PMTS 10-Q
CPI Card Group Inc. (PMTS)
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form
(Mark One)
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities and Exchange Act of 1934 |
For the Quarterly Period Ended
or
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the Transition Period from to
Commission File Number:
(Exact name of the registrant as specified in its charter)
(State or other jurisdiction of incorporation or organization) | (I.R.S. employer identification no.) | |
(Address of principal executive offices) | (Zip Code) |
(
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:
Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ☐ | ☒ | |
Non-accelerated filer | ☐ | Smaller reporting company | |
Emerging growth company |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes
Number of shares of Common Stock, $0.001 par value, outstanding as of May 2, 2023:
Table of Contents
| Page |
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3 | |||
Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations | 16 | ||
Item 3 — Quantitative and Qualitative Disclosures About Market Risk | 24 | ||
24 | |||
25 | |||
25 | |||
27 | |||
28 |
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PART I - Financial Information
Item 1. Financial Statements
CPI Card Group Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(in thousands, except share and per share amounts)
(Unaudited)
March 31, | December 31, | ||||
2023 | 2022 | ||||
Assets | |||||
Current assets: | |||||
Cash and cash equivalents | $ | | $ | | |
Accounts receivable, net | | | |||
Inventories, net | | | |||
Prepaid expenses and other current assets | | | |||
Total current assets | | | |||
Plant, equipment, leasehold improvements and operating lease right-of-use assets, net of accumulated depreciation of $ | | | |||
Intangible assets, net of accumulated amortization of $ | | | |||
Goodwill | | | |||
Other assets | | | |||
Total assets | $ | | $ | | |
Liabilities and stockholders’ deficit | |||||
Current liabilities: | |||||
Accounts payable | $ | | $ | | |
Accrued expenses | | | |||
Deferred revenue and customer deposits | | | |||
Total current liabilities | | | |||
Long-term debt | | | |||
Deferred income taxes | | | |||
Other long-term liabilities | | | |||
Total liabilities | | | |||
Commitments and contingencies (Note 11) | |||||
Series A Preferred Stock; $ | |||||
Stockholders’ deficit: | |||||
Common stock; $ | | | |||
Capital deficiency | ( | ( | |||
Accumulated earnings | | | |||
Total stockholders’ deficit | ( | ( | |||
Total liabilities and stockholders’ deficit | $ | | $ | | |
See accompanying notes to condensed consolidated financial statements
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CPI Card Group Inc. and Subsidiaries
Condensed Consolidated Statements of Operations and Comprehensive Income
(in thousands, except share and per share amounts)
(Unaudited)
Three Months Ended March 31, | |||||
2023 |
| 2022 | |||
Net sales: | |||||
Products | $ | | $ | | |
Services | | | |||
Total net sales | | | |||
Cost of sales: | |||||
Products (exclusive of depreciation and amortization shown below) | | | |||
Services (exclusive of depreciation and amortization shown below) | | | |||
Depreciation and amortization | | | |||
Total cost of sales | | | |||
Gross profit | | | |||
Operating expenses: | |||||
Selling, general and administrative (exclusive of depreciation and amortization shown below) | | | |||
Depreciation and amortization | | | |||
Total operating expenses | | | |||
Income from operations | | | |||
Other expense, net: | |||||
Interest, net | ( | ( | |||
Other expense, net | ( | ( | |||
Total other expense, net | ( | ( | |||
Income before income taxes | | | |||
Income tax expense | ( | ( | |||
Net income | $ | | $ | | |
Basic and diluted earnings per share: | |||||
Basic earnings per share | $ | | $ | | |
Diluted earnings per share | $ | | $ | | |
Basic weighted-average shares outstanding | | | |||
Diluted weighted-average shares outstanding | | | |||
Comprehensive income: | |||||
Net income | $ | | $ | | |
Total comprehensive income | $ | | $ | | |
See accompanying notes to condensed consolidated financial statements
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CPI Card Group Inc. and Subsidiaries
Condensed Consolidated Statements of Stockholders’ Deficit
(in thousands, except per share amounts)
(Unaudited)
Common Stock | Capital | Accumulated | |||||||||||
Shares | Amount | deficiency | earnings | Total | |||||||||
December 31, 2022 | | $ | | $ | ( | $ | | $ | ( | ||||
Shares issued under stock-based compensation plans | | — | ( | — | ( | ||||||||
Stock-based compensation | — | | — | | |||||||||
Components of comprehensive income: | |||||||||||||
Net income | — | — | | | |||||||||
March 31, 2023 | | $ | | $ | ( | $ | | $ | ( | ||||
Common Stock | Capital | Accumulated | |||||||||||
Shares | Amount | deficiency | earnings (loss) | Total | |||||||||
December 31, 2021 | | $ | | $ | ( | $ | ( | $ | ( | ||||
Shares issued under stock-based compensation plans | — | — | — | — | — | ||||||||
Stock-based compensation | — | | — | | |||||||||
Components of comprehensive income: | |||||||||||||
Net income | — | — | | | |||||||||
March 31, 2022 | | $ | | $ | ( | $ | ( | $ | ( | ||||
See accompanying notes to condensed consolidated financial statements
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CPI Card Group Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
Three Months Ended March 31, | |||||
2023 |
| 2022 | |||
Operating activities | |||||
Net income | $ | | $ | | |
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | |||||
Depreciation expense | | | |||
Amortization expense | | | |||
Stock-based compensation expense | | | |||
Amortization of debt issuance costs and debt discount | | | |||
Loss on debt extinguishment | | | |||
Deferred income taxes | ( | | |||
Other, net | | | |||
Changes in operating assets and liabilities: | |||||
Accounts receivable | | ( | |||
Inventories | ( | ( | |||
Prepaid expenses and other assets | | ( | |||
Income taxes, net | | | |||
Accounts payable | | | |||
Accrued expenses and other liabilities | ( | ( | |||
Deferred revenue and customer deposits | ( | ( | |||
Cash provided by (used in) operating activities | | ( | |||
Investing activities | |||||
Capital expenditures for plant, equipment and leasehold improvements | ( | ( | |||
Other | | | |||
Cash used in investing activities | ( | ( | |||
Financing activities | |||||
Principal payments on Senior Notes | ( | ( | |||
Proceeds from ABL Revolver | | | |||
Payments on debt extinguishment and other | ( | ( | |||
Proceeds from finance lease financing | — | | |||
Payments on finance lease obligations | ( | ( | |||
Cash (used in) provided by financing activities | ( | | |||
Effect of exchange rates on cash | | — | |||
Net increase (decrease) in cash and cash equivalents | | ( | |||
Cash and cash equivalents, beginning of period | | | |||
Cash and cash equivalents, end of period | $ | | $ | | |
Supplemental disclosures of cash flow information | |||||
Cash paid during the period for: | |||||
Interest | $ | | $ | | |
Income taxes paid | $ | | $ | | |
Right-of-use assets obtained in exchange for lease obligations: | |||||
Operating leases | $ | | $ | | |
Financing leases | $ | | $ | | |
Accounts payable and accrued expenses for capital expenditures for plant, equipment and leasehold improvements | $ | | $ | | |
See accompanying notes to condensed consolidated financial statements
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CPI Card Group Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Business Overview and Summary of Significant Accounting Policies
Business Overview
CPI Card Group Inc. (which, together with its subsidiary companies, is referred to herein as “CPI” or the “Company”) is a payment technology company and leading provider of comprehensive Financial Payment Card solutions in the United States. CPI is engaged in the design, production, data personalization, packaging and fulfillment of Financial Payment Cards, which the Company defines as credit, debit and Prepaid Debit Cards (defined below) issued on the networks of the Payment Card Brands (Visa, Mastercard®, American Express® and Discover®). CPI defines “Prepaid Debit Cards” as debit cards issued on the networks of the Payment Card Brands, but not linked to a traditional bank account. CPI also offers an instant card issuance solution, which provides customers the ability to issue a personalized debit or credit card within the bank branch to individual cardholders.
