CPI Card Group Inc. (NASDAQ:PMTS) Q1 2023 Earnings Call Transcript May 14, 2023

Operator: Welcome to the CPI Card Group’s First Quarter 2023 Earnings Call. My name is Bailey and I will be your operator today. [Operator Instructions]. Now, I will turn the call over to Mike Salop, CPI’s Head of Investor Relations.

Mike Salop: Thanks, operator. And good morning, everyone. Welcome to the CPI Card Group first quarter 2023 earnings webcast and conference call. Today’s date is May 9, 2023. And on the call today from CPI Card Group are Scott Scheirman, President and Chief Executive Officer; and Amintore Schenkel, Chief Financial Officer. Before we begin, I’d like to remind everyone that this call may contain forward-looking statements as they are defined under the Private Securities Litigation Reform Act of 1995. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. For a discussion of such risks and uncertainties, please see CPI Card Group’s most recent filings with the SEC.

All forward-looking statements made today reflect our current expectations only, and we undertake no obligation to update any statements to reflect the events that occur after this call. Also, during the course of today’s call, the company will be discussing one or more non-GAAP financial measures, including, but not limited to, EBITDA, adjusted EBITDA, adjusted EBITDA margin, net leverage ratio and free cash flow. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures are included in the press release and slide presentation we issued this morning. Copies of today’s press release as well as the presentation that accompanies this conference call are accessible on CPI’s Investor Relations website, investors.cpicardgroup.com.

In addition, CPI’s Form 10-Q for the quarter ended March 31, 2023 will be available on CPI’s Investor Relations website. And now, I’d like to turn the call over to President and Chief Executive Officer, Scott Schierman.

Scott Scheirman: Thanks, Mike. And good morning, everyone. During today’s call, I will discuss CPI’s first quarter performance, reiterate our outlook for the full year and review our long term strategy. Amintore will review the financial results in more detail and then we’ll open up the call for questions. We will start on slide 4. Overall, I’m very pleased with the first quarter performance. We increased sales by 8% despite comparisons with a very strong first quarter in 2022, which benefited from large eco-focused card orders and significant instant issuance printer upgrade sales. Growth in this year’s first quarter was led by ongoing strength in sales of contactless cards and we also delivered good growth from other areas across our debit and credit portfolio.

We grew adjusted EBITDA 11% to $25 million and increased the adjusted EBITDA margin 50 basis points to 20.7%, driven by operating leverage. We increased net income by 81% to nearly $11 million, aided by sales growth, operating leverage, a lower tax rate and lower interest expense, as we’ve utilized cash flow to reduce our average borrowings. We also improved our overall financial position in the quarter, generating nearly $4 million of positive free cash flow, retiring an additional $8 million of our senior notes and reducing our net leverage ratio up to 2.9 times at quarter-end. As we mentioned in March, this year, we’re focused on continuing to execute our strategies, grow the business, win share in the marketplace, increase cash flow and reduce leverage.

We believe the first quarter demonstrated good progress against each of these goals. As we look to the rest of the year, our sales efforts will remain focused on gaining market share with our differentiated portfolio of innovative products and services and end-to-end solutions and leading quality and customer service. Turning to our outlook on slide 5. Today, we are affirming the financial outlook we provided in March. We believe continued strong performance from contactless cards, additional sales of end-to-end solutions, and further penetration of instance issuance will drive sales growth for the full year. However, there was more risk and uncertainty in the market. The banking industry stress that emerged following the collapse of Silicon Valley Bank in March has contributed to more cautious spending environments among issuers.

Although we do not have any significant direct exposure to the three major banks that have failed, we have recently seen softening customer demand in our Debit and Credit segment and, consequently, do not expect second quarter results to be as strong as the first quarter. Near term, it’s difficult to project the extent of the banking industry stress or how long it will continue to impact us. However, given the uncertainty, we have implemented various new initiatives to drive sales and manage expenses more tightly in 2023. Based on what we know today and the strong first quarter performance, we have affirmed the full year outlook we provided in March. Despite the near term challenges, we continue to believe we operate in attractive long term growth markets.

