CPI Card Group Inc. (PMTS) Earnings Call Transcript & Summary

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

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 statement to reflect the events that occur after this call. Also, during the course of today's call, the company will be discussing one or more non-GAAP financial measures, including, but not limited to, EBITDA, adjusted EBITDA, adjusted EBITDA margin, 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, investor.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 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 have 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 to 2.9x at quarter end. As we mentioned in March, this year we are focused on continuing to execute our strategy, 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 instant issuance will drive sales growth for the full year. However, there is 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 environment among issuers. Although we do not have any significant direct exposure to the 3 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 an attractive long-term growth market. Secular card trends have remained healthy as evidenced by the 11% compounded annual growth rate on MasterCard and Visa U.S. cards in circulation for the 3-year period ending December 31, 2022, and the ongoing movements towards eco-focused cards and contactless cards should continue to aid growth. I would also remind you that the card business is recurring in nature with historically approximately 90% of payment cards issuance being for reissuance and replacements, so there is strong support for the market over time. We have successfully gained share in a growing market over the past 5 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 with recovered ocean-bound plastic core in the quarter and continue to be a leader in the U.S. 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 4 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 the 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?

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 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 segment 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 of costs incurred related to the conversion from a temporary to a 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 3x 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?

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 15, replacing Amintore, who had previously declared his plan 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 Price Waterhouse, among others. Amintore will stay with CPI full time through the end of the second quarter, and then will continue as an adviser 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 improvement in our net leverage ratio. Although we have seen some new risks arise from the banking industry turmoil of recent weeks, we are taking responsive actions and have affirmed our full year outlook. Overall, we remain focused on continuing to execute our strategy, 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.

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

Congrats on the early nice start to the year. Scott, I just want to dig into your caution around Q2. Is the softening demand more related to pushouts? Or are you seeing cancellations as well?

What I would describe it as we move through the month of April, just saw softening in customer demand or customer orders coming in, some customers that might be not placing an order, some customers that might be pushing the order to, say, the third quarter or fourth quarter. So it really seems to have tied back to the Silicon Valley Bank and subsequent -- I'm going to use the word banking turmoil, Jaeson, where customers feel uncertain about the future. We believe they're probably tightening their spending just to see how things will unroll over the weeks, maybe the months to come from that standpoint. But again, I have a lot of confidence in the long-term business. There's a lot of secular trends in place for sure. Cards continue to grow. Card payments are growing at the expense of cash. As we shared in the script, Visa, Mastercard, cards in circulation have grown at 11% CAGR over the last 3 years ending December 31, 2022. And I believe contactless cards are still a really good opportunity for us. We think at the end of '22, the market was 50% to 60% converted to contactless. We think that will be over 80% by '25. And then I'll also just emphasize our eco cards, right? The broadly -- banks, end-user consumers, the issuers, the networks, everybody is trying to be more sustainable, and we are definitely a market leader with eco-focused cards issuing over 95 million. So I think there are some near-term challenges, but long term, I'm very positive on the business and believe there's continued opportunity to gain share and grow over the long term.

Okay. That makes sense and all really helpful. And I think you probably answered sort of what my next question was going to be, on sort of the confidence that Q2 is simply this air pocket and you would resume to a more normalized environment. Is this really just due to kind of customers noting that these launches have simply been delayed into the second half?

Well, there -- I would say there's some of that, right? There's things that are happening in the market, where I would say the regulators and the government are continuing to try and do things to provide more confidence to end-user consumers with banks. They've done, in my view, some of the right things to get these banks recapitalized or take them over. So hopefully, this banking turmoil will subside in the coming weeks or months, if you will. But again, as we called out in the earnings release or the script comments that we assume that the turmoil in the banking industry affects the second quarter but does not worsen. And we believe we'll return to a more normalized environment over the course of the year. But we'll have to play it out from that standpoint. But so far in the month of April, customer demand has been soft.

Okay. Got it. And then just the last one for me, and I'll jump back in the queue. Just curious if you could expand on some of these new initiatives that you've implemented to drive sales?

Sure. Sure. No, it's -- and you'll probably appreciate, Jaeson, for competitive reasons I don't want to get into a lot of detail here. But over the last week to 10 days the teams have been meeting and they've come up with a number of ideas that I believe will be helpful to drive the top line, insert some demand in the marketplace. And then also, we are just closely -- like probably many companies are right now, just closely managing our expenses and making some decisions on some the expenses that maybe can be pushed off to later in the year or into 2024. So it's a combination of those. But again, for competitive reasons, I don't want to get into a lot of detail on how we're driving demand.