CPI serves its customers through a network of high-security production and card services facilities in the United States, each of which is audited for compliance with the standards of the Payment Card Industry Security Standards Council (the “PCI Security Standards Council”) by one or more of the Payment Card Brands. CPI’s network of high-security production facilities allows the Company to optimize its solutions offerings and serve its customers.
The Company’s business consists of the following reportable segments: Debit and Credit, Prepaid Debit and Other. The Debit and Credit segment primarily produces Financial Payment Cards and provides integrated card services for card-issuing financial institutions primarily in the United States. The Prepaid Debit segment primarily provides integrated card services to Prepaid Debit Card program managers primarily in the United States. The Company’s “Other” segment includes corporate expenses.
Basis of Presentation
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to Form 10-Q and Article 8 of Regulation S-X. In the opinion of management, these financial statements reflect all adjustments (consisting of normal recurring adjustments) considered necessary for the fair statement of the results of the interim periods presented. The condensed consolidated balance sheet as of December 31, 2022 is derived from the audited financial statements as of that date. The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.
Use of Estimates
Management uses estimates and assumptions relating to the reporting of assets and liabilities at the date of the financial statements, the reported revenues and expenses recognized during the reporting period, and certain financial statement disclosures in the preparation of the condensed consolidated financial statements. Significant items subject to such estimates and assumptions include the carrying amount of property and equipment, goodwill and intangible assets, leases, valuation allowances for inventories and deferred taxes, revenue recognized for work performed but not completed and uncertain tax positions. Actual results could differ from those estimates.
Recent Accounting Pronouncements
Recently Adopted Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which changes the criteria under which credit losses on financial instruments (such as the Company’s trade receivables) are measured. The ASU introduces a new credit reserve model known as the Current Expected Credit Loss (“CECL”) model, which replaces the incurred loss impairment methodology previously used under GAAP with an expected loss
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methodology. Effective January 1, 2023, the Company adopted the CECL model. The adoption of the model did not have a material impact on the Company’s consolidated financial position or results of operations.
2. Net Sales
The Company disaggregates its net sales by major source as follows:
Three Months Ended March 31, 2023 | ||||||||
Products | Services | Total | ||||||
(dollars in thousands) | ||||||||
Debit and Credit | $ | | $ | | $ | | ||
Prepaid Debit | — | | | |||||
Intersegment eliminations | ( |
| ( |
| ( | |||
Total | $ | | $ | | $ | | ||
Three Months Ended March 31, 2022 | ||||||||
Products | Services | Total | ||||||
(dollars in thousands) | ||||||||
Debit and Credit | $ | | $ | | $ | | ||
Prepaid Debit | — | | | |||||
Intersegment eliminations | ( |
| ( |
| ( | |||
Total | $ | | $ | | $ | | ||
Products Net Sales
“Products” net sales are recognized when obligations under the terms of a contract with a customer are satisfied. In most instances, this occurs over time as cards are produced for specific customers and have no alternative use and the Company has an enforceable right to payment for work performed. For unbilled work performed but not completed, the Company estimates revenue by taking actual costs incurred and applying historical margins for similar types of contracts. Items included in “Products” net sales are the design and production of Financial Payment Cards, including contact-EMV®, contactless dual-interface EMV, contactless and magnetic stripe cards, CPI’s eco-focused solutions, including Second Wave® and Earthwise® cards made with upcycled plastic, metal cards, private label credit cards and retail gift cards. Card@Once® printers and consumables are also included in “Products” net sales, and their associated revenues are recognized at the time of shipping. The Company includes gross shipping and handling revenue in net sales, and shipping and handling costs in cost of sales.
EMV® is a registered trademark in the U.S. and other countries and an unregistered trademark elsewhere. The EMV trademark is owned by EMV Co, LLC.
Services Net Sales
Net sales are recognized for “Services” as the services are performed. Items included in “Services” net sales include the personalization and fulfillment of Financial Payment Cards, providing tamper-evident secure packaging and fulfillment services to Prepaid Debit Card program managers, and software-as-a-service personalization of instant issuance debit cards. As applicable, for unbilled work performed but not completed, the Company estimates revenue by taking actual costs incurred and applying historical margins for similar types of contracts.
Customer Contracts
The Company often enters into Master Services Agreements (“MSAs”) with its customers. Generally, enforceable rights and obligations for goods and services occur only when a customer places a purchase order or statement of work to obtain goods or services under an MSA. The contract term as defined by ASC 606, Revenue from Contracts with Customers, is the length of time it takes to deliver the goods or services promised under the purchase order or statement of work. As such, the Company's contracts are generally short term in nature.
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3. Accounts Receivable
Accounts receivable consisted of the following:
March 31, | December 31, | ||||
2023 | 2022 | ||||
(dollars in thousands) | |||||
Trade accounts receivable | $ | |
| $ | |
Unbilled accounts receivable | |
| | ||
|
| | |||
Less allowance | ( | ( | |||
$ | | $ | | ||
4. Inventories
Inventories consisted of the following:
March 31, | December 31, | ||||
2023 | 2022 | ||||
(dollars in thousands) | |||||
Raw materials | $ | |
| $ | |
Finished goods | |
| | ||
Inventory reserve | ( | ( | |||
$ | |
| $ | | |
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5. Plant, Equipment, Leasehold Improvements and Operating Lease Right-of-Use Assets
Plant, equipment, leasehold improvements and operating lease right-of-use assets consisted of the following:
March 31, | December 31, | ||||
2023 | 2022 | ||||
(dollars in thousands) | |||||
Machinery and equipment | $ | |
| $ | |
Machinery and equipment under financing leases | | | |||
Furniture, fixtures and computer equipment | |
| | ||
Leasehold improvements | |
| | ||
Construction in progress | |
| | ||
Operating lease right-of-use assets | | | |||
| | ||||
Less accumulated depreciation and amortization | ( |
| ( | ||
$ | |
| $ | | |
6. Fair Value of Financial Instruments
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). In determining fair value, the Company utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:
● Level 1—Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities accessible to the reporting entity at the measurement date.
● Level 2— Observable inputs other than Level 1 prices, such as quoted prices in active markets for similar assets and liabilities, quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term for the assets or liabilities.
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● Level 3— Valuations based on unobservable inputs for the asset or liability used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date.
The Company’s financial assets and liabilities that are not required to be re-measured at fair value in the condensed consolidated balance sheets were as follows:
Carrying | Estimated | |||||||||||||
Value as of | Fair Value as of | Fair Value Measurement at March 31, 2023 | ||||||||||||
March 31, | March 31, | (Using Fair Value Hierarchy) | ||||||||||||
2023 | 2023 | Level 1 | Level 2 | Level 3 | ||||||||||
(dollars in thousands) | ||||||||||||||
Liabilities: |
|
|
|
| ||||||||||
Senior Notes | $ | | $ | | $ | — | $ | | $ | — | ||||
ABL Revolver | $ | | $ | | $ | — | $ | | $ | — | ||||
Carrying | Estimated | |||||||||||||
Value as of | Fair Value as of | Fair Value Measurement at December 31, 2022 | ||||||||||||
December 31, | December 31, | (Using Fair Value Hierarchy) | ||||||||||||
2022 | 2022 | Level 1 | Level 2 | Level 3 | ||||||||||
(dollars in thousands) | ||||||||||||||
Liabilities: |
|
|
|
| ||||||||||
Senior Notes | $ | |
| $ | | $ | — |
| $ | | $ | — | ||
ABL Revolver | $ | | $ | | $ | — | $ | | $ | — | ||||
The aggregate fair value of the Company’s Senior Notes (as defined in Note 8, “Long-Term Debt”) was based on bank quotes. The fair value measurement associated with the ABL Revolver (as defined in Note 8, “Long-Term Debt”) approximates its carrying value as of March 31, 2023, given the applicable variable interest rates and nature of the security interest in Company assets.
