CPI Card Group (NASDAQ:PMTS) Q4 2019 Earnings Conference Call March 9, 2020 9:00 AM ET
Jennifer Almquist - Investor Relations
Scott Scheirman - President and Chief Executive Officer
John Lowe - Chief Financial Officer
Good morning and welcome to the CPI Card Group Fourth Quarter and Full Year 2019 Earnings Webcast. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jennifer Almquist, Investor Relations. Please go ahead.
Thanks and good morning everyone. Welcome to the CPI Card Group fourth quarter and full year 2019 earnings webcast and conference call. On the call today from CPI Card Group is Scott Scheirman, President and Chief Executive Officer; and John Lowe, Chief Financial Officer.
Before we begin, I would like to remind everyone that this call may contain forward-looking statements as they are defined under the Private Securities Litigation Reform Act of 1995. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. For a discussion of such risks and uncertainties, please see CPI Card Group’s most recent filings with the SEC and on SEDAR. All forward-looking statements made today reflect our current expectations only and we undertake no obligation to update any statement to reflect the events that occur after this call.
Also during the course of today’s call, the company will be discussing one or more non-GAAP financial measures, including, but not limited to, EBITDA, adjusted EBITDA, adjusted EBITDA margin, adjusted free cash flow, net sales growth excluding Canadian operations and operating margin, excluding litigation settlement gains, all reported on a continuing operations basis. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures are included in the press release or slide presentation we issued this morning.
Please be advised that the financial results discussed on the call today reflect continuing operations and therefore exclude the results of CPI’s UK Limited segment, which was divested on August of 2018 and has been accounted for as discontinued operations in accordance with U.S. GAAP. The disposition of the CPI Canada business closed on April 1, 2019 and does not qualify as a discontinued operation in accordance with U.S. GAAP. Results for the Canada business through the date of disposition as well as the disposition related costs are reflected in the other segment. Copies of today’s press release as well as the presentation that accompanies this conference call are accessible on CPI’s Investor Relations website, investor.cpicardgroup.com. In addition, CPI’s Form 10-Q for the year ended December 31, 2019 was recently filed with the SEC and is available on CPI’s Investor Relations website. Please note that this call will conclude after our prepared remarks.
And now, I would like to turn the call over to Scott Scheirman, President and Chief Executive Officer of CPI.
Thanks Jen, and good morning everyone. Thank you for joining us today. Before I begin, I would like to take a moment to address the devastating tornadoes in the Nashville area last week, where we have operations. We are grateful that our employees are safe, although some were impacted by the storm. Our thoughts and prayers are with the people of Nashville as they rebuild and recover.
I will begin my prepared remarks on Slide 4. We delivered strong results in the fourth quarter and full year 2019. We believe we have gained market share across all business units in 2019 as we increased net sales and significantly improved our bottom line results by focusing on our customer-centric strategy. During the fourth quarter, we delivered a net sales increase of 6% or 9% when excluding the Canadian business that was sold in the second quarter. For the full year, net sales increased 9% or 12% excluding Canada. This is on top of the double-digit year-over-year increase in net sales we delivered in 2018 as our strategies and crisp execution are delivering strong results. Net loss improved 71% for both the fourth quarter and full year. Adjusted EBITDA increased 74% year-over-year for the fourth quarter and increased 39% year-over-year for the full year.
Turning to Slide 5. 2019 was a year of growth through targeted initiatives. Our achievements in 2019 are a testament to our steadfast focus on being a partner of choice by providing market leading quality products and customer service through a market competitive business model and crisp execution of our four strategic priorities. First, through our deep customer focused strategy, we strive to be the trusted partner in payments by exceeding the expectations of our customers through high-quality and collaboration and delivering differentiated and innovative products and solutions. Entering 2019, we stood ready with over 10 years’ experience in dual interface card manufacturing to meet customers’ needs as they transition to dual interface. During 2019, we executed well on this market demand, which we believe contributed to our market share gains.
