CPI Card Group Inc. (PMTS) Q3 2018 Earnings Report, Transcript and Summary

Good morning, and welcome to the CPI Card Group's Third Quarter 2018 Earnings Conference Call. [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, Operator, and good morning everyone. Welcome to the CPI Card Group third 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 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 that reflects the events that occur after this call. As a reminder, all of the figures presented today reflect CPI's U.K. Limited segment accounted for as a discontinued operation in accordance with U.S. GAAP. 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 release on CPI's website for all the disclosures required by the SEC, including reconciliations to 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 of CPI.

Thanks Will, and good morning everyone. Thank you for joining us today. Beginning on Slide 4, you will find highlights of our third quarter 2018 results. Overall we are pleased with our third quarter results and we're performing well relative to our objectives for the first nine months of 2018. We generated net sales of $71 million up 16% year-over-year driven by double-digit net sales growth across both U.S. debit and credit and prepaid debit segments. Our U.S. debit and credit segment net sales grew approximately 20% year-over-year primarily reflecting growth of our emerging products and solutions. Our prepaid debit segment net sales growth in the third quarter was approximately 11% compared to the year ago period reflecting additional business from our customer base. We recorded a GAAP net loss from continuing operations of approximately $1 million in the third quarter and we were essentially breakeven on an adjusted basis. We generated adjusted EBITDA from continuing operations or approximately $9 million in the third quarter primarily reflecting net sales growth offset by $1.9 million of incremental employee performance incentive compensation due to the company's improved performance in 2018. And finally, we ended the quarter with $32.8 million of total liquidity comprised of $12.8 million of cash on our balance sheet, and $20 million available on our revolving credit facility. Turning now to Slide 5, as I mentioned we are pleased with our improved results in the third quarter and year-to-date 2018. We believe our recent performance and the momentum we are seeing in our business reflects the continued focus of our entire organization on our four key priorities which include; first, deep customer focus; second, providing market-leading quality products and customer service; third, a market competitive business model; and fourth, continuous innovation. Now turning to Slide 6, similar to our past few calls, I would like to provide you with a business update which provides additional insight into our progress against our four key priorities. Beginning with our first priority deep customer focus, placing the customer first in everything we do is a fundamental part of CPI's business. By intensifying our focus on improving all aspects of our customers experience and providing solutions that help build their brands by elevating their customers experience we’re strengthening our existing relationships and increasing our ability to win new business. One example of our success in this area is with PSCU, the largest credit union service organization in United States serving over 900 credit unions. In the third quarter, we renewed our contract with this strategic partner to continue to be the primary card manufacturer for PSCU. We believe our dedication to our customer first approach combined with our leadership in EMV and Dual Interface was a deciding factor in the recent contract extension. We're pleased to continue serve this long-standing customer for years to come. Building upon this theme of customer centricity driving success, I would also like to highlight additional examples of recent customer wins which we're excited about. The first is with a leading U.S. financial institution to manufacture secure cards including standard EMV, metal, and dual interface cards. The second is with a major U.S.-based retailer to provide prepaid cards and related services. Moving to our second priority market-leading quality products and customer service, our ability to deliver differentiated in the end suite of financial card products and solutions combined with a heightened focus on quality and customer service is helping us to expand our wallet share with our existing customers and win new business. The continued solid growth of our Card@Once instant issuance solution is a testament to our ability to offer market-leading solutions and superior customer service. We ended the third quarter of 2018 with approximately 8900 Card@Once installations up from approximately 8400 installation in the prior quarter and an increase of over 30% from approximately 6700 installations in the third quarter of 2017. We continue to see opportunities to grow our instant issuance business with both new and existing customers. Examples of new Card@Once wins in the third quarter include Foresight Financial Group headquartered in Illinois, and Centier Bank based in Indiana among others. Our leading position in prepaid is another example of our ability to provide market-leading quality products and services. In the third quarter we generated 11% prepaid segment net sales growth and year-to-date net sales were up over 25%. Wins with our existing customers have driven our performance in prepaid which we believe is directly related to our leadership position in this business and the strength of our offering. Turning now to our third priority on Slide 7, a market competitive business model. We continue to focus on our initiatives to drive increased productivity and efficiency primarily through business process improvements and direct and indirect procurement savings. Our work in this area is contributing to improved performance. In the third quarter, we completed our U.S. personalization site consolidation. In addition as a reminder we divested our U.K. business which is enabled us to sharpen our focus on executing our four key priorities. We're beginning to see the benefits of these initiatives. Looking ahead, we will continue to evaluate opportunities that will allow us to further focus on our core business by optimizing CPI's portfolio. By doing so we will be better positioned to excel in our markets and even better equipped to provide market-leading quality products and customer service. Lastly with respect to our fourth priority continuous innovation, I’d like to focus on two of our emerging products CPI metals and dual interface or tap-and-go cards. For CPI metals, we're seeing interest from both traditional financial institutions and nontraditional customers such as FinTech's. While metal remains a small portion of our overall business we continue to see opportunity for the snitch premium product. For dual interface EMV cards, we're seeing early signs of some transition to tap-and-go cards with our customer base in the overall market. Dual interface is a small portion of our business today and we're optimistic about this opportunity and look forward to sharing progress with you in 2019. I will now turn the call over to John Lowe to review our financial and operating results in more detail for the third quarter. John?

Thanks Scott, and good morning everyone. As Scott mentioned we are pleased with our third quarter financial and operating results. On Slide 10 you will see an overview of our third quarter 2018. As a reminder, all of the financial results I'm sharing today reflect continuing operations and exclude our U.K. business segment which was sold on August 3 and is treated as a discontinued operation under U.S. GAAP. Total net sales were $71 million, an increase of 16.4% from $61 million in the third quarter of 2017. Product net sales increased 29.5% year-over-year to $34.7 million in the third quarter. This growth was driven primarily by our emerging products and solutions including dual interface EMV cards, CPI metals, and Card@Once. Services net sales increased 6.1% year-over-year to $36.3 million primarily driven by growth in our U.S. prepaid debit segment, as well as our card personalization and fulfillment business. Gross profit for the third quarter was $23.3 million, a 19.9% year-over-year and representing a gross margin of 32.8% compared with $19.4 million and 31.9% in the third quarter of 2017. The year-over-year increase in our gross profit and margin for the third quarter of 2018 primarily reflects our top line growth, our focus on higher-margin products and solutions, and our ongoing cost reductions and efficiency initiatives. Our SG&A expenses for the third quarter of 2018 were $17 million, up 17.1% year-over-year. The increase in our SG&A is primarily due to higher employee performance incentive compensation as a result of improved performance year-over-year. Income from operations in the third quarter of 2018 was $4.7 million, up 39.1% from $3.4 million in the prior year period. We reported a GAAP net loss from continuing operations of $1.1 million or $0.10 loss per diluted share in the third quarter of 2018. This is compared with a net loss from continuing operations of $800,000 or a $0.07 loss per diluted share in the prior year period. Higher net interest expense in the third quarter of 2018 versus 2017 impacted our net loss in Q3. Turning to our non-GAAP metrics. Adjusted EBITDA from continuing operations for the third quarter of 2018 was $9.1 million. Our adjusted EBITDA performance reflects our top line growth offset by $1.9 million of incremental employee performance incentive compensation due to the company's improved performance in 2018 which I mentioned earlier. Adjusted EBITDA margin was 12.9% compared with 15.1% in the prior year period. Adjusted net loss from continuing operations was approximately breakeven in the third quarter of 2018 compared with adjusted net income of approximately $1 million or $0.09 per share in the year ago period. Now I will review our segment results for the third quarter of 2018 on Slide 11. U.S. debit and credit segment net sales were $48 million for the third quarter, a 19.8% increase from the prior year period. EBITDA was $9.1 million up 40% compared with $6.5 million in the prior year period. The increase in net sales was primarily due to increased net sales from our emerging products and solutions including dual interface EMV, metal cards and Card@Once. With respect to standard EMV cards, CPI sold approximately 22.1 million EMV cards in the third quarter of 2018, up 13% from 19.5 million cards in the third quarter of 2017 and up 16% from 19.1 million cards in Q2 2018. U.S. prepaid debit segment net sales were $21.2 million in the third quarter, up 10.7% year-over-year. The increase in net sales was driven primarily by additional sales volumes from our existing customer base. Prepaid debit segment EBITDA was $8.8 million, up 16.1% from $7.6 million recorded in the prior year period. Turning to our cash flow overview on Slide 12. We reported a use of cash from continuing operations in the third quarter 2018 of approximately $500,000 compared to cash provided by continuing operations of $3.3 million in the prior year period. The year-over-year decline in our cash from continuing operations primarily reflects changes in working capital due to strong third quarter net sales. Capital expenditures from continuing operations in the third quarter of 2018 were $2.9 million compared with $1.9 million in the prior year period, yielding third quarter 2018 negative free cash flow of $3.4 million versus positive free cash flow of $1.4 million in the third quarter of 2017. Moving to Slide 13, our ending cash balance as of September 30, 2018 was $12.8 million down from $17.8 million at June 30, 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 $299.7 million. Including the deferred financing costs and discounts, our recorded net debt balance was $305.3 million. At September 30, 2018, our net debt leverage ratio was 11.9 times. As of September 30, 2018, we had a $40 million revolving credit facility which is undrawn and has $20 million available for borrowing. Our term loan has no financial covenants and is not mature until August of 2022. Total available liquidity was $32.8 million as of September 30, 2018. We believe we have adequate cash and liquidity to support our business plan. 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. Now on Slide 14, I’d like to cover the market and industry trends that we are currently seen. The current topic relates to tariffs imposed on direct materials. I'm pleased to share that the tariff impact is insignificant to CPI due to our focus on sourcing and procurement. Regarding the market, conditions are consistent with what we discussed with you on our last earnings call. 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 anticipated that average selling prices will continue to decline in the market for standard EMV products during the remainder 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-car issuance, expiration and loss and stolen replacement activity. I will now turn the call back to Scott for some closing remarks. Scott?

Thanks John. We delivered solid third quarter results and we have performed well relative to our objectives for the first nine months of 2018. Our daily focus remains on our four key priorities which we believe will position us to be the partner of choice by providing market-leading quality products and customer service with a market competitive business model. I am pleased with the progress we've made and look forward to sharing our continued progress with you early next year on our fourth quarter earnings call. Operator, you may now end the call.

The conference has now concluded. We thank you for attending today's presentation. You may now disconnect.