CPI Card Group Inc. (PMTS) Q3 2019 Earnings Report, Transcript and Summary

Good morning, and welcome to the CPI Card Group Third Quarter and Year-to-date 2019 Earnings Conference Call. All participants are in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jennifer Almquist, Investor Relations. Please go ahead.

Thank you, and good morning, everyone. Welcome to the CPI Card Group Third Quarter and Year-to-date 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 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. 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, adjusted EBITDA, adjusted EBITDA margin, adjusted free cash flow, net sales growth excluding Canadian operations, income from operations, excluding litigation settlement gain, and operating margin, excluding litigation settlement gains, 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 was closed on April 1, 2019, and does not qualify as a discontinued operation in accordance with U.S. GAAP. Results for the Canadian 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 three and nine-months ended September 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 would 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 third quarter and year-to-date results reflects solid execution against our plan. Our ongoing commitment to our strategic priorities allowed us to deliver net sales growth and significantly increased profitability and margins on a year-over-year basis. Net sales for the quarter were up 1% year-over-year or 3% when excluding Canada. U.S. Debit and Credit segment net sales were up 7% year-over-year driven by increased net sales from personalization, dual interface cards and card at once. Year-to-date net sales from the U.S. Debit and Credit segment were up 17%. Net sales for our Prepaid Debit segment were down 3% during the third quarter while year-to-date net sales of $53 million were up 2% over the same period last year. As a reminder, 2018 benefited from portfolio wins that as expected did not reoccur in 2019. Net loss for the quarter was $700,000 bringing our year-to-date net loss to $2.2 million, inclusive of a $6 million cash litigation settlement gain recorded in the second quarter. Adjusted EBITDA was $12.3 million in the third quarter an increase of 34% compared with the same quarter a year ago. Our year-to-date adjusted EBITDA was $28.8 million a 31% increase over the same period last year. We believe the strong performance for the third quarter and first nine-months has us on-track to achieve the goals we established for ourselves this year. Turning to Slide 5. Our success this year has come from strong execution against our four strategic priorities. First the customer focus, second market-leading quality products and customer service. Third market competitive business model and fourth continuous innovation. We believe continued commitment to these priorities is key to delivering on our vision. Part of this commitment is ensuring that our organization aligns with these priorities. Recently we changed our leadership relating to the Secure Card business which will not be led by Guy DiMaggio. Guy join CPI in 2018 has played a key role in helping to grow the personalization business. Jason Bore has stepped down from his role as SVP and General Managers of Secure Card. I want to thank Jason for his contributions and to recognize all of our employees for their support, dedication and commitment as they continue evolve as an organization. We believe this realignment will further optimize our businesses and support our future growth and continuing to serve our customers effectively and efficiently. Turning to Slide 6, I want to take a moment to update you on our progress against our strategic priorities so far 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. One great example is the launch a Second Wave our dual interface capable payment card which incorporates a core made with recovered ocean bound plastic. We are proud of our leadership in this area, which enables CPI to be first-to-market with a product designed to reduce first use plastic and divert plastic waste from entering the ocean. The environmental upside is powerful, we estimate that for every one million Second Wave payment cards produced over one ton of plastic waste will be diverted from entering the world oceans, water ways and shorelines. The end use case is compelling, as this is a win for all involved. First, this is an important part of CPI's overall initiative to reduce first use plastic and to be more environmentally conscientious in our operations. Second, it uses up cycled plastic waste that would otherwise be ocean bound. The increasing levels of plastic in our oceans threatens delicate ecosystems and our Second Wave innovation incorporate this material to help address the problem. Third, it provides our customers with a differentiated, socially and environmentally relevant product that supports the sustainability commitments and is compelling for their customers. In a recent CPI survey of debit and credit card users conducted by an independent research firm more than half of respondents indicated they would be willing to switch to another financial institution that if it offered cards made with recovered ocean bound plastic and had the same features and benefits as their current cards. Second Wave