We collaborated with our customers allowing their needs and the markets they serve to inform our business, which in turn enhanced our ability to deliver value and help their businesses thrive. We are providing our customers with choice, convenience, and control through multiple products launched this year, including our Second Wave card featuring a core made with recovered ocean-bound plastic. In 2019, as a result of our dual interface card manufacturing expertise and innovative product offerings, we successfully built upon our relationship with one of the largest U.S. based card issuing financial institutions by committing to provide them with debit and credit cards, along with our Second Wave card. This resulted in our Second Wave card being the first recovered ocean-bound plastic card to market.
Second, through strong execution of our market-leading quality of products and customer service strategy, we believe we gained market share across all of our business units while positioning ourselves to capitalize on market opportunities. For example, we continue to win business with our market leading Card@Once software-as-a-service instant issuance solution ending 2019 with nearly 11,000 printers across approximately 1,600 financial institutions. Through strong teamwork with multiple distribution channel partners, including Harland Clarke as well as direct sales relationships, we sold over 2,000 printers and printed over 6 million cards in 2019.
Our third strategy is continuous innovation. We collaborate with our customers to help them enhance their brands and provide them with differentiated products and solutions. By being the first to market with Second Wave, a dual interface payment card featuring a core made with recovered ocean-bound plastic, we provide our customers with a distinct and innovative way to serve a growing market of environmentally conscious consumers while helping to address their sustainability objectives. We believe Second Wave has an outstanding value proposition and a strong use case for financial institutions and other customer segments, including transit, hospitality, entertainment, retail, consumer brands, and their respective cardholders. Likewise, as our customers in the market transition to contactless technology, we are providing them with multiple contactless products launched in 2019, including dual interface metal cards and Adaptives, our embedded contactless technology for payment objects.
In our Card@Once business, we continue to improve and enhance this market leading software-as-a-service solution. Our innovative product capabilities and personalization, including CPI On-Demand allow our customers to quickly personalize their end user experiences through high-quality and uniquely customized cards, carriers, and collateral. For our prepaid business, we continue to innovate with market-leading SecureCard packaging, innovation, and robust designs. To put it simply, through continuous innovation we are winning new business and expanding relationships by providing our customers with products and solutions designed to build their brands and differentiate their offerings in the market.
Our fourth strategy is market-competitive business model. During 2019, we have built upon our 2018 successes and implemented additional initiatives to enhance our business model and improve profitability. In 2019, we significantly expanded margins year-over-year by continuing to focus on a number of initiatives. We realized the benefits of the consolidation of our personalization facilities from 3 to 2, and the divestiture of our UK business in 2018 and our Canadian business in 2019. In addition, we continue to execute efficiency initiatives.
Turning to Slide 6, as we enter 2020, we believe we are well positioned to capitalize on market opportunities, including continued growth of dual interface cards in the U.S., which generally have a higher selling price and strong demand for instant issuance and other innovative solutions such as Second Wave. We believe our 2019 success in growing through targeted initiatives has us well positioned to continue to scale our solution, diversify our products, and expand our customer base. To accomplish this, we are focused on continued crisp execution of our strategies. Our first strategy is deep customer focus. We will continue to keep our customers at the center of everything we do strengthening and deepening our customer relationships by delivering value to help our customers thrive. Our second strategy is market leading quality of products and customer service. We continually raise the bar on delivering innovative quality products while pursuing initiatives to ensure exceptional service and making it easier to do business with CPI. Our third strategy is continuous innovation. We will continue to partner with customers to enhance their brands and achieve top of wallet status by offering products and solutions that support our customers’ initiatives to differentiate. Our fourth strategy is a market competitive business model. We will continue to focus on driving efficiency and productivity through process improvements, operational automation, technology, and equipment advancement.
Turning to Slide 7, as we enter 2020, we believe we are well-positioned to meet customer and market demand through our strong portfolio of differentiated products and solutions. I would like to take a moment to review how we are thinking about this with respect to our segments and products. First, with our U.S. Debit and Credit segment, which include SecureCard, Card@Once, and personalization. In our SecureCard business, we have a long history of manufacturing experience and a large and growing portfolio of innovative and differentiated products. We believe we are well positioned to continue to win in the market as the U.S. continues to migrate to dual interface and contactless cards. We aim to further bolster our position in the market with our Second Wave cards, which offer a solution to support the sustainability initiatives of our customers.
Entering 2020, we plan to continue to win in the marketplace by collaborating with our customers and providing them with differentiated products and solutions. For Card@Once, we plan to build upon our market-leading instant issuance solution which at the end of 2019 had nearly 11,000 printers in the field across approximately 1,600 financial institutions. Our customer-friendly Card@Once software-as-a-service solution eases the burden on our customers as we securely manage IT setup, support, and maintenance for our web-based solutions. As a market leader, we believe we can continue to win new business, particularly with respect to small and medium-sized financial institutions as we expand our addressable market across new relationships and verticals. In our personalization business, we have invested in broadening our product and solutions capabilities, including CPI On-Demand. We believe we can win incremental business from our customers, while expanding our customers’ base given our enhanced product and solution capabilities and high level of customer service.
For our prepaid segment, we believe our position as a market leader and our expanding portfolio of innovative solutions, including the use of differentiated card materials and secure and sustainable packaging capabilities enable us to win in the space. In addition, we plan to build upon our success in bringing more environmentally friendly solutions to our customers. With the launch of our Second Wave products in 2019, we delivered a more ecofriendly card that is reliable, durable, high-quality, and meets payment brand certification requirements. We are investing behind the success to scale and support demand, while also executing against our new product development roadmap focused on providing more choice, convenience and control to our customers. Internally, we are executing initiatives that limit our impact on the environment as sustainability is one of our key values. Finally, due to the operating leverage in our business model, we believe we can drive incremental profitability and strengthen our balance sheet as the top line grows.
Turning to Slide 8, in summary 2019, we executed well on our strategies and operating initiatives, which resulted in strong top line growth and significantly improved bottom line performance while providing more robust products and solutions for our customers. As we enter 2020, we look to build upon that success through steadfast commitment to achieving our vision of being the partner of choice by providing market leading quality of products and customer service with a market competitive business model. We believe we are well positioned to execute on our strategic plan as we keep our customers at the center of everything we do.
I will now turn the call over to John Lowe to review our financial and operating results. John?
Thanks, Scott. Good morning, everyone. I will begin my overview of our results from the fourth quarter and full year 2019 on Slide 10. As a reminder, 2018 comparative results are on a continuing operations basis and excludes the UK business, that was divested and reported as a discontinued operation during 2018 as required by U.S. GAAP. The April 2019 disposition of our Canadian business did not qualify as a discontinued operation under U.S. GAAP; and therefore, the results from this business are included in the other segment.
We delivered strong sales growth in the fourth quarter and full year 2019. Net sales were up 6% and 9% year-over-year for the fourth quarter and full year respectively. Excluding the impact of the divested Canadian business, net sales increased 9% in the fourth quarter and 12% for the full year. 2019 top line results were driven by sales of higher-priced dual interface EMV cards, including Second Wave and strong performance in personalization, including Card@Once. Fourth quarter gross profit was $22 million, up 5% year-over-year and gross margin was 30.3%, directionally the same as the year ago fourth quarter.
For the full year 2019, we generated gross profit of $91.3 million, up 16% compared to 2018. We also expanded gross margins by over 200 basis points year-over-year from 30.7% in 2018 to 32.8% in 2019. Gross margin expansion in 2019 was driven by higher net sales in our U.S Debt and Credit segment, creating greater leverage of our operating model, a smaller geographic footprint having consolidated our personalization facilities from 3 to 2 and divested our non-core business in Canada and a more favorable product mix in 2019.
During the fourth quarter, we reported income from operations of $3.9 million compared with a loss from operations of $0.4 million in the fourth quarter of 2018. 2019 full year operating income was $25.5 million and our operating margin was 9.2%. This includes the benefit of the $6 million cash litigation settlement gain we received during the 2019 second quarter. Excluding this $6 million gain, operating margin was 7%, up more than 500 basis points compared to last year.
Turning to Slide 11, our fourth quarter 2019 net loss of $2.1 million or a $0.19 loss per share was a significant improvement over the net loss of $7.2 million or a $0.65 loss per share in the fourth quarter of 2018. Fourth quarter adjusted EBITDA was $8.8 million, up 74% from the fourth quarter of 2018. Adjusted EBITDA margin increased to 12.1% from 7.4% in the fourth quarter of 2018. These improvements were driven primarily by higher net sales, which delivered greater operating leverage. In addition, the fourth quarter benefited from lower corporate expenses, including the effects of divesting our Canadian business. For the full year, loss before income taxes was $0.7 million compared to a $19.1 million loss before income taxes in the prior year. After tax, net loss was $4.3 million or a $0.39 loss per share both are meaningful improvements from 2018. Full year 2019 adjusted EBITDA was $37.6 million, up 39% compared with 2018. Adjusted EBITDA margins increased to 13.5% in 2019 from 10.6% in 2018. These improvements were driven by higher net sales, which delivered greater operating leverage as well as lower corporate expenses.
Turning to our segments on Slide 12, fourth quarter U.S. Debit and Credit segment net sales were up 24% year-over-year to $61.6 million. During the quarter, we benefited from strong sales of higher price dual interface EMV cards, including Second Wave and strong volumes from personalization. Fourth quarter U.S. Debit and Credit segment income from operations was $11.4 million, up 68% year-over-year. Income from operations benefited from higher net sales and a more favorable mix of products and services. Full year U.S. Debit and Credit segment net sales were up 19% year-over-year to $213.1 million driven by strong performance from dual interface EMV cards and personalization, including Card@Once. U.S. Debit and Credit income from operations for the full year was up 61% to $36 million and operating margin increased more than 400 basis points to 16.9%. These year-over-year improvements demonstrate the operating leverage in our business model and were driven by strong performance from dual interface EMV cards and personalization, including Card@Once.
Looking at our U.S. prepaid debit business, as expected net sales for our U.S. prepaid debit segment were down year-over-year for both the fourth quarter and full year as we worked against tough year-over-year comparisons to the record net sales we posted in 2018. Fourth quarter net sales were $11.2 million and $64.3 million for the full year. Fourth quarter 2019 U.S. prepaid debit segment income from operations was $1.9 million and operating margins were 16.8%, down from $5 million and 29.3% respectively during the fourth quarter of 2018 due to unfavorable cost absorption resulting from lower sales. Full year 2019 U.S. prepaid debit segment operating margins were strong and consistent with 2018 at 31.7%. As a reminder with the April 1, 2019 completion of the disposition of the Canadian business, results from our other segment no longer includes the losses previously generated by this business, nor the associated net sales.
Turning to Slide 13, our cash balance at the end of the year was $18.7 million. Cash provided by operating activities was $3 million for the full year 2019. As a remainder, this result includes investments of over $10 million in additional inventories to support growth in the business. In addition, cash from operating activities also includes a $6 million cash litigation settlement gain recorded in the second quarter. Cash outflows for capital expenditures were $4.2 million and adjusted free cash flow was a negative $7.2 million. During the year, we made significant investments in our business, including operational and information technology equipment, IT security and our people. Altogether, these investments in purchased and leased equipment and in inventory totaled over $20 million.
Turning to our capital structure, we ended the year with total debt principal outstanding of $312.5 million. As of December 31, 2019, our net debt leverage ratio was 8.0x, an improvement from 10.9x at year end 2018 and 12.2x at its peak on March 31, 2018. Our term loan matures in August of 2022.
Now, I would like to take a moment to discuss the new $30 million credit facility we announced this morning. Over the last couple of years, we have made significant progress in executing our strategic plan and expanding our top line. The investments we have been making in the business have played a key part in supporting our strategy. This new facility provides us with capital to continue to execute our strategic plan and provides us with cash as our revolving credit facility was set to mature in August of this year. The new facility was led by a lender with whom the company has a longstanding relationship. The facility provides us with approximately $27 million in net cash at closing, bears interest at a floating rate and matures in May of 2022. The impact of this new facility to our net debt leverage ratio is minimal. Our revolving credit facility had no outstanding borrowings as of year end or on the date of the close of the new facility. The revolver was terminated on the closing date of the new credit facility.
We are pleased to receive the support of our lending partners and believe this new facility reflects their confidence in our business and our strategic plan. As a reminder, our business results fluctuate from quarter-to-quarter based on several factors, including customer ordering patterns, which can be lumpy as well as broader economic cyclicality and quarterly seasonality. For