Q3 2024 CPI Card Group Inc Earnings Call
Welcome to CPI Card Groups 3rd Quarter 2020 for earnings call. My name is Rob and I will be your operator today.
If you are viewing on the webcast, you may advance the slides forward by pressing the arrow buttons.
The call will be open for questions after the company's remarks. If you would like to get in the queue for questions, please press star 1 on your telephone keypad. Now I would like to turn the call over to Mike Salop CPI's Head of Investor Relations.
Mike Salop: Thank you, Blackwader. Welcome to the CPI Card Group third quarter 2024 earnings webcast and conference call. Today's date is November 5, 2024, and on the call today from CPI Card Group, our John Lowe, President and Chief Executive Officer, and Jeff Hoxton at Chief Financial Officer.
Mike Salop: Before we begin, I'd like to remind everyone that this column may contain forward-looking statements, as they are defined in the private security obligation 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.
Mike Salop: For discussion of such risk and uncertainties, please see CPI Card Group's most recent filing with the SEC. All forward-looking statements may today reflect our current expectations only, and we undertake no obligations of the any statement to reflect the events of the curve after this call.
Mike Salop: 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.
Mike Salop: Reconciliations of these non-GAAP financial measures, the most directly comparable GAAP measures, are included in the press release and slide presentation we issued this morning.
Mike Salop: Topics 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.
Mike Salop: In addition, CPI's Form 10-Q for the quarter ended September 30, 2024, will be available on CPI's Investor Relations website. On today's call, all growth rates refer to comparisons with the prior year period, unless otherwise noted.
Mike Salop: The agenda for today's call is on slide three. John will give a brief overview of the third quarter and our strategies, and Jeff will provide more detail on the results and our financial outlook, and then we'll open the call for questions.
Speaker Change: And now we can move to slide four, and I'll turn the call over to John.
John Lowe: Thanks, Mike, and good morning, everyone.
John Lowe: We're excited to share our strong third quarter results and increased outlook this morning. We delivered the second largest sales quarter in the company's history and generated nearly 20% growth in both net sales and adjusted EBITDA.
John Lowe: We also continue to make advances with our adjacent market strategies and are seeing growing interest in our expanding set of digital solutions.
as we highlighted at the beginning of the year.
John Lowe: We expected the first half to be challenging, as channel inventories continue to be worked down, and expected to see good growth in the second half, and the third quarter reflects that.
John Lowe: Net sales increased 18% in the quarter, with product sales, which primarily represent debit and credit cards, growing 25%, led by strong sales of eco-focused contactless cards.
John Lowe: While channel inventory levels are still elevated, they are improving and we believe we are winning business in the market.
John Lowe: In addition to our card performance, we continue to grow our card-at-once instant issuance solutions and our personalization businesses, and our prepaid business remains strong, delivering 13% growth in the quarter.
John Lowe: We also made great progress improving our profitability, with gross margins increasing 170 basis points compared to prior year, and adjusted EBITDA increasing 18%. And we completed some significant financing and capital strategy items.
John Lowe: issuing new senior notes extending maturities out to 2029 and supporting a secondary offering by our majority stockholder group, which had a trading liquidity for our stock over time.
John Lowe: Based on our results and current expectations for the fourth quarter, we have updated our full-year outlook for 2024, increasing our net sales range due to strength across our portfolio and also increasing our adjusted EBITDA and cash flow expectations.
John Lowe: Jeff will provide you with more detail on our results and outlook in a few minutes, but I will first review our strategic progress on slide 5.
John Lowe: Our strategies remain focused on the customer, innovation, and high quality to grow and gain share in our traditional businesses, while enhancing growth by expanding into adjacent markets, including digital solutions, over the long term.
John Lowe: One innovation example is our recently announced ability to produce cards with a new advanced contactless chip that integrates the antenna within the chip itself. This feature allows for more flexibility on card design and reduces carbon footprint as it eliminates the need for separate layers within the card for the antenna.
John Lowe: Although there are generally long adoption cycles for changes in chip technology, we are now ready to initiate pilots with customers, positioning CPI as a potential early adopter of an important new technology.
John Lowe: In addition to driving growth in our traditional core businesses, we are advancing our efforts to capitalize on new opportunities by chasing markets, including offering more products and digital solutions to existing customers and expanding to new customer verticals.
John Lowe: During the quarter we announced another digital solution offering when we signed an agreement with RippleShot to offer their fraud prevention tools to our customer base.
John Lowe: RippleShot's tools generate predictive analytics, leveraging data from thousands of financial institutions, generating millions of transactions each day.
John Lowe: We believe these tools will help our small and medium-sized financial institution customers reduce losses by identifying fraud patterns to block attacks before they strike, detecting compromised merchants and high-risk cars.
John Lowe: In addition to this offering, we also continue to see growing interest in our broader digital solutions, including push provisioning.
John Lowe: These are just a few examples of our progress, and we believe these opportunities will supplement our growth over the coming years.
John Lowe: Turning to slide 6, we continue to expect our core markets to provide solid long-term growth. On this slide, you can see the latest U.S. cards and circulation trends from Visa and MasterCard.
John Lowe: For the three years ending June 30th, cards in circulation in the U.S. increased at a 9% CAGR, and reports from large issuers also indicate a healthy card market.
John Lowe: As an example, JPMorgan Chase reported an 11% year-over-year increase in cards outstanding and Bank of America noted the addition of 1 million credit card accounts.
John Lowe: So, issuance trends are strong, channel inventory is being worked down, and we believe we can continue to win in the marketplace with both our traditional businesses and as we expand into adjacent markets, including digital solutions.
John Lowe: I would like to now turn the call over to Jeff to discuss our third quarter financial results and 2024 Outlook in more detail. Jeff?
Jeff Hoxton: Thanks, John, and good morning, everyone. I will begin my overview on slide 8.
Jeff Hoxton: As John mentioned, we delivered very strong sales growth in the quarter with increases across our portfolio. The sales growth drove gross margin expansion, and we also delivered a strong increase in adjusted EBITDA despite increased performance-based employee incentive compensation expenses.
Jeff Hoxton: Net income declined in the quarter due to the impact of debt refinancing costs as we completed the retirement of our previous senior notes and the issuance of new notes due in 2029.
John Lowe: Free cash flow generation was healthy, and our net leverage ratio of 3.2 times that quarter end improved slightly compared to the second quarter, despite the cash outflows associated with debt refinancing costs.
John Lowe: Turning to the detailed third quarter results on slide 9, the overall 18% sales increase reflected a 19% increase in our debit and credit segment and a 13% increase in our prepaid segment.
John Lowe: Prepaid segment growth continues to reflect demand for higher priced fraud focused packaging solutions as we discussed last quarter.
John Lowe: Gross profit increased 24% in the quarter, as gross margins increased from 34.1% in the prior year quarter to 35.8%, driven by operating leverage.
John Lowe: Interest expense increased $6.7 million in the quarter, primarily due to payment of a 2.156% call premium, or $5.8 million, to redeem the $268 million outstanding of our senior notes due 2026.
John Lowe: We also recorded a $3 million loss on debt extinguishment and other expense, which reflects the write-down of unamortized deferred financing costs on our retired debt and credit facilities.
John Lowe: We recorded an income tax benefit in the quarter, which brought our year-to-date tax rate to 24%.
John Lowe: The benefit reflects increased deductibility of stock compensation primarily related to certain option exercises which triggered recognition of updated values of the option expense for tax purposes.
John Lowe: Net income in the third quarter decreased 66% or $2.6 million due to the $8.8 million of pre-tax debt refinancing costs.
John Lowe: Adjusted EBITDA increased 18% to $25.1 million and adjusted EBITDA margins were consistent with prior year at 20.1% as the improvement in gross margin was offset by the increased incentive compensation expenses in SG&A.
John Lowe: Turning now to our year-to-date results on slide 10.
John Lowe: Within debit and credit, the year-to-date sales increase can be attributed to growth in contactless card sales led by eco-focused cards and consistent growth from instant issuance and other card personalization services, partially offset by declines in contact card sales.