The carrying amounts for cash and cash equivalents, accounts receivable and accounts payable each approximate fair value due to their short-term nature.
7. Accrued Expenses
Accrued expenses consisted of the following:
March 31, | December 31, | ||||
2023 | 2022 | ||||
(dollars in thousands) | |||||
Accrued payroll and related employee expenses | $ | |
| $ | |
Accrued employee performance bonuses | |
| | ||
Employer payroll taxes | |
| | ||
Accrued rebates | | | |||
Estimated sales tax liability | | | |||
Accrued interest | | | |||
Current operating and financing lease liabilities | | | |||
Other | | | |||
Total accrued expenses | $ | | $ | | |
Other accrued expenses as of March 31, 2023 and December 31, 2022 consisted primarily of sales and income tax accruals, miscellaneous accruals for invoices not yet received, and other items such as self-insurance claims that have yet to be reported and accrued royalties.
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8. Long-Term Debt
At March 31, 2023 and December 31, 2022, long-term debt consisted of the following:
Interest |
| March 31, |
| December 31, | ||||
Rate (1) | 2023 | 2022 | ||||||
(dollars in thousands) | ||||||||
Senior Notes | | % | $ | | $ | | ||
ABL Revolver | | % | | | ||||
Unamortized deferred financing costs |
| ( |
| ( | ||||
Total long-term debt | | | ||||||
Less current maturities | — | — | ||||||
Long-term debt, net of current maturities | $ | | $ | | ||||
| (1) | The Senior Notes bear interest at a fixed rate and the ABL Revolver bears interest at a variable rate. |
Senior Notes
On March 15, 2021, the Company completed a private offering by its wholly-owned subsidiary, CPI CG Inc., of $
The Company has obligations to make an offer to repay the Senior Notes, requiring prepayment in advance of the maturity date, upon the occurrence of certain events including a change of control, certain asset sales and based on an annual excess cash flow calculation. The annual excess cash flow calculation is determined pursuant to the terms of that certain Indenture, dated as of March 15, 2021, by and among CPI CG Inc., the Company, the subsidiary guarantors and U.S. Bank National Association, as trustee, with any required prepayments to be made after the issuance of the Company’s annual financial statements.
During the three months ended March 31, 2023, the Company used cash on hand and available borrowing capacity under the ABL Revolver (defined below) to retire a portion of the Senior Notes totaling $
ABL
On March 15, 2021, the Company and CPI CG Inc., as borrower, entered into a Credit Agreement with Wells Fargo Bank, National Association, as lender, administrative agent and collateral agent, providing for an asset-based, senior secured revolving credit facility of up to $
Borrowings under the amended ABL Revolver bear interest at a rate per annum equal to the applicable term SOFR adjusted for a credit spread, plus an applicable interest rate margin. The Company may select a one, three or six month term SOFR, which is adjusted for a credit spread of
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margin and unused line fee percentage changed, effective April 1, 2023, to between
Deferred Financing Costs and Discount
Certain costs and discounts incurred with borrowings are reflected as a reduction to the long-term debt balance. These costs are amortized as an adjustment to interest expense over the life of the borrowing using the effective-interest rate method. The remaining unamortized debt issuance costs recorded on the Senior Notes were $
9. Income Taxes
The Company’s effective tax rate on pre-tax income was
For the three months ended March 31, 2023 and 2022, the effective tax rate differs from the U.S. federal statutory income tax rate as follows:
March 31, | |||||
2023 |
| 2022 | |||
Tax at federal statutory rate | | % | | % | |
State taxes, net | | | |||
Valuation allowance | ( | | |||
Permanent items | | | |||
Other | ( | | |||
Effective income tax rate | | % | | % | |
10. Earnings per Share
Basic and diluted earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding during the period. For the three months ended March 31, 2023 and 2022,
The following table sets forth the computation of basic and diluted earnings per share:
Three Months Ended March 31, | |||||
2023 |
| 2022 | |||
(dollars in thousands) | |||||
Numerator: | |||||
Net income | $ | | $ | | |
Denominator: | |||||
Basic weighted-average common shares outstanding |
| |
| | |
Dilutive shares | | | |||
Diluted weighted-average common shares outstanding | | | |||
Basic earnings per share | $ | | $ | ||
Diluted earnings per share | $ | | $ | ||
11. Commitments and Contingencies
Commitments
During the normal course of business, the Company enters into non-cancellable agreements to purchase goods and services, including production equipment and information technology systems. The Company leases real property
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for its facilities under non-cancellable operating lease agreements. Land and facility leases expire at various dates between 2023 and 2029 and contain various provisions for rental adjustments and renewals. The leases typically require the Company to pay property taxes, insurance and normal maintenance costs. The Company’s financing leases expire at various dates between 2023 and 2028 and contain purchase options which the Company may exercise to keep the machinery in use.
Contingencies
In accordance with applicable accounting guidance, the Company establishes an accrued expense when loss contingencies are both probable and estimable. In such cases, there may be an exposure to loss in excess of any amounts accrued. As a matter develops, the Company, in conjunction with any outside counsel handling the matter, evaluates on an ongoing basis whether such matter presents a loss contingency that is probable and estimable. Once the loss contingency is deemed to be both probable and estimable, the Company will establish an accrued expense and record a corresponding amount of expense. The Company expenses professional fees associated with litigation claims and assessments as incurred.
Smart Packaging Solutions SA v. CPI Card Group Inc.
On April 20, 2021, Smart Packaging Solutions, SA (“SPS”) filed a patent infringement lawsuit against the Company in the United States District Court for the District of Delaware seeking an unspecified amount of damages and equitable relief. In the complaint, SPS alleges that the Company infringed
In addition to the matter described above, the Company may be subject to routine legal proceedings in the ordinary course of business. The Company believes that the ultimate resolution of any such matters will not have a material adverse effect on its business, financial condition or results of operations.
Voluntary Disclosure Program
The Company is subject to unclaimed or abandoned property (escheat) laws which require it to turn over to state governmental authorities the property of others held by the Company that has been unclaimed for specified periods of time. Property subject to escheat laws generally relates to uncashed checks, trade accounts receivable credits and unpaid payable balances. During the second quarter of 2022, the Company received a letter from the Delaware Secretary of State inviting the Company to participate in the Delaware Secretary of State’s Abandoned or Unclaimed Property Voluntary Disclosure Agreement Program to avoid being sent an audit notice by the Delaware Department of Finance. On August 31, 2022, the Company entered into Delaware’s Voluntary Disclosure Agreement Program in order to voluntarily comply with Delaware’s abandoned property law in exchange for certain protections and benefits. The Company intends to work in good faith to complete a review of its books and records related to unclaimed or abandoned property during the periods required under the program. Any potential loss, or range of loss, that may result from this matter is not currently reasonably estimable.
12. Stock-Based Compensation
In October 2015, the Company adopted the CPI Card Group Inc. Omnibus Incentive Plan (the ‘Omnibus Plan”) pursuant to which cash and equity-based incentives may be granted to participating employees, advisors, and directors. On May 27, 2021, the Company’s stockholders approved an amendment and restate of the Omnibus Plan, to among other things, increase the total number of shares of the Company’s Common Stock reserved and available for issuance, resulting in a total of
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Beginning in the first quarter of 2023, certain of the Company’s employees are eligible to receive a quarterly grant comprising one-fourth of the annual equity-based incentive component of their total compensation. These awards will be in the form of a mix of restricted stock units and stock options granted under the Omnibus Plan. The number of shares awarded will be determined based on the grant-date fair value for options and on a value tied to the monthly average closing price of the Company’s common stock for restricted stock awards. All equity awards are contingent and issued only upon quarterly approval by the compensation committee of the Company’s board of directors. The Company accounts for stock-based compensation pursuant to ASC 718, Share-Based Payments. All stock-based compensation to employees is measured at fair value and expensed on a straight-line basis over the requisite service period for each tranche of the award.