Secular card trends have remained healthy, as evidenced by the 11% compounded annual growth rate on MasterCard and Visa US cards in circulation for the three year period ending December 31, 2022, and the ongoing movement towards eco-focused cards and contactless cards should continue to aid growth. I would also remind you that the card business is reoccurring in nature, with historically approximately 90% of payment cards issuance being for reissuance and replacements where there is support for the market over time. We have successfully gained share in growing markets over the past five years by focusing on our key strategies, and we expect those to continue to be the foundation for our growth. Specifically, turning to slide 6, our key strategic priorities remain deep customer focus, market leading quality products and customer service, continuous innovation and a market competitive business model.

We believe the first quarter results demonstrated further advances against these priorities. Although eco-focused card sales were down compared to some very large orders in the prior year, we still sold nearly 7 million of our innovative cards made from recovered ocean-bound plastic core in the quarter and continue to be a leader in the US eco-focused card space. We also continue to leverage our high quality end-to-end solutions, driving growth in contactless cards, personalization services and our Card@Once SaaS-based, instant issuance business. Prepaid was down slightly in the quarter, but we did continue to have success with new customer types. And we demonstrated a competitive business model. We generated operating leverage despite ongoing inflationary impacts on key material costs and continue to balance pricing with managing long term customer relationships.

These four key strategic priorities will continue to guide our actions to grow and gain market share, and we also plan to pursue additional opportunities in the market, such as our expansion of prepaid use cases and development of complementary digital offerings. We remain confident in long term growth prospects for the market and in our ability to execute against our strategies to win business and grow share. Now I will turn the call over to Amintore to review our first quarter results and our outlook in more detail. Amintore?

Amintore Schenkel: Thank you, Scott. And good morning everyone. I will begin my overview on slide 8. First quarter net sales increased 8% to $120.9 million compared to the prior year quarter, led by the Debit and Credit segment which increased 11%. As Scott mentioned, Debit and Credit sales growth was driven by strong sales of contactless cards and personalization services also contributed solid sales growth, as did Card@Once instant issuance solutions. Prepaid Debit segment net sales decreased 2% compared with the prior year, and we continue to expect full year prepaid sales to be similar to 2022 levels. Overall, pricing contributed a little less than half of the sales growth in the quarter, primarily due to pricing actions implemented over the course of 2022.

First quarter gross profit of $43.1 million increased 10% from the prior year, while gross profit margin increased from 35.3% to 35.7%, driven by operating leverage from sales growth, including benefits from price increases, partially offset by the impacts of inflation on materials costs and expenses incurred related to a production staffing model change in our Prepaid segment. SG&A expenses increased by approximately $1 million in the quarter compared to the prior year, primarily due to increased headcount and related compensation expenses to support our growth and strategic execution, partially offset by a reduction in professional services expenses, primarily related to third-party SOX costs incurred in the prior year. Our tax rate was 20.7% in the quarter, which compared to 38.3% in the prior year quarter due to higher interest expense deductibility and a favorable adjustment to reflect a change in state tax law.

We would project a normalized rate excluding any adjustment items of between 25% and 30%, but including the Q1 adjustment benefit, we currently expect the overall 2023 rate to be at the lower end of that range. Net income in the first quarter increased 81% to $10.9 million and adjusted EBITDA increased 11% to $25.1 million. Adjusted EBITDA margin improved from 20.2% in the prior year to 20.7%, driven by operating leverage from sales, including pricing benefits, while net income growth also benefited from the lower tax rate and lower interest expense. Turning now to our segments on slide 9. I mentioned the segments sales drivers earlier. So I will just discuss segment profitability on this slide. Income from operations for the Debit and Credit segment increased 25% in the quarter to $30 million, driven by the higher net sales and operating leverage, including the benefits of price increases.