John Lowe: Year-to-date gross profit increased 7% as gross margin increased from 35.1% to 36.2%.
John Lowe: SG&A increased $12.7 million from the prior year period, driven primarily by an increase in CEO transition-related costs and increased performance-based employee incentive compensation compared to 2023.
John Lowe: The CEO transition related costs increased approximately four million dollars from prior year due to increased stock compensation expense
John Lowe: from Special Key Employee Grants issued in the second half of last year and Executive Severance Expenses, partially offset by reduced impact from the CEO Retention Award, which was completed in the first quarter.
John Lowe: The year-to-date tax rate of 24% declined versus last year's of 30.5% as this year's rate reflects increased stock compensation deductibility, and last year's rate reflected limitations on deductibility of executive compensation expense.
John Lowe: Net income in the first nine months decreased 40% to $12.7 million, affected by the debt refinancing costs and CEO transition-related costs. An adjusted EBITDA increased 1% to $70 million.
John Lowe: Adjusted EBITDA margin of 19.7% was down from 20.4% in the prior year, primarily due to the increase in performance-based incentive compensation expense, partially offset by improved gross margins.
John Lowe: Turning now to our segments on slide 11.
John Lowe: Income from operations for the debit and credit segment increased 30% to $27 million in the third quarter, driven by the sales increase and strong gross margin expansion, and declined 1% year-to-date due to the impact of increased compensation-related expenses.
John Lowe: Prepaid debit segment income from operations increased 7% to $7.1 million in the third quarter and 27% year-to-date driven by sales growth, with the year-to-date increase also driven by strong gross margin improvement.
John Lowe: Turning to the balance sheet, liquidity, and cash flow on slide 12.
John Lowe: For the first nine months of the year, we generated $16.7 million of cash from operating activities and invested $4.2 million in capital expenditures, which resulted in free cash flow of $12.5 million.
John Lowe: This compares to operating cash flow of $22.3 million and free cash flow of $16.2 million in the prior year.
John Lowe: The lower generation in this year's period was primarily driven by increased working capital usage, partially offset by lower capital spending.
John Lowe: Working capital usage reflects an increase in inventory driven by purchase commitments for contactless chips.
John Lowe: As mentioned previously, we are carrying more contactless chip inventory than normal this year due to our agreement with our main supplier, but we expect to be able to use these chips going forward.
John Lowe: Free cash flow through the first nine months of 2024 was also affected by incentives related to the customer contract signed in the first quarter and the payment of former CEO's retention award, partially offset by lower short-term employee incentive payments based on 2023 performance.
John Lowe: Capital spending is down just under $2 million from our prior year, but we expect spending to increase in the fourth quarter as we advance the build-out of our new secure card production facility in Indiana.
John Lowe: On the balance sheet at quarter end, we had $14.7 million of cash, no borrowings on our ABL revolver, and $285 million of senior secured notes outstanding at quarter end.
John Lowe: Our net leverage ratio was 3.2 times, down slightly from the second quarter despite payment at the $5.8 million call premium on our retired senior notes and approximately $6.5 million of other cash outflows related to our debt refinancing.
John Lowe: Our capital structure and allocation priorities remain focused on investing in the business, including possible strategic acquisitions, deleveraging the balance sheet, and returning funds to stockholders.
John Lowe: As mentioned last quarter, in July we completed the refinancing of our debt, issuing $285 million of 10% coupon senior secured notes due in 2029, and entering into a new $75 million ABL reballing facility while retiring our senior notes that were due in 2026.
John Lowe: With our share repurchase program, we have bought back approximately $9 million since inception in the fourth quarter of last year.
John Lowe: In the third quarter, we completed the purchase of 121,000 shares for $2.2 million from our majority stockholder group, funds affiliated with Parallel 49 Equity, pursuant to the Stock Purchase Agreement announced in March.
John Lowe: Under that agreement, we continue to repurchase shares from Parallel 49 at a ratio of 3 to 1 to the number of shares we repurchase in the open market from April to June at a price of 98% of the average open market repurchase price over that period.
John Lowe: We did not execute any open market repurchases in the third quarter.
John Lowe: Also, on September 30th, we announced a secondary offering of shares of common stock from funds affiliated with the majority stockholder group. On October 2nd, the offering closed and 1.38 million shares were sold in a public offering. CPI did not sell any shares or receive any proceeds from the offering.
John Lowe: We believe this offering will be beneficial for shareholders as more shares were moved to the public float and majority ownership was decreased, as the transaction resulted in the majority stockholder group ownership decreasing from 56% of shares outstanding to 43%.
John Lowe: This transaction was structured and executed by Parallel 49 Equity, and it will be their decision if they pursue additional offerings in the future. We cannot speak on their behalf, but we will say they are very constructive and long-term focused.
John Lowe: They have been in this investment for many years and believe that increasing the public float could be beneficial for both the company and the economics of potential future offerings.
John Lowe: We also note that a controlling person of our majority stockholder group purchased 250,000 shares in the offering through his family office, which indicates strong belief in the company's future.
John Lowe: Turning to our 2024 financial outlook on slide 13.
John Lowe: As John mentioned, we have updated our financial outlook for 2024. We have increased our net sales range to mid-to-high single-digit growth up from mid-single-digit previously due to strength across our portfolio, and we have increased our adjusted EBITDA outlook to low single-digit growth up from slight growth in our previous outlook.
John Lowe: We have also increased our full-year free cash flow outlook to be slightly below the 2023 level compared to approximately half the prior year level in our previous outlook, primarily reflecting working capital improvements, lower expected capital spending, and a lower tax rate.
John Lowe: We now expect our year-end net leverage ratio to be similar to the 2023 year-end level, compared to our previous outlook of between 3.0 and 3.5 times.
John Lowe: Net leverage was 3.1 times that year in 2023. Improvement this year was negatively impacted by the cash outflows associated with the debt refinancing, but our goal is to continue to work it down over time.
Speaker Change: I will now pass the call back to John for some closing remarks on slide 14. John?
John Lowe: Thanks, Jeff.
John Lowe: To summarize, we are very pleased with the third quarter performance. Our debit and credit card business provided strong growth, while we continue to also drive growth in prepaid, instant issuance, and our other card personalization services.
John Lowe: Based on the strength of our portfolio, we updated our full year expectations, increasing our net sales, adjusted EBITDA, and free cash flow outlooks.
John Lowe: We continue to advance our strategies to gain share by leading in customer service, quality, and innovation, and increasing our addressable market through expansion into adjacencies, including digital solutions, over time.
John Lowe: We are pleased with our positioning and progress, and look forward to continuing to drive performance for our shareholders. Operator, we will now open the call up for any questions.
Speaker Change: We will now open the call for your questions. If you would like to ask a question, please press star then 1 on your telephone keypad.
Speaker Change: Your first question comes from a line of Jaeson Schmidt from Lake Street Capital Markets. Your line is open.
Jaeson Schmidt: Hey guys, thanks for taking my questions and congrats on the nice results. Um, just want to start with sort of that revenue momentum. I know the excess inventory was creating some headwinds earlier this year, but is it fair to say that that is completely behind you now?
Speaker Change: Jaeson, good morning. And so I would say not necessarily behind us. I mean, things are improving, not over, but the market is strong. Cards in circulation are still growing at a 9% CAGR over the last three years.
Speaker Change: And if you go back in time to the beginning of this year,
Speaker Change: We did expect growth in the second half, you know, after kind of a down, a little bit of downside in the first half, and the third quarter reflects that. We had a strong third quarter with, you know, performance across the card side including eco-focused.
Speaker Change: Prepaid had a good quarter and our software as a service digital solution card at once had a great quarter and our personalization business has had a great quarter. So overall market momentum is still there but channel inventories are still working themselves down but we do believe we're a winning business in the market.
Speaker Change: Yeah, I mean, look, we're excited about what we call the all-in-one chip.
Speaker Change: you know, creates a chip where the antenna is essentially put within the chip itself versus adding
Speaker Change: card layers within the cards, so helps our customers expand their design options, reduces carbon footprint. But we're in early stages, right? It'll take years to really ramp up, so we don't necessarily know the pace. So I wouldn't wanna speak to the financial impact quite yet.
Speaker Change: But we're excited to be an early adopter, and hopefully we'll see adoption faster than slower.
Speaker Change: All right. Thanks a lot, guys.
Speaker Change: Thanks, Jaeson.
Speaker Change: Your next question comes from a line of Andrew Scott from Roth Capital Partners. Your line is open.
Andrew Scott: Hey good morning guys and thank you for taking my questions. First one for me you guys have kind of spoken to strength in some of the ancillary businesses
Speaker Change: They card it once and push provisioning. Can you kind of, as far as push provisioning goes, you...
Speaker Change: been a couple months into the MEA partnership, can you kind of kind of talk about momentum that you're that you're seeing there?
Speaker Change: Yeah, I mean momentum is strong. I'd say it's a it's still very minor impact to our financials at this point in time
Speaker Change: But just, Andrew, to your question, MEA is a reminder. They probably have 300 FIs that they work with.
Speaker Change: We're now able to work with their FIs providing them push provisioning.
Speaker Change: There is a pipeline that we're kind of working with and push has been successful so far, but it's kind of slowly ramping, right? Banks are always slow to adopt and ramp things up, but there's definitely a strong interest, which is great.
Speaker Change: And if you think about our car-to-once solution, right, our software-as-a-service solution, we've been in that business for more than 10 years. That's a business where we're in more than 16,000 branches.
Speaker Change: across the United States and that's been a strong growth business for us. It's a high margin business similar to what our broader digital solutions are as well. So we'll share more on push prospectively from a metric perspective, but what I can say is there's a strong momentum, but it's still early days.
Speaker Change: Awesome. No, great to hear. Second one for me, you kind of spoke on the revenue momentum in debit and credit. We also saw a nice bump up in prepaid in the quarter. Can you just kind of speak to what you saw in that business over the last few months?
Speaker Change: Scott Scheirman, Michael Salop, John Lowe, Jaeson Schmidt, Jeffrey Hochstadt, Scott Scheirman,
Speaker Change: Great for us, but also protects our customers' customers, if you will.
Speaker Change: And then the other side is, there's a number of...
Speaker Change: prepaid areas we're moving into it from an adjacency perspective into the healthcare side and that's benefiting our prepaid business. So strong quarter for the prepaid team and we're hoping for a strong growth for the remainder of the year.
Speaker Change: Great, well congrats on the continued momentum and I'll hop back into the queue.
Speaker Change: All right. Thanks, Inder.
Speaker Change: Your next question comes from the line of Peter Heckman from D.A. Davidson. Your line is open.
Peter Heckman: Hey, good morning, everyone. Thanks for taking the question. I'm calling on that that last question you're you're you're
Peter Heckman: The raising your four-year guidance does imply
Peter Heckman: another strong quarter for the fourth and just trying to think about in terms of thinking about Seasonality and debit and credit versus prepaid debit. I guess could you give a little bit of
Peter Heckman: thoughts in terms of the relative strength of those two. It certainly looks like prepaid is
Speaker Change: is on track to have a really great year and Devin and Credit a good year, but I guess that's dependent upon my forecast. So in terms of how you think about the fourth quarter, would you expect it to, in terms of the relative growth rates of the two segments, would you expect it to be about the same or would you expect it to be a significant variance?
Speaker Change: Yeah, hey Pete. Actually, I mean, good question. You know, we really, over the years, you know, we haven't been as fluctuating as seasonally as we had in the past.
Speaker Change: So, you know, we feel like both businesses will have, you know, a good continuation in Q4. I don't think there's really a significant seasonality in either of these businesses at this point.
Speaker Change: Okay, okay, and then just in terms of your new production facility in Indiana, can you talk a little bit about how that...