During the three months ended March 31, 2023, the Company granted
During the three months ended March 31, 2023, the Company granted
13. Segment Reporting
The Company has identified reportable segments that represent 10% or more of its net sales, EBITDA (as defined below) or total assets, or when the Company believes information about the segment would be useful to the readers of the financial statements. The Company’s chief operating decision maker is its Chief Executive Officer, who is charged with management of the Company and is responsible for the evaluation of operating performance and decision making about the allocation of resources to operating segments based on measures, such as net sales and EBITDA.
EBITDA is the primary measure used by the Company’s chief operating decision maker to evaluate segment operating performance. As the Company uses the term, “EBITDA” is defined as income before interest expense, income taxes, depreciation and amortization. The Company’s chief operating decision maker believes EBITDA is a meaningful measure and is useful as a supplement to GAAP measures as it represents a transparent view of the Company’s operating performance that is unaffected by fluctuations in property, equipment and leasehold improvement additions. The Company’s chief operating decision maker uses EBITDA to perform periodic reviews and comparison of operating trends and to identify strategies to improve the allocation of resources amongst segments.
As of March 31, 2023, the Company’s reportable segments were as follows:
● Debit and Credit;
● Prepaid Debit; and
● Other.
Debit and Credit Segment
The Debit and Credit segment primarily produces Financial Payment Cards and provides integrated card services for card-issuing financial institutions primarily in the United States. Products produced by this segment primarily include EMV and non-EMV Financial Payment Cards, including contact and contactless cards, and Earth ElementsTM Eco-Focused Cards. The Company also sells Card@Once instant card issuance solutions, and private label credit cards that are not issued on the networks of the Payment Card Brands. The Company provides print-on-demand services, where images, personalized payment cards, and related collateral are produced on a one-by-one, on demand basis for customers. This segment also provides a variety of integrated card services, including card personalization and fulfillment services and instant issuance services. The Debit and Credit segment facilities and operations are audited for compliance with the standards of the PCI Security Standards Council by multiple Payment Card Brands.
Prepaid Debit Segment
The Prepaid Debit segment primarily provides integrated prepaid card services to Prepaid Debit Card program managers primarily in the United States, including tamper-evident security packaging. This segment also produces Financial Payment Cards issued on the networks of the Payment Card Brands that are included in the tamper-evident
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security packages. The Prepaid Debit segment facilities and operations are audited for compliance with the standards of the PCI Security Standards Council by multiple Payment Card Brands.
Other
The Other segment includes corporate expenses.
Performance Measures of Reportable Segments
Net sales and EBITDA of the Company’s reportable segments, as well as a reconciliation of total segment EBITDA to income from operations and net income for the three months ended March 31, 2023 and 2022, were as follows:
Three Months Ended March 31, 2023 | ||||||||||||||
Debit and Credit | Prepaid Debit | Other | Intersegment Eliminations | Total | ||||||||||
(dollars in thousands) | ||||||||||||||
Net sales | $ | | $ | | $ | — | $ | ( | $ | | ||||
Cost of sales | | | — | ( | | |||||||||
Gross profit | | | — | — | | |||||||||
Operating expenses | | | | — | | |||||||||
Income from operations | $ | | $ | | $ | ( | $ | — | $ | | ||||
EBITDA by segment: | ||||||||||||||
Income from operations | $ | | $ | | $ | ( | $ | — | $ | | ||||
Depreciation and amortization | | | | — | | |||||||||
Other income (expenses) | | — | ( | — | ( | |||||||||
EBITDA | $ | | $ | | $ | ( | $ | — | $ | | ||||
Three Months Ended March 31, 2022 | ||||||||||||||
Debit and Credit | Prepaid Debit | Other | Intersegment Eliminations | Total | ||||||||||
(dollars in thousands) | ||||||||||||||
Net sales | $ | | $ | | $ | — | $ | ( | $ | | ||||
Cost of sales | | | — | ( | | |||||||||
Gross profit | | | — | — | | |||||||||
Operating expenses | | | | — | | |||||||||
Income from operations | $ | | $ | | $ | ( | $ | — | $ | | ||||
EBITDA by segment: | ||||||||||||||
Income from operations | $ | | $ | | $ | ( | $ | — | $ | | ||||
Depreciation and amortization | | | | — | | |||||||||
Other income (expenses) | | ( | ( | — | ( | |||||||||
EBITDA | $ | | $ | | $ | ( | $ | — | $ | | ||||
Three Months Ended March 31, | |||||
2023 |
| 2022 | |||
(dollars in thousands) | |||||
Total segment EBITDA | $ | | $ | | |
Interest, net | ( | ( | |||
Income tax expense |
| ( |
| ( | |
Depreciation and amortization |
| ( |
| ( | |
Net income | $ | | $ | | |
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
References to the “Company,” “our,” “us” or “we” refer to CPI Card Group Inc. and its subsidiaries. For an understanding of the significant factors that influenced our results, the following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q for the quarter ended March 31, 2023. This management’s discussion and analysis should also be read in conjunction with the management’s discussion and analysis and consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2022 filed with the Securities and Exchange Commission (“SEC”).
Cautionary Statement Regarding Forward-Looking Information
Certain statements and information in this Quarterly Report on Form 10-Q for the quarter ended March 31, 2023 (as well as information included in other written or oral statements we make from time to time) may contain or constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The words “believe,” “estimate,” “project,” “expect,” “anticipate,” “plan,” “intend,” “foresee,” “should,” “would,” “could,” “continue,” “committed,” “attempt,” “target,” “objective,” “guides,” “seek,” “focus,” “provides guidance,” “provides outlook” or other similar expressions are intended to identify forward-looking statements, which are not historical in nature. These forward-looking statements, including statements about our strategic initiatives and market opportunities, are based on our current expectations and beliefs concerning future developments and their potential effect on us and other information currently available. Such forward-looking statements, because they relate to future events, are by their very nature subject to many important risks and uncertainties that could cause actual results or other events to differ materially from those contemplated.
These risks and uncertainties include, but are not limited to: adverse conditions in the banking system and financial markets, including the failure of banks and financial institutions; a deterioration in general economic conditions, including rising inflation and resulting in reduced consumer confidence and business spending, and a decline in consumer credit worthiness impacting demand for our products; a disruption or other failure in our supply chain, including as a result of the Russia-Ukraine conflict and with respect to single source suppliers, or the failure or inability of suppliers to comply with our code of conduct or contractual requirements, or political unrest in countries in which our suppliers operate, resulting in increased costs and inability to pass those costs on to our customers and extended production lead times and difficulty meeting customers’ delivery expectations; our failure to retain our existing customers or identify and attract new customers; the unpredictability of our operating results, including an inability to anticipate changes in customer inventory management practices and its impact on our business; our status as an accelerated filer and complying with Section 404 of the Sarbanes-Oxley Act of 2002 and the costs associated with such compliance and implementation of procedures thereunder; our failure to maintain effective internal control over financial reporting; our inability to recruit, retain and develop qualified personnel, including key personnel; the potential effects of COVID-19 and responses thereto on our business, including our supply chain, customer demand, workforce, operations; system security risks, data protection breaches and cyber-attacks; interruptions in our operations, including our information technology systems, or in the operations of the third parties that operate computing infrastructure on which we rely; our inability to develop, introduce and commercialize new products; our substantial indebtedness, including inability to make debt service payments or refinance such indebtedness; the restrictive terms of our indebtedness and covenants of future agreements governing indebtedness and the resulting restraints on our ability to pursue our business strategies; disruptions in production at one or more of our facilities; defects in our software; environmental, social and governance preferences and demands of various stakeholders and our ability to conform to such preferences and demands and to comply with any related regulatory requirements; the effects of climate change, negative perceptions of our products due to the impact of our products and production processes on the environment and other ESG-related risks; disruptions in production due to weather conditions, climate change, political instability or social unrest; our inability to adequately protect our trade secrets and intellectual property rights from misappropriation, infringement claims brought against us and risks related to open source software; our limited ability to raise capital; problems in production quality, materials and process; costs and impacts to our financial results relating to the obligatory collection of sales tax and claims for uncollected sales tax in states that impose sales tax collection requirements on out-of-state businesses or unclaimed property, as well as potential new U.S. tax legislation increasing the corporate income tax rate and challenges to our income tax positions; our inability to successfully execute on our divestitures or acquisitions; our inability to realize the full value of our long-lived assets; costs relating to product defects and any related product liability and/or warranty claims; our inability to renew licenses with key technology licensors; the highly competitive,
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saturated and consolidated nature of our marketplace; the effects of restrictions, delays or interruptions in our ability to source raw materials and components used in our products from foreign countries; the effects on the global economy of the ongoing military action by Russia in Ukraine; costs and potential liabilities associated with compliance or failure to comply with regulations, customer contractual requirements and evolving industry standards regarding consumer privacy and data use and security; new and developing technologies that make our existing technology solutions and products obsolete or less relevant or our failure to introduce new products and services in a timely manner; quarterly variation in our operating results; our failure to operate our business in accordance with the Payment Card Industry Security Standards Council security standards or other industry standards; our failure to comply with environmental, health and safety laws and regulations that apply to our products and the raw materials we use in our production processes; risks associated with the majority stockholders’ ownership of our stock; potential conflicts of interest that may arise due to our board of directors being comprised in part of directors who are principals of our majority stockholders; the influence of securities analysts over the trading market for and price of our common stock; failure to meet the continued listing standards of the Nasdaq Global Market; the impact of stockholder activism or securities litigation on the trading price and volatility of our common stock; certain provisions of our organizational documents and other contractual provisions that may delay or prevent a change in control and make it difficult for stockholders other than our majority stockholders to change the composition of our board of directors; our ability to comply with a wide variety of complex laws and regulations and the exposure to liability for any failure to comply; the effect of legal and regulatory proceedings; and other risks that are described in Part I, Item 1A – Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2022 filed with the SEC on March 8, 2023, in Part II, Item 1A – Risk Factors of this Quarterly Report on Form 10-Q and our other reports filed from time to time with the SEC.
We caution and advise readers not to place undue reliance on forward-looking statements, which speak only as of the date hereof. These statements are based on assumptions that may not be realized and involve risks and uncertainties that could cause actual results or other events to differ materially from the expectations and beliefs contained herein. We undertake no obligation to publicly update or revise any forward-looking statements after the date they are made, whether as a result of new information, future events or otherwise.
Overview
We are a payment technology company and leading provider of comprehensive Financial Payment Card solutions in the United States. We define “Financial Payment Cards” as credit, debit and Prepaid Debit Cards (as defined below) issued on the networks of the “Payment Card Brands” (Visa, Mastercard®, American Express® and Discover®). We define “Prepaid Debit Cards” as debit cards issued on the networks of the Payment Card Brands, but not linked to a traditional bank account. We also offer an instant card issuance solution, which provides customers the ability to issue a personalized debit or credit card within the bank branch to individual cardholders. We have established a leading position in the Financial Payment Card solutions market through more than 20 years of experience.
We serve a diverse set of several thousand customers which includes direct customers and indirect customer relationships, whereby CPI provides Financial Payment Card solutions to a customer through a Group Service Provider (as defined below). Our customers include some of the largest issuers of debit and credit cards in the United States, the largest Prepaid Debit Card program managers in the United States, numerous financial technology companies (“fintechs”), as well as independent community banks, credit unions and Group Service Providers. We define “Group Service Providers” as reseller or card processor organizations that assist small card issuers, such as credit unions, with managing their credit and debit card programs, including managing the Financial Payment Card issuance process, core banking operations and other financial services.
We serve our customers through a network of high-security production and card services facilities in the United States, each of which is audited for compliance with the standards of the Payment Card Industry Security Standards Council (the “PCI Security Standards Council”) by one or more of the Payment Card Brands. Many of our customers require us to comply with PCI Security Standards Council requirements that relate to the provision of our products and services. Our network of high-security production facilities allows us to optimize our solutions offerings and to serve the needs of our diverse customer base.
Driven by a combination of our strong relationships, quality, technology, innovation, and supply-chain management, we believe we have strong positions in the following markets:
| ● | the U.S. prepaid debit market, including the largest U.S. Prepaid Debit Card program managers; |
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| ● | the U.S. small-to mid-sized financial institutions market, which includes independent community banks and credit unions; |
| ● | the U.S. large issuer market, serving some of the largest U.S. debit and credit card issuers; and |
| ● | the U.S. fintech market, where we produce and personalize Financial Payment Cards for financial technology companies. |
Our business consists of the following reportable segments:
| ● | Debit and Credit, which primarily produces Financial Payment Cards and provides integrated card services to card-issuing financial institutions primarily in the United States; |
| ● | Prepaid Debit, which primarily provides integrated prepaid card services to Prepaid Debit Card program managers primarily in the United States; and |
| ● | “Other,” which includes corporate expenses. |
Trends and Key Factors Affecting our Financial Performance
We believe the following key factors may have a meaningful impact on our business performance and may negatively influence our financial and operating results:
| ● | We believe some customers have reduced demand for our products and services and we may experience reduced demand from customers in the future due to the following: |
| o | Certain economic indicators continue to point towards the likelihood that the U.S. economy will experience a recession in the near future, which may cause our customers to have concerns about the broader economic environment and reduce overall spending, including on card programs or other products and services we offer. |
| o | Certain banks have recently experienced negative liquidity events, including some being taken over by industry regulators and others experiencing deposit outflows, deteriorating share prices and limited access to capital, leading to cautionary signals and uncertainty in the financial services industry. Following these events, we experienced reduced demand in the Debit and Credit segment. |
| o | Some of our customers may have anticipated supply-chain-related delays and correspondingly increased their own inventory of the Company’s products on hand during 2022. |
| ● | We have experienced inflationary pressure in our supply chain, as well as delays and difficulties in sourcing key materials and components needed for our products. We have seen improvements in many areas and our production lead times have improved significantly, however we continue to have challenges in some areas which have resulted in increased costs of certain raw materials and components, longer supplier lead times and unpredictability. We continue to take actions to limit the impact of these dynamics. |
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Results of Operations
The following table presents the components of our condensed consolidated statements of operations for each of the periods presented:
Three Months Ended | |||||||||||
March 31, | |||||||||||
2023 |
| 2022 | $ Change | % Change | |||||||
(dollars in thousands) | |||||||||||
Net sales: (1) | |||||||||||
Products | $ | 75,790 | $ | 68,316 | $ | 7,474 | 10.9 | % | |||
Services | 45,062 | 43,108 | 1,954 | 4.5 | % | ||||||
Total net sales | 120,852 | 111,424 | 9,428 | 8.5 | % | ||||||
Cost of sales (1) | 77,758 | 72,146 | 5,612 | 7.8 | % | ||||||
Gross profit | 43,094 | 39,278 | 3,816 | 9.7 | % | ||||||
Operating expenses | 22,496 | 21,297 | 1,199 | 5.6 | % | ||||||
Income from operations | 20,598 | 17,981 | 2,617 | 14.6 | % | ||||||
Other expense, net: | |||||||||||
Interest, net | (6,781) | (7,865) | 1,084 | (13.8) | % | ||||||
Other expense, net | (114) | (396) | 282 | (71.2) | % | ||||||
Income before taxes | 13,703 | 9,720 | 3,983 | 41.0 | % | ||||||
Income tax expense | (2,830) | (3,718) | 888 | (23.9) | % | ||||||
Net income | $ | 10,873 | $ | 6,002 | $ | 4,871 | 81.2 | % | |||
Gross profit margin | 35.7% | 35.3% | |||||||||
| (1) | For the three months ended March 31, 2023 and 2022, net sales and cost of sales each include $0.3 million and less than $0.1 million of intersegment eliminations, respectively. |
The following discussion of our consolidated results of operations and segment results refers to the three months ended March 31, 2023 compared to the corresponding period in the prior year. The results of operations should be read in conjunction with the discussion of our segment results of operations, which provide more detailed discussions concerning certain components of the Condensed Consolidated Statements of Income.
