CPI Card Group Inc. (PMTS) Q2 2019 Earnings Report, Transcript and Summary

Good morning, and welcome to the CPI Card Group Second Quarter and First-Half 2019 Earnings Conference Call. 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 Scott Scheirman, Chief Executive Officer. Please go ahead.

Thanks, operator, and good morning, everyone. Welcome to the CPI Card Group Second Quarter and First-Half 2019 Earnings Webcast and Conference Call. On the call today from CPI Card Group is Scott Scheirman, President and Chief Executive officer; and John Lowe, 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. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. For a discussion of such risks and uncertainties, please see CPI Card Group’s most recent filings with the SEC and on SEDAR. 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, but not limited to, EBITDA, adjusted EBITDA, adjusted EBITDA margin, adjusted free cash flow, income from operations, excluding litigation settlement gain, and operating margin, excluding litigation settlement, all reported on a continuing operations basis. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures are included in the press release and in the slide presentation we issued this morning. Please be advised that the financial results discussed on the call today reflect the continuing operations and therefore, exclude the results of CPI’s UK Limited segment, which was divested in August of 2018, and has been accounted for as discontinued operations in accordance with U.S. GAAP. The disposition of the CPI Canada business closed on April 1, 2019, and does not qualify as a discontinued operation in accordance with U.S. GAAP. Results for the Canada business through the date of disposition as well as disposition related costs are reflected in the other segment. Copies of today’s press release as well as the presentation that accompanies this conference call are accessible on CPI’s Investor Relations website, investor.cpicardgroup.com. In addition, CPI’s Form 10-Q for the quarter and six months ended June 30, 2019 was filed with the SEC earlier today and is also available on CPI’s Investor Relations website. 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, Jen, and good morning, everyone. Thank you for joining us today. I will begin my prepared remarks on Slide 4. Our second quarter results reflect solid execution against our customer -centric strategy. During the quarter, we delivered a 9% year-over-year increase in net sales, resulting in first-half 2019 net sales increase of 15% over the prior year. Turning to our segments. In the second quarter, we delivered a 17% increase in net sales from our U.S. Debit and Credit segment through continued volume increases and the more favorable mix of products and services. Net sales from our Prepaid Debit segment was up 3%, outperforming our strong 2018 second quarter results, which, as you recall, included significant net sales associated with the new portfolio launch. During the second quarter, we generated net income of $1.6 million, or $0.14 per share, inclusive of a $6 million cash gain related to a settlement of a previously disclosed litigation. This brings the year-to-date bottom line to a net loss of $1.5 million. Adjusted EBITDA, which excludes the $6 million cash gain was $8.5 million for the second quarter, bringing our year-to-date total to $16.5 million, a year-over-year increase of 28%. We believe the top line and bottom line momentum we have been experienced thus far in 2019 puts us on track to achieve the goals we set out for ourselves this year. Turning to Slide 5. We continue to execute on our four strategic priorities. First, deep customer focus; second, market-leading quality products and customer service; third, market competitive business model; and fourth, continuous innovation. On Slide 6, I will take a few moments to update you on our progress against these priorities and highlight some initiatives we have delivered on during the first-half of this year. Beginning with our first priority, deep customer focus. We continue to listen to the needs of our customer and focus our energy on helping them deliver unique and differentiated solutions that elevate their customers’ experience. For the emerging dual interface market, we continue to meet the needs of our customers. This resulted in double-digit percentage increase in in EMV card manufacturing volumes during the second quarter, propelled by dual interface EMV cards. During the first-half of the year, we also invested in our strategic priorities by increasing operating capacity for our prepaid and Card@Once businesses to meet the needs of our customers and the opportunities we see over the long-term. Our second strategic priority is providing market-leading quality products and five star customer service. By effectively executing on this priority, we further establish CPI as a partner of choice. For example, we were recognized by the International Card Manufacturers Association, or ICMA, for the manufacturing of the Pinnacle Financial Partners, Corserv Holdings’ World Elite Encased Tungsten card. The sleek, sophisticated card provides our customer with a distinctive, highly differentiated and luxurious card that showcases the best of their brand to their customers. By partnering with this customer, we were able to bring their vision to life and we are proud of the accolades this product and the services that supporters have received. Turning to our third strategic priority, market competitive business model. We remain focused on driving increased productivity and efficiency. Over the last 18 months, we’ve better positioned ourselves to serve customers by focusing on our core businesses, including secure card manufacturing, personalization, instant issuance and prepaid. We divested our UK and Canadian businesses and consolidated our personalization facilities from three to two. Streamlining our operations and enabling us to allocate resources to provide customers with unmatched solutions, innovation and world-class service. As a result of our top line strategic initiatives and our focus on operational efficiencies, our operating margins are up meaningfully compared to last year. Our fourth strategic priority is continuous innovation, which is integral to winning business and helping our customers differentiate themselves with distinctive products. Considering the growing popularity of wearables and non-wearable payment devices globally, we recently announced the launch of our embedded contactless technology adaptives. This technology enables our customers to create payment devices for various end-users and form factors, reflecting their unique brands and addressing evolving customer preferences. One recent example is our collaboration with Fit Pay. Fit Pay is using adaptives to power contactless transactions for Flip, its new compact contactless payment device. Flip allows consumers to make purchases at millions of retail locations that accept contactless payments and address Fit Pay’s commitment to advancing payment technology and options for their customers. Turning to Slide 7. In wrapping up, we remain committed to providing market-leading quality products and customer service with a market competitive business model, as we build upon CPI’s position as a partner of choice. We believe our second quarter and first-half results reflect solid execution towards our goals, as we continue to focus on our key priorities. I will now turn the call over to John Lowe to review our second quarter and first-half financial and operating results. John?

Thanks, Scott, and good morning, everyone. I will begin my overview of our results from the second quarter and first-half of 2019 on Slide 9. As a reminder, 2018 comparative results are on a continuing operations basis and exclude the UK business that was divested and reported as a discontinued operation during 2018 as required by U.S. GAAP. The disposition of our Canadian business, which closed April 1, 2019 did not qualify as a discontinued operation under U.S. GAAP. And therefore, the results from this business are included in the Other segments. Second quarter net sales increased 9% compared with the second quarter of 2018, driven by 17% increase in net sales from our U.S. Debit and Credit segment and 3% net sales growth from our U.S. Prepaid Debit segment. These quarterly gains were partially offset by a $2.4 million year-over-year decrease in Canada sales due to the recent disposition, net of the Canadian secure card business that migrated to our U.S. operations. For the first-half of 2019, net sales were $133.8 million, up 15%. over the same period in 2018. Second quarter gross profit was $22.4 million, up 13% over the second quarter of last year. Gross margins for the second quarter increased 120 basis points year-over-year to 33.5%, our fourth consecutive quarter of improved year-over-year gross margins. Looking year-to-date, we generated gross profit of $43.9 million, up 28% from the first-half of 2018. On a year-to-date basis, we expanded gross margins by 330 basis points year-over-year. This gross margin growth was due to higher net sales, which led to more favorable cost absorption and a reduction in expenses resulting from last year’s consolidation of our personalization operations. This growth was partially offset by higher card manufacturing materials costs, driven primarily by a mix of certain products. During the second quarter, we reported income from operations of $10.1 million, yielding an operating margin of 15.1%. Included in income from operations is a $6 million cash gain stemming from the settlement of litigation, the details of which are in the 10-Q we filed earlier today. Excluding the $6 million gain, second quarter operating margins were 6.1%, up from 4.3% in the second quarter of last year. This improvement was due to higher net sales and a more favorable mix of products and services, which in turn drove greater operating leverage. First-half operating margins were 10.2%, or 5.7%, excluding the litigation gain, up from 0.3% last year. Turning to Slide 10. We generated net income of $1.6 million, or $0.14 per diluted share, and a net loss of $1.5 million, or a $0.14 loss per diluted share during the second quarter and first-half of 2019, respectively, both our improvements from the year-ago periods. In addition to the $6 million cash litigation settlement, the second quarter 2019 results include a $1.3 million non-cash foreign currency loss, resulting from the required GAAP accounting related to the disposition of our Canadian business. Adjusted EBITDA, which excludes the $6 million cash litigation settlement gain, was $8.5 million, down 4% from the $8.9 million we reported in the second quarter of 2018. This was largely due to higher card manufacturing materials costs resulting from a certain mix of products and increased employee performance incentive compensation commensurate with the improved performance of the business relative to our expectations. Year-to-date, adjusted EBITDA, excluding the cash litigation settlement gain, was $16.5 million, up 28% compared with the first-half of 2018. Turning to our segments on Slide 11. Second quarter U.S. Debit and Credit segment net sales were up 17% year-over-year to $51.1 million. During the quarter, we benefited from year-over-year volume increases in financial payment card manufacturing and personalization and fulfillment services, as well as a shift towards higher-priced products and services. During the quarter, EMV card manufacturing volumes, propelled by dual interfacing EMV cards, increased by a double-digit percentage year-over-year. The increase in dual interface manufacturing volumes was driven primarily by demand from larger issuers as expected. For Card@Once, printer sales were down year-over-year. Though sales remained healthy at approximately 500 printers sold in the quarter, we believe the second quarter softness to be largely the result of timing, as printer sales tend to be lumpy. Net sales of Card@Once personalization and consumables were up by a double-digit percentage for both the quarter and first-half of 2019, underscoring the value of this Software-as-a-Service solution and our confidence in long-term potential for this differentiated product offering. Second quarter U.S. Debit and Credit income from operations was $8 million, up 20% year-over-year. Income from operations benefited from higher sales and reduced costs resulting from the consolidation of our personalization facilities last year. This was partially offset by higher card manufacturing materials cost that I discussed previously, as we continue to make investments to deliver quality products and services to our customers. For the first-half, U.S. Debit and Credit segment net sales were up 24% year-over-year to $100 million and income from operations was up 72% to $15.8 million. For our U.S. Prepaid Debit segment, net sales were $16 million in the second quarter of 2019, a year-over-year increase of 3%. This increase and moreover, the 6% year-over-year increase in the first six months of 2019 is on top of strong performance for the segment in 2018, which included significant net sales associated with a new portfolio launch. While net sales for the segment tend to be lumpy, our second quarter and year-to-date results are encouraging. Prepaid Debit segment income from operations was $5.4 million in the second quarter 2019, up 27% from the prior year. For the first-half, income from operations was $10.7 million, up 25% from the same period in 2018. Year-over-year, Prepaid Debit segment operating margins were up approximately 630 basis points in the quarter and more than 500 basis points for the first-half, reflecting higher sales, improved cost absorption and a more favorable product mix. As a reminder, with the April 1 completion of the disposition of the Canadian business, results from our Other segment now reflect the loss of the associated net sales. Turning to Slide 12. Our cash balance as of June 30, 2019 was $17.5 million. As of June 30, 2019, we had $20 million available for borrowing on a revolving credit facility, bringing total available liquidity to $37.5 million at the end of the second quarter. We ended the quarter with total debt principal outstanding $312.5 million. At the end of the second quarter, our net debt leverage ratio was 9.8 times, an improvement from 10.9 times at year-end 2018. During the second quarter, we generated $9.2 million in cash from operating activities, inclusive of cash received from the litigation settlement. In addition, we spent $0.5 million in cash on capital expenditures, as we continue to leverage equipment financing. This resulted in adjusted free cash flow for the quarter of $2.7 million. As a reminder, our business results fluctuate from quarter-to-quarter based on several factors, including customer ordering patterns, broader economic cyclicality and quarterly seasonality. In recent years, net sales and adjusted EBITDA have been lower in the first-half and higher in the second-half of the year, resulting in a use of cash until the latter part of the year, due in part to the seasonality of our business. As we have said in the past, we continue to believe we have adequate cash and liquidity to support our business plan. As a quick update on the market. We continue to expect that U.S. industry EMV card manufacturing will grow in 2019, driven by dual interface conversions, primarily from larger issuers and contact EMV reissuances, primarily from smaller financial institutions. This is consistent with what we have been experiencing. For dual interface, or tap and go. We continue to expect card issuance to grow as a proportion of the market in the U.S. in 2019, but view the U.S. migration to dual interface is one that will occur gradually over the next few years. I will now turn the call back over to Scott for some closing remarks. Scott?

Thanks, John. We are pleased with our business performance in the first-half of 2019, and we believe that we are well-positioned to deliver on our strategies and 2019 goals as we enter the second-half of the year. I look forward to updating you on our progress. Operator, you may now end the call.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.