Speaker Change: Processes coming and when you would expect to go live and
Speaker Change: And then if you could, I don't think you've done this in the past, but if it's possible if you could maybe quantify a little bit about that additional volume of commitment you've received from that customer and what we'd like to see that start to hit in results.
Speaker Change: Well, hey Pete, good to talk to you. I'll let Jeff talk about kind of in the A&N capacity and on the customer contract side the one we locked into in Q1.
Jeff Hoxton: Just as a reminder, that's a six-year deal, commitments that really ramp in 25 and the outer years.
Speaker Change: This year is kind of the start to it so we continue to strengthen our relationship with that customer and it's a good way for us to win share and we're excited about it.
Speaker Change: But don't want to really want to comment on the performance quite yet given it's a six-year deal that said
Speaker Change: Indiana, we're excited about it. I think, as I understand it, we've got walls up and a roof on.
Speaker Change: So we're slowly getting it up and running. I think it's mid next year before it's.
Speaker Change: starting to be operational. But, Jeff, you want to comment? Yeah, Pete, it will be, like John said, we broke ground and walls are up. We should be in by the end of 2025. We did say previously
Speaker Change: We did say previously that the whole cost of the facility will be about $20 million.
Speaker Change: We think that will be a cash flow impact for the first two years of about $13 million, $12 to $13 million.
Speaker Change: So that has increased our CapEx this year.
Speaker Change: We are increasing our footprint in Indiana. We're doubling our footprint in Indiana and that overall is about a 10% increase in our overall footprint company-wide.
Speaker Change: So, it does, it will increase capacity over time and
Speaker Change: Your next question comes from a line of Hal Ghosh from B. Reilly Securities. Your line is open.
Hal Ghosh: Hey, thank you all. On the sales growth, you know, you were lapping, you had 25% growth in product sales, lapping a minus 22. So really just kind of getting back to where you were maybe at 20, 22 levels.
Speaker Change: Could you give us a little color on how much of that is normalization
Speaker Change: new programs and what's the the composition of the growth kind of year over year?
Speaker Change: Yeah, I'll give you a high level, Hal, and good to talk to you, and then pass it off to Jeff.
Speaker Change: If you...
Speaker Change: go back to 2022. I mean, that was a record year.
Speaker Change: That was predominantly driven by payment card sales, right? I mean, that was when the market had extremely high demand.
Speaker Change: and drove our secure car business to have significant growth and ultimately we had a nearly 30% year-over-year growth in that year.
Speaker Change: If you look at this year, while year-over-year and Q3 card sales were strong, right, and our volumes have been increasing progressively through the year,
Speaker Change: We're still not necessarily at the levels that we were at 22.
Speaker Change: Our instant business, it's grown since 22. Our personalization businesses are performing strong. And if you think about our prepaid business, that's performing really well in 2024.
Speaker Change: about that as well, but...
Speaker Change: Yeah, I think you're right.
Speaker Change: in the sense that it's coming back. But also, you know, we've seen some really strong sequential growth from Q1 to Q2, Q2 to Q3.
Speaker Change: So, you know, as John mentioned at the outset of the call, our second highest quarter ever. So, you know, we're, you know, like John mentioned earlier, you know, the rebalancing is still going through the system, but we feel like the other parts of our portfolio are also performing at high levels. So, we feel some good momentum right now.
Speaker Change: Okay, so what to say, would you say it's mostly existing customers or some new, a mix of both?
Speaker Change: Well, that's a great question. No, we are winning new customers in the market from our portfolio. Okay, great. Thank you.
Speaker Change: As there are no further questions in queue, I would now like to turn the call back over to John Lowe for closing remarks.
John Lowe: Okay, well thanks operator. Thanks everybody for joining the call. I want to again acknowledge and thank all of our CPI employees for everything they do for our company and our customers.
Speaker Change: as they execute on our vision, values, and strategies every day.
Speaker Change: and continue to drive our business forward. Thank you all for joining our call this morning and we hope you have a great day.
Speaker Change: This concludes today's conference call. Thank you for your participation. You may now disconnect.