Prepaid Debit segment income from operations decreased 38% in the first quarter to $3.7 million. Prepaid income was negatively impacted by approximately $1 million costs incurred related to the conversion from a temporary to full time staffing model at our prepaid production facility and was also negatively impacted by the reduction in sales. We expect the prepaid margins to be stronger over the remainder of the year as we gain efficiencies from the labor conversion and benefit from more beneficial mix and operating leverage. Turning to the balance sheet, liquidity and cash flow on slide 10. We made substantial progress with our financial position in the first quarter. We generated $8 million of cash flow from operating activities in the quarter and invested $4.1 million on capital expenditures, which resulted in free cash flow of $3.9 million.

This compared to the free cash flow usage of $19.1 million in the prior-year period, with the strong improvement driven by increased net income and reduced working capital usage. Accounts receivable balances decreased $4 million from year-end as we collected the receivables related to the high sales levels in the fourth quarter and inventories only increased $1 million or less than 2%. On the balance sheet, at March 31, we had $14 million of cash and $13 million of borrowings outstanding on our $75 million ABL revolver. We had $277 million of senior secured notes outstanding at quarter-end as we repurchased $8 million of notes in the open market in the first quarter. Subsequent to quarter-end, we repurchased an additional $7 million in the second quarter.

Our capital structure and allocation priorities remain focused on maintaining ample liquidity, investing in the business, including possible strategic acquisitions, deleveraging the balance sheet and potentially returning funds to stockholders. Overall, the first quarter results were strong, and we have affirmed our 2023 full-year outlook. Specifically, for 2023, we continue to expect mid-single digit net sales growth, with higher growth in the Debit and Credit segment and Prepaid sales similar to 2022 levels; mid-to-high single-digit adjusted EBITDA growth, free cash flow to more than double from the 2022 level as we grow earnings and optimize working capital in a more stable supply chain environment; and net leverage ratio improvement to between 2.5 and 3 times as we generate strong cash flow and continue to reduce our senior notes balance.

Our outlook assumes the turmoil in the banking industry affects second quarter results, but does not worsen and we return to a more normalized environment over the course of the year. I will now pass the call back to Scott for some closing remarks on slide 11. Scott?

Scott Scheirman: Thanks, Amintore. Before opening the call for questions, I would like to welcome Jeff Hochstadt to the CPI team. We announced today that Jeff will become our new Chief Financial Officer effective May 13, replacing Amintore, who had previously declared his plans to resign in 2023 due to family related personal reasons. Jeff is a proven strategic leader who brings a vast background of diverse business and financial experience to CPI. He most recently had his own company providing strategic and financial consulting services, which followed his career at Western Union from 2006 through 2021, including roles as Chief Strategy Officer and Senior Vice President and Head of Global Financial Planning. Jeff has also held various financial and strategic positions with First Data, Morgan Stanley, IBM and Pricewaterhouse, among others.

Amintore will stay with CPI full time through the end of the second quarter and then will continue as an advisor for a period of time. I want to again thank Amintore for his many contributions to CPI and his commitment to ensure a smooth transition. To summarize today’s call, we had a strong performance in the first quarter, increasing sales, adjusted EBITDA margins and free cash flow and driving further improvements in our net leverage ratio. Although we have seen some new risks arise from the banking industry turmoil of recent weeks, we’re taking responsive actions and have affirmed our full year outlook. Overall, we remain focused on continuing to execute our strategies, grow the business, win share in the marketplace, increase cash flow and reduce net leverage in 2023.

Thank you for joining our call today. And we will now open up the call for any questions.

Q&A Session

Operator: [Operator Instructions]. And your first question will come from Jaeson Schmidt.

Operator: Your next question comes from Leanne Hayden.

Operator: And with no further questions, that concludes today’s CPI Card Group’s first quarter earnings call. Thank you for joining.