instant issuance solution to credit unions that enable them to respond immediately to members for new and replacement cards. Building on success story, the continued positive momentum of our Card@Once instant issuance solution is evidence of our ability to offer market-leading and differentiated solutions with excellent customer support. We ended the second quarter of 2018 with approximately 8,400 Card@Once installations, up from approximately 7,700 installations in the prior quarter and an increase of 31% from approximately 6,400 installations in the second quarter of 2017. We are pleased with our second quarter Card@Once performance, and we see continued opportunities to grow this business with both new and existing customers. For example, in the second quarter, Midland Bank, based in Illinois, expanded their relationship with us by placing an order for our next-generation instant issuance solution to be deployed across their bank branch footprint. In addition to that, Midland recently completed the acquisition of another local bank, which is an existing Card@Once customer and will be upgrading that bank from an earlier model to our next-generation solution. In addition, First US Bank, which is an existing CPI personalization client, is expanding their offering to their end customers by deploying our Card@Once instant issuance solutions. Turning to our third priority, which can be found on Slide 7, our market competitive business model. We continue to advance our initiatives to drive productivity and efficiency improvements throughout the business through three key areas, including business process improvements and efficiencies, a continued focus on direct and indirect procurement savings and an optimized footprint. We remain on track and are in final stages of the consolidation of our U.S. personalization sites from three sites to two sites. As a reminder, the benefit to our cost structure from the personalization site consolidation will primarily be in 2019. With respect to our fourth priority, continuous innovation, I'd like to provide you with a couple of updates. For CPI Metals, we continue to see good interest from our customers for this premium product, and we are encouraged by the level of interaction we are having with our clients regarding their metal card strategies. Acorns, the country's fastest-growing financial system with 3.5 million users, recently engaged us to produce an encased Tungsten CPI Metals Debit Card with a green custom core. While still early, we are also encouraged by the metal card order activity that contributed to our second quarter results. For dual interface EMV cards, we remain in active conversations with many customers regarding their dual interface product road maps and how we can play a role in fulfilling their future needs. We manufactured modest levels of dual interface EMV cards in the second quarter. However, we continue to expect that dual interface will not contribute to our 2018 revenue in a meaningful way. Finally, I would like to cover the industry trends that we are currently seeing in the market. Overall, market conditions are consistent with what we discussed with you on our last earnings call. We continue to expect the 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 the 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, stolen card replacement activity. For U.S. Prepaid, we continue to expect that CPI will participate in the prepaid industry's modest growth this year. I will now turn the call over to John Lowe to review our detailed financial and operating results in the second quarter. John?

Thanks, Scott, and good morning, everyone. Before taking you through the quarter, I'd first like to say how excited I am to join CPI Card Group. I've been here for nearly two months, and my time with the company has served to further solidify the reasons why I decided to join the CPI team. From a business perspective, I was very attracted to CPI's strong position in our market space, its talented and dedicated team and history as an innovator in the industry. In my short tenure at CPI, I have been excited to learn that our management team is very focused on serving our customers, improving business performance and making investments to put CPI on a path of financial improvement and growth. This is a direct credit to the organizational culture that Scott has instilled into CPI and the hard work of the entire organization. Looking ahead, my focus will be finding areas where we, as a company, can drive even greater value to our customers and continue to improve our performance. To that end, I'm excited to partner with Scott and the rest of the team to build on our leadership position in the market and further our company's long-term vision for growth and innovation. Before I discuss our financial results for the quarter, I'd like to share some more on the sale of our UK business, which closed on August 3. The UK business is in a challenging market and had an operating loss of US$2.8 million for the six months ended June 30. We sold the UK business for US$4.5 million and will receive approximately $0.3 million in cash proceeds after paying off the UK business's debt and other liabilities. In addition, the structure of the sale created a future tax benefit to CPI of approximately US$3 million. As a result of the UK performance and the sale, we recorded impairments and asset write-downs of the UK business of US$14.8 million. All of the UK business's historical financial results, including its impairments and asset write-downs, are presented in our earnings release and financial statements as discontinued operations as required under U.S. GAAP. Now turning to our results. On Slide 11, you will see an overview of our second quarterof 2018. All of the financial results I'm sharing today reflect continuing operations and exclude our UK business segment which, as I described, is treated as a discontinued operations. Total net sales were $61.5 million, an increase of 12.1% from $54.8 million in the second quarter of 2017. Product net sales increased 18.2% year-over-year to $31.5 million in the second quarter. This growth was driven primarily by strong growth in our Card@Once business unit, but we see strong interest in our Card@Once product offerings. In addition, we had continued performance in our secured card unit, where we delivered 1.6% year-over-year and 14% sequential growth in the number of U.S. Debit and Credit EMV chip cards sold. Services net sales increased 6.3% year-over-year to $30 million, primarily driven by strong growth in our U.S. Prepaid Debit segment, partially offset by a modest decline in card personalization and fulfillment revenue compared to the second quarter of 2017. Gross profit for the second quarter was $19.9 million, up 19.3% year-over-year and representing a gross margin of 32.3% compared with $16.7 million and 30.4% in the second quarter of 2017. Our SG&A expenses for the second quarter of 2018 continue to be impacted by restructuring charges, related to consolidation of our footprint. In addition, we continue to invest in our dedicated workforce here at CPI. Income from operations in the second quarter of 2018 was $2.7 million compared with an operating income of $0.7 million in the prior year period. The year-over-year changes in our gross profit and income from operations for the second quarter of 2018 primarily reflect our top line growth and ongoing cost reductions and efficiency initiatives, partially offset by strategic investments in our business to enhance our products, solutions and go-to-market strategy. We reported a GAAP net loss from continuing operations of $0.8 million or a $0.07 loss per diluted share in the second quarter of 2018. This is compared with net loss from continuing operations of $3.3 million or a $0.30 loss per diluted share in the prior year period, retroactively adjusted to reflect the one-for-five reverse stock split in December of 2017. Turning to our non-GAAP metrics. Adjusted EBITDA from continuing operations for the second quarter of 2018 was $8.9 million, up 24.1% from $7.2 million in the second quarter of 2017. Adjusted EBITDA margin was 14.5% compared with 13.1% 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 income from continuing operations was $1.1 million in the second quarter of 2018 or $0.10 per diluted share compared with $1.1 million loss or an $0.10 loss per share in the year-ago period. Now I will review our segments for the second quarter of 2018 on Slide 12. U.S. Debit and Credit segment net sales were $43.8 million for the second quarter, a 3.5% increase from the prior year period. The corresponding segment EBITDA was $9.9 million compared with $7.9 million in the prior year period. The year-over-year growth in our U.S. Debit and Credit segment was primarily driven by an increase in revenue from our emerging products and solutions, including Card@Once and metal cards, partially offset by a decrease in revenue from non-EMV and other sales, card personalization and fulfillment and EMV card revenues due to lower average selling prices. CPI sold 19.1 million EMV cards in the second quarter of 2018, up from 18.8 million cards in the second quarter of 2017 and also up from 16.8 million cards in Q1 of 2018. U.S. Prepaid Debit segment net sales were $15.4 million in the second quarter, up $3.2 million or 25.9% year-over-year. The increase in revenue was primarily driven by additional volume from recent client portfolio wins discussed on our last earnings call. Prepaid Debit segment EBITDA was $4.7 million, up from $3.6 million recorded in the prior year period. Turning to our cash flow overview on Slide 13. Cash provided by continuing operations for the second quarter was $0.2 million compared with cash used in continuing operations of $1 million in the prior year period. Capital expenditures from continuing operations in the second quarter of 2018 were $1.4 million, down from $2.1 million in the prior year period, yielding second quarter 2018 negative free cash flow of $1.2 million, which is an improvement of $1.9 million from second quarter 2017. Moving on to Slide 14. Our ending cash balance as of June 30 was $17.8 million, down from $20.2 million at Q1 2018 and $23.2 million at year-end of 2017. We ended the quarter with total debt principal outstanding of $312.5 million and a net debt balance of $294.7 million. Netting the deferred financing costs and discounts, our recorded total debt balance was $304.8 million. At June 30, 2018, our net debt leverage ratio was 12.1x. As of June 30, 2018, we had a $14 million revolving credit facility, which is undrawn and has $20 million available for borrowing. Our term loan has no financial covenants and do not mature until August 2022. Total available liquidity was $37.8 million as of June 30, 2018. As a reminder, our business segment results do fluctuate from quarter to quarter based on several factors, including ordering patterns of our customers and seasonality. In addition, we believe we have adequate cash and liquidity to support our business plan. I will now turn the call back over to Scott for some closing remarks. Scott?

Thanks, John. In summary, we are pleased with our second quarter results and are on track with our business plan through the first half of 2018. The execution of our key priorities is driving solid progress in terms of new business wins as well as business process improvements and an unwavering focus on serving our customers well. While we still have a lot to do, I am pleased with all that we have accomplished so far and want to thank our entire CPI organization for their dedication and tireless efforts towards our goals. We look forward to sharing our continued progress with you. Operator, you may now end the call.