Net Sales:
Net sales increased $9.4 million, or 8.5%, for the three months ended March 31, 2023 compared to the corresponding period in the prior year, driven by the Debit and Credit segment. The increase was primarily due to increased sales of higher-priced contactless card products and personalization services and includes benefits from price increases.
Gross Profit and Gross Profit Margin:
Gross profit increased $3.8 million, or 9.7%, for the three months ended March 31, 2023 compared to the corresponding period in the prior year. Gross profit margin was 35.7%, compared to 35.3% in the corresponding period in the prior year. The increase in gross profit was primarily due to operating leverage from higher net sales, including benefits from price increases, partially offset by inflationary impacts on materials costs and expenses associated with a production staffing model change in our Prepaid business.
Operating Expenses:
Operating expenses increased $1.2 million, or 5.6%, for the three months ended March 31, 2023 compared to the corresponding period in the prior year, primarily due to a $1.9 million increase in compensation expenses, mainly in the “Other” segment, as a result of increased employee headcount and salary increases, partially offset by a $0.7 million decrease in professional services and other costs.
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Interest, net:
Interest expense decreased $1.1 million, or 13.8%, for the three months ended March 31, 2023 compared to the corresponding period in the prior year, primarily due to lower outstanding principal balances on our borrowings.
Other Expense, net:
Other expense, net decreased $0.3 million, or 71.2%, for the three months ended March 31, 2023 compared to the corresponding period in the prior year, primarily due to lower unamortized deferred financing cost write-offs as a result of reduced retirements of our 8.625% Senior Secured Notes due 2026 (the “Senior Notes”) compared to the corresponding period in the prior year.
Income Tax Expense:
Our effective tax rate on pre-tax income was 20.7% and 38.2% for the three months ended March 31, 2023 and 2022, respectively. The decrease in our effective tax rate for the three months ended March 31, 2023 compared to the corresponding period in the prior year, was a result of increased deductibility of interest costs due to a tax election made by the Company in the third quarter of 2022 and the reduction of a valuation allowance in the first quarter of 2023 related to a state’s law change.
Segment Discussion
Debit and Credit:
Three Months Ended | |||||||||||
March 31, | |||||||||||
2023 |
| 2022 | $ Change | % Change | |||||||
(dollars in thousands) | |||||||||||
Net sales | $ | 101,985 | $ | 92,015 | $ | 9,970 | 10.8 | % | |||
Gross profit | $ | 38,184 | $ | 32,230 | $ | 5,954 | 18.5 | % | |||
Income from operations | $ | 30,026 | $ | 24,110 | $ | 5,916 | 24.5 | % | |||
Gross margin | 37.4% | 35.0% | |||||||||
Net Sales:
Net sales for Debit and Credit increased $10.0 million, or 10.8%, for the three months ended March 31, 2023 compared to the corresponding period in the prior year. Products net sales increased primarily due to increased sales from existing customers, including benefits from the transition to contactless cards and price increases. Services net sales increased as a result of higher personalization sales due to higher sales from existing customers, including benefits from prices increases, and higher Card@Once services driven by a higher printer install base.
Gross Profit and Gross Profit Margin:
Gross profit for Debit and Credit increased $6.0 million, or 18.5%, for the three months ended March 31, 2023 compared to the corresponding period in the prior year, primarily due to the net sales increase described above. Gross profit margin increased to 37.4% during the three months ended March 31, 2023, compared to 35.0% in the corresponding period in the prior year. The increase in gross margin was primarily due to operating leverage from higher net sales, including the benefit of price increases, partially offset by inflationary impacts on materials costs.
Income from Operations:
Income from operations for Debit and Credit increased $5.9 million, or 24.5%, for the three months ended March 31, 2023 compared to the corresponding period in the prior year, due primarily to the factors discussed in “Gross Profit and Gross Profit Margin” above.
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Prepaid Debit:
Three Months Ended | |||||||||||
March 31, | |||||||||||
2023 |
| 2022 | $ Change | % Change | |||||||
(dollars in thousands) | |||||||||||
Net sales | $ | 19,130 | $ | 19,461 | $ | (331) | (1.7) | % | |||
Gross profit | $ | 4,910 | $ | 7,048 | $ | (2,138) | (30.3) | % | |||
Income from operations | $ | 3,677 | $ | 5,968 | $ | (2,291) | (38.4) | % | |||
Gross margin | 25.7% | 36.2% | |||||||||
Net Sales:
Net sales for Prepaid Debit decreased $0.3 million, or 1.7%, for the three months ended March 31, 2023 compared to the corresponding period in the prior year, primarily due to decreased volumes partially offset by the benefit of price increases.
Gross Profit and Gross Profit Margin:
Gross profit for Prepaid Debit decreased $2.1 million, or 30.3%, for the three months ended March 31, 2023 compared to the corresponding period in the prior year. Gross profit margin for Prepaid Debit decreased to 25.7% for the three months ended March 31, 2023 compared to 36.2% in the corresponding period in the prior year. The decreases were primarily due to expenses incurred related to a change in our production staffing model, as we transitioned positions staffed with temporary workers to permanent employees, and lower net sales.
Income from Operations:
Income from operations for Prepaid Debit decreased $2.3 million, or 38.4%, for the three months ended March 31, 2023 compared to the corresponding period in the prior year, primarily due to lower gross profit and an increase in operating expenses due to increased compensation costs.
Other:
As the Other segment is comprised entirely of corporate expenses, income from operations for Other consists of operating expenses shown below.
Three Months Ended | |||||||||||
March 31, | |||||||||||
2023 |
| 2022 | $ Change | % Change | |||||||
(dollars in thousands) | |||||||||||
Operating expenses | $ | 13,105 | $ | 12,097 | $ | 1,008 | 8.3 | % | |||
Operating Expenses:
Other operating expenses increased $1.0 million, or 8.3%, for the three months ended March 31, 2023 compared to the corresponding period in the prior year, primarily due to a $1.5 million increase in compensation expenses due to the factors described in the consolidated discussion above, partially offset by a $0.5 million decrease in professional services and other costs.
Liquidity and Capital Resources
At March 31, 2023, we had $14.2 million of cash and cash equivalents.
Our ability to make investments in and grow our business, service our debt and improve our debt leverage ratios, while maintaining strong liquidity, will depend upon our ability to generate excess operating cash flows through our operating subsidiaries. Although we can provide no assurances, we believe that our cash flows from operations,
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combined with our current cash levels, will be adequate to fund debt service requirements and provide cash, as required, to support our ongoing operations, capital expenditures, lease obligations and working capital needs.
Senior Notes
On March 15, 2021, we completed a private offering of $310.0 million aggregate principal amount of the Senior Notes and related guarantees at an issue price of 100%. The Senior Notes bear interest at a rate of 8.625% per annum and mature on March 15, 2026. Interest is payable on the Senior Notes on March 15 and September 15 of each year.
The Company has obligations to make an offer to repay the Senior Notes, requiring prepayment in advance of the maturity date, upon the occurrence of certain events including a change of control, certain asset sales and based on an annual excess cash flow calculation. The annual excess cash flow calculation is determined based on an adjusted net income calculation pursuant to the terms of the indenture, and varies based on the Company’s annual net leverage ratio. The Company is required to offer to pay 50% of excess cash flow if the net leverage ratio exceeds 4.5 to 1; 25% if the net leverage ratio is between 4 to 1 and 4.5 to 1, and 0% if the net leverage ratio is no more than 4 to 1. Any required prepayments are to be made within 125 days after the issuance of the Company’s annual financial statements. No such payment was required to be made in 2023 based on the Company’s operating results for the year ended December 31, 2022.
As permitted by the indenture governing the Senior Notes, the Company may from time to time repurchase some or all of the Senior Notes in open market transactions, in privately negotiated transactions or otherwise. The Company may redeem some or all of the Senior Notes pursuant to the terms of the indenture at a redemption price initially set at 104.313% of the principal amount of the notes to be redeemed, and reducing over time to 100%, in each case plus accrued and unpaid interest. The timing and amount of any such redemptions or repurchases will depend upon market conditions, contractual commitments, the Company’s capital needs and other factors.
As of the three months ended March 31, 2023, the Company had $277.0 million aggregate principal amount outstanding on the Senior Notes, plus accrued and unpaid interest.
ABL
On March 15, 2021, we entered into a Credit Agreement with Wells Fargo Bank, National Association providing for an ABL Revolver of up to $50.0 million. On March 3, 2022, we entered into Amendment No. 1 to the Credit Agreement, which amended the ABL Revolver to among other things, increased the available borrowing capacity to $75.0 million, increased the uncommitted accordion feature to $25.0 million and revised the interest rate provisions to replace the prior LIBOR benchmark with updated benchmark provisions using the secured overnight financing rate (“SOFR”) as administered by the Federal Reserve Bank of New York. On October 11, 2022, we entered into Amendment No. 2 to the Credit Agreement, which amended the ABL Revolver to adjust certain monthly document delivery terms and to clarify the treatment of certain inventory.
Borrowings under the amended ABL Revolver bear interest at a rate per annum equal to the applicable term SOFR adjusted for a credit spread, plus an applicable interest rate margin. We may select a one, three or six month term SOFR, which is adjusted for a credit spread of 0.10% to 0.30% depending on the term selected. Through March 31, 2023, the applicable interest rate margin ranges from 1.50% to 1.75% depending on the average excess availability of the facility for the most recently completed quarter. The unused portion of the ABL Revolver commitment accrues a monthly unused line fee, 0.50% per annum through March 31, 2023, multiplied by the aggregate amount of Revolver commitments less the average Revolver usage during the immediately preceding month. The interest rate margin and unused line fee percentage changed, effective April 1, 2023, to between 1.25% and 1.75% (interest rate margin) and 0.375% and 0.50% (unused line fee).
Amounts borrowed and outstanding under the ABL Revolver are required to be repaid in full, together with any accrued and unpaid interest, on the earliest to occur of March 15, 2026 and the date that is 90 days prior to the maturity of the Senior Notes (and may be subject to earlier mandatory prepayment upon certain events).
As of the three months ended March 31, 2023, the Company had $13.0 million in ABL Revolver borrowings outstanding, plus accrued and unpaid interest.
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Operating Activities
Cash provided by operating activities for the three months ended March 31, 2023 was $8.0 million compared to cash used in operating activities of $16.0 million during the three months ended March 31, 2022. Cash generated from earnings for the three months ended March 31, 2023 was partially offset by a decrease in accrued expenses of $11.4 million, primarily related to payments on accrued interest and employee performance incentive compensation during the period, and an increase in inventories by $1.5 million. These changes were partially offset by a decrease in accounts receivable of $4.3 million primarily due to lower net sales in the first quarter of 2023 compared to the fourth quarter of 2022.
Investing Activities
Cash used in investing activities for the three months ended March 31, 2023 was $4.1 million, compared to $3.1 million during the three months ended March 31, 2022. Cash used in investing activities was related primarily to capital expenditures, including investments to support the business, such as machinery and information technology equipment. As presented in our supplemental disclosures of non-cash information on the statement of cash flows, finance leases were executed for the acquisition of right-of-use machinery and equipment assets totaling $2.2 million during the three months ended March 31, 2023, compared to $3.5 million during the corresponding period in the prior year.
Financing Activities
During the three months ended March 31, 2023, cash used in financing activities was $0.8 million. Proceeds from the ABL Revolver were $8.0 million, we retired $8.0 million of Senior Notes and we paid $0.8 million of principal on financing leases.
During the three months ended March 31, 2022, cash provided by financing activities was $10.6 million. Proceeds from the ABL Revolver were $30.0 million and in connection with the ABL Amendment, we paid $0.3 million of debt issuance costs. A portion of the proceeds from the ABL Revolver were used to redeem $20.0 million of Senior Notes and to pay $0.6 million of early redemption costs. We received $2.1 million under financing leases and we paid $0.6 million of principal on financing leases.
Working Capital
Our working capital as of March 31, 2023 was $110.9 million, compared to $99.6 million as of March 31, 2022. The increase in our working capital as of March 31, 2023 was primarily due to a decrease in accrued expenses of $10.6 million, an increase in cash of $3.1 million and increased inventories of $1.3 million, partially offset by decreased accounts receivable of $4.4 million. Our working capital needs are typically highest in the first and third quarters due to the timing of payments for interest on outstanding borrowings and employee incentive compensation. The majority of our interest payments are due in the first and third quarters.
Material Cash Requirements
Our material cash requirements include interest payments on our long-term debt, operating and finance lease payments, and purchase obligations to support our operations.
Debt Service Requirements
As of March 31, 2023, the total projected principal and interest payments on our borrowings were $363.5 million, primarily related to the Senior Notes, of which $25.0 million of interest is expected to be paid in the next 12 months. The remaining interest payments are expected to be paid over the remaining term of the Senior Notes, which mature in 2026, and the principal is due upon maturity. We have estimated our future interest payments assuming no additional borrowings under the ABL Revolver, no early redemptions of principal on the Senior Notes, no early voluntary or required repayment of the borrowings under the ABL Revolver within the next twelve months, and no debt issuances or renewals upon the maturity dates of our notes. However, we may borrow additional amounts under the ABL Revolver, redeem principal on the Senior Notes early or refinance all or a portion of our borrowings in future periods.
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Leases
We lease real property for production and services, in addition to equipment. Refer to Part II, Item 8, Financial Statements and Supplementary Data, Note 9, Financing and Operating Leases, in our Annual Report on Form 10-K for the year ended December 31, 2022 for details on our leasing arrangements, including future maturities of our operating lease liabilities.
Purchase Obligations
A purchase obligation is an agreement to purchase goods or services that is enforceable, legally binding, and specifies all significant terms. As of March 31, 2023, there have not been any material changes to the purchase obligations disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts and disclosures in the financial statements and accompanying notes. Actual results could differ from those estimates. Our Critical Accounting Policies and Estimates disclosed in our Annual Report on Form 10-K for the year ended December 31, 2022, for which there were no material changes as of March 31, 2023, included:
| ● | Revenue recognition, including estimates of work performed but not completed, and |
| ● | Income taxes, including estimates regarding future compensation for covered individuals, valuation allowances and uncertain tax positions. |
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Not required due to smaller reporting company status.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our controls and procedures related to our reporting and disclosure obligations (as defined by Rules 13a-15(e) and 15d-15(e) within the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of March 31, 2023, which is the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2023, the disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act, is recorded, processed, summarized and reported, as applicable, within the time periods specified in the rules and forms of the Securities and Exchange Commission, and are designed to ensure that information required to be disclosed by us in the reports that we file or submit is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There were no changes that occurred during the fiscal quarter covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II – Other Information
Item 1. Legal Proceedings
Smart Packaging Solutions SA v. CPI Card Group Inc.
On April 20, 2021, Smart Packaging Solutions, SA (“SPS”) filed a patent infringement lawsuit against the Company in the United States District Court for the District of Delaware seeking an unspecified amount of damages and equitable relief. In the complaint, SPS alleges that the Company infringed four patents that SPS has exclusively licensed from Feinics AmaTech Teoranta. The patents all relate to antenna technology. SPS alleges that the Company incorporates the patented technology into its products that use contactless communication. The Company does not produce antennas; it purchases certain antenna-related components from SPS and a number of other suppliers. The Company’s motion to dismiss the complaint is currently pending. Additionally, a third party, Infineon, has filed requests for Inter Parties Review (“IPR”) proceedings concerning each of the four patents. As a result, the Delaware District Court stayed the case pending resolution of the requests for review. The United States Patent Office has instituted proceedings with respect to all of the IPR requests. The current proceedings in the patent office are scheduled to run through September 2023. Should the patents survive review by the United States Patent Office, the Company intends to defend the suit vigorously. However, no assurance can be given that this matter will be resolved favorably.
In addition to the matter described above, the Company may be subject to routine legal proceedings in the ordinary course of business. The Company believes that the ultimate resolution of any such matters will not have a material adverse effect on its business, financial condition or results of operations.
Item 1A. Risk Factors
The risk factors disclosed in Part I, Item 1A Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2022 set forth information relating to various risks and uncertainties that could materially adversely affect our business, financial condition and operating results. Such risk factors continue to be relevant to an understanding of our business, financial condition and operating results. As of the date of this Quarterly Report on Form 10-Q, there have been the following material changes with respect to such risk factors.
Conditions in the banking system and financial markets, including the failure of banks and financial institutions, could have an adverse effect on our business, financial condition and results of operations.
Events involving limited liquidity, defaults, non-performance or other adverse developments that affect financial institutions, transactional counterparties or other companies in the financial services industry or the financial services industry generally, or concerns or rumors about any events of these kinds or other similar risks, have in the past and may in the future lead to market-wide liquidity problems. For example, on March 10 and March 12, 2023, the Federal Deposit Insurance Corporation took control and was appointed receiver of Silicon Valley Bank and Signature Bank, respectively, after each bank was unable to continue their operations, and more recently, assisted with the assumption of First Republic Bank’s deposits and assets by JP Morgan Chase. These events exposed vulnerabilities in the banking sector, including uncertainties, significant volatility and contagion risk, any or all of which could have an adverse effect on our business, financial condition and results of operations.
In addition to the market-wide impacts, our reliance on financial institutions and non-traditional financial service providers such as fintechs as our primary customers expose us to additional risk from adverse events affecting the industry. The failure of financial institutions, the migration of deposits from smaller financial institutions to larger ones due to reduced confidence in or concerns about the stability of smaller financial institutions or non-traditional financial service providers, as well as consumers opening fewer new accounts at these institutions, may impact the quantity and timing of orders for our products. Additionally, the recent uncertainty in the banking sector, as well as broader economic conditions in general, may cause banks and financial institutions to implement precautionary measures such as reducing spending on card programs or being more selective about issuing or renewing cards to customers. Any of the foregoing events could result in lower demand for our products, which in turn could have a material adverse effect on our business, financial condition and results of operations.
Critical vendors, third-party manufacturers, or other third parties on which we rely, could also be adversely affected by the liquidity and other risks related to bank failures, which in turn could result in material adverse impacts on our business, financial condition and results of operations. These could include, but may not be limited to, delayed access to deposits or other financial assets or the uninsured loss of deposits or other financial assets and difficulty in accessing commercial financing on acceptable terms or at all due to tightening credit markets, covenant terms and higher interest rates. Any third-party bankruptcy or insolvency, or any breach or default by a third party on which we rely, or the loss of any significant supplier relationships, could result in material adverse impacts on our business, financial condition and results of operations.
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Item 5. Other Information
(a) The Board of Directors (the “Board”) of the Company has approved the appointment of Jeffrey Hochstadt as the Company’s Chief Financial Officer (“CFO”), effective as of May 15, 2023. Mr. Hochstadt will succeed Amintore Schenkel, who previously notified the Company of his desire to step down due to family related reasons.
Prior to joining CPI, Mr. Hochstadt, 51, provided financial and strategy consulting services to clients in various industries from October 2021 to May 2023. Prior to that, beginning in 2006, Mr. Hochstadt held roles of increasing responsibility at The Western Union Company (“Western Union”), a multinational financial services company, including Global Head of Financial Planning and Analysis and most recently served as Chief Strategy Officer from January 2018 to March 2021. Prior to joining Western Union, Mr. Hochstadt held numerous financial and strategy roles for First Data Corporation, Morgan Stanley Capital International (MSCI), IBM, A.G. Edwards and Price Waterhouse. Mr. Hochstadt graduated with honors from the Olin School of Business at Washington University in St. Louis and received an MBA from the Wharton School of Business at the University of Pennsylvania.
Mr. Hochstadt does not have any family relationship with any director or executive officer of the Company, or any person nominated or chosen to become a director or executive officer of the Company, and there are no applicable transactions that would require disclosure under Item 404(a) of Regulation S-K.
In connection with Mr. Hochstadt’s appointment as CFO, he will receive an annual base salary of $400,000 and will be eligible for an annual bonus under the Company’s Short-Term Incentive Plan (“STIP”), with a STIP target opportunity of $325,000. STIP bonuses are based on individual and Company performance results and require recipients to be continuously employed through the date of the payout. For the 2023 STIP plan year, Mr. Hochstadt’s target bonus opportunity will be pro-rated from his start date. Additionally, Mr. Hochstadt will receive sign-on bonus consisting of an equity award with a grant date fair value of $250,000. He will also have an annual long-term incentive target award opportunity of $250,000, which will be prorated for 2023 and is expected to be granted quarterly. Mr. Hochstadt’s equity award will be granted under the Company’s Amended and Restated Omnibus Incentive Plan (the “Omnibus Plan”) in such form and on such terms as approved by the Compensation Committee of the Board. Mr. Hochstadt will be entitled to other benefits generally available to other executive officers of the Company, including severance benefits. The offer letter between the Company and Mr. Hochstadt is filed as Exhibit 10.1 to this report.
As part of the transition of the CFO duties to Mr. Hochstadt, Mr. Schenkel will remain with the Company as a full-time employee through June 30, 2023 and shall receive his base salary and other benefits through that time. The Company expects to enter into a consulting agreement effective July 1, 2023 with Mr. Schenkel, pursuant to which he may continue to provide advisory services to the Company’s Chief Executive Officer and the CFO for a period of time thereafter. Mr. Schenkel is also entitled to payment under the STIP of any short-term incentive compensation earned for the second quarter of 2023 and the pro-rata portion of any “annual performance incentive” that would be payable to Mr. Schenkel based on the Company’s 2023 annual performance.
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Item 6. Exhibits
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SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
CPI CARD GROUP INC. | |
May 9, 2023 | /s/ Scott Scheirman |
Scott Scheirman | |
Chief Executive Officer | |
(Principal Executive Officer) | |
May 9, 2023 | /s/ Amintore Schenkel |
Amintore Schenkel | |
Chief Financial Officer | |
(Principal Financial Officer) |
May 9, 2023 | /s/ Donna Abbey |
Donna Abbey | |
Chief Accounting Officer | |
(Principal Accounting Officer) |
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