provides financial institutions the opportunity to do just that. Our Second Wave products is resonating with our customers, and current with the launch of Second Wave, we entered into an agreement with one of the largest U.S. base card issuing financial institutions to provide Second Wave cards in addition to current debit and credit financial payment cards. Another example of the customer focus is our approach to dual interface. Our customers transition to dual interface cards, we strive to provide them with differentiated solutions including dual interface, capable metal and Second Wave payment cards both of which are certified by two of the major payment brands. Increasingly, we see large financial institutions as well as small to medium issuers asking for dual interface financial payment cards. We continue to be responsive to the specific needs of these customers and have seen dual interface card volume increase significantly year-over-year. Our second strategic priority is providing market leading quality products and Five Star customer service as we strengthen our position as a partner of choice. With our Card@Once solution, we remain focused on our customers need. The value added and convenience provided this fast base instant issuing solution enables us to continue winning new business with prospects while increasing business with our existing customers. Many of whom are expanding their Instant Issue programs across their branch networks. Year-to-date, we have sold 1,400 new Card@Once printer which contribute to our continued growth this year. Turning to our third strategic priority, market competitive business model. Third quarter operating margin were 11.1% up 450 basis points year-over-year bringing year-to-date operating margin to 10.5%. Year-to-date adjusted EBITDA margins were up more than 200 basis points year-over-year. These improvements are a direct result of our continued focused on process improvement, efficiency and improved capabilities, as we provide our customers with unmatched solutions, innovation and world-class service. In addition, we continue to experience the benefits of consolidating our personalization facilities from three to two and divesting our non-core businesses. Now to our four strategic priority, continues innovation. We continue to look for ways to enhance and further differentiate solutions for our customers by innovating and improving upon our successes. With the launch of Second Wave payment card, we are now the first to market with the product specifically designed to reduce first use plastic by upside going plastic that would otherwise the ocean bound. These cards are in circulation today as financial payment cards and we believe this innovative product can also provide a compelling in use case for other segments of the card industry including transit, hospitality, entertainment and retail consumer brands and their respective card holders. Turning to Slide 7. Stead fast focus on our four strategic priorities generated strong progress in the third quarter and the first nine-months of 2019. We believe continued commitment to these priorities is key to delivering our vision of being the partner of choice by providing market leading quality products and customer service with the market competitive business model. I will now turn the call over to John Lowe to review our third quarter and year-to-date financial and operating results. John.

Thanks, Scott and good morning everyone. I will begin my overview by results from the third quarter and first nine-months 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 discontinued operation during 2018 as required by U.S. GAAP. That equal 2019 disposition of our Canadian business did not qualify as a discontinued operation under U.S. GAAP. And therefore the results from this business are included in the other segments. Third quarter net sales were up 1% or 3%, when excluding Canada on top of a strong comparable quarter in 2018. Looking year-to-date, net sales were up 10% year-over-year, but 13% when excluding Canada, led by 17% year-over-year increase in the U.S. Debit and Credit segment and a 2% year-over-year increase in the U.S. Prepaid Debit segment. Third quarter gross profit was $25.4 million up 9% year-over-year. Gross margin was 35.5% for the third quarter an increase a 270 basis points year-over-year, marking our fifth consecutive quarter of improved year-over-year gross margins. For the year-to-date, we generated gross profit of $69.3 million up $11.7 million, or 20%, compared to the same period in 2018. We also expanded gross margins by 290 basis points year-over-year from 30.8% in the year-to-date 2018 to 33.7% in the year-to-date 2019. This gross margin expansion was driven by higher net sales, leading to a more favorable cost absorption, a smaller geographic footprint, having consolidated our personalization facilities from three to two and divested our non-core business in Canada and a more favorable product mix in the 2019 periods. This growth was personally offset by higher card material costs, driven primarily by product mix. During the third quarter, we reported income from operations of $8 million up 70% from a third quarter of 2018.Third quarter operating margin increased 450 basis points year-over-year to 11.1%. Year-to-date, operating income was $21.6 million and operating margin was 10.5%. This includes the benefit of the $6 million cash litigation settlement gains we discussed last quarter. Excluding the $6 million gains year-to-date operating margins were 7.6%, up nearly 500 basis points from 2.7% last year. Turning to Slide 10. We generated a net loss of $700,000 or $0.06 loss per share in and a net loss of $2.2 million or $0.20 loss per share during the third quarter and year-to-date 2019 respectively, doth are improvements from the year ago periods. Third quarter adjusted EBITDA was $12.3 million up to 34% from the $9.1 million we reported in the third quarter of 2018.Year-to-date, adjusted EBITDA, which excludes the $6 million second quarter cash litigation settlement gain was $28.8 million, up 31% compared with the same period in 2018 and already 6% greater than our 2018 full-year adjusted EBITDA of $27.1 million. Turning to our segments on Slide 11.Third quarter U.S. Debit and Credit segment net sales were up 7% year-over-year to $51.5 million. During the quarter, we benefited from year-over-year increased net sales from personalization and fulfillment services. A shift towards higher price, dual interfacing EMV cards into 21% increase in net sales from Card@Once. Third quarter U.S. Debit and Credit segment income from operations was $8.9 million up 36% year-over-year. Income from operations benefited from reduced costs resulting from the consolidation of our personalization facilities last year, as well as higher net sales and a favorable mix of products and services. This was partially offset by higher card materials cost driven primarily from product mix. Year-to-date U.S. Debit and Credit segment net sales were up 17% year-over-year to $151.5 million and income from operations was up 57% to $24.6 million. For our U.S. Prepaid Debit segment net sales declined 3% to $20.5 million in the third quarter. Year-to-date net sales were up 2% year-over-year. As a reminder, 2018 was a record year for the U.S. Prepaid Debit segment and included significant net sales associates associated with new portfolio wins that do not recur in 2019. In 2019 net sales for the segment have kept pace with our record year last year due impart to the timing of larger than expected customer sales in the first half as we supported existing customers through changing demands in the industry. U.S. Prepaid Debit segment incomes from operations were $7.8 million in the third quarter of 2019, down 7% from prior year. On a year-to-date basis, profitability improved with income from operations of $18.5 million, up 9% from the same period last year. Year-to-date, U.S. Prepaid Debit segment operating margins were up 230 basis points compared to the same period in 2018, reflecting a more favorable product mix, as well as cost benefits resulting from improvements in operating efficiency. As a reminder, with April 1st, completion of the disposition of the Canadian business the results from our other segment no longer includes the losses previously generated by this business, nor the associated net sales. Turning to Slide 12. Our cash balance at the end of the third quarter was $14.3 million. As of September 30th, we had $20 million available for borrowing on a revolving credit facility, bringing total available liquidity to $34.3 million at the end of the third quarter. Third quarter cash used in operating activities was $2 million and included continued investments in inventories to support the growth of the business. Capital expenditures during the third quarter were $600,000, bringing adjusted free cash flow for the quarter to a negative $2.7 million. We ended the quarter with total debt principal outstanding of $312.5 million. As of September 30th, our net debt leverage ratio was nine times, an improvement from 10.9 times at year-end 2018. As a reminder, our term loan matures in August 2022 and our revolving credit facility matures in August of 2020. We believe we have adequate cash and operating cash flows to support our business plan. Looking at the markets, we continue to expect the U.S. industry E&B card volume will continue to grow driven by dual interface conversions, primarily from larger issuers and to a lesser extent small to medium issuers as we have been experiencing I will now turn the call back to Scott for some closing remarks. Scott.

Thanks John. In wrapping up we remain committed to our vision of being a partner of choice by providing market-leading quality products and customer service with the market competitive business model. Over the last two years, we have start to achieve this vision by executing on our four strategic priorities by first getting the Company fit for growth and then in 2019 driving top-line performance and profitability as we continue to focus on serving our customers well. Our third quarter and year-to-date results show that we are successfully executing on the path we have laid out. As we wrap up 2019 and look ahead to next year. We aim to capitalize on the successes we have had, scaling and growing through continued focus on our four strategic priorities and recent innovations. We believe we are well equipped to embark on the next stage of growth as we continue to build upon our position as the partner of choice. I look forward to updating you on our progress. Operator you may now end the call. End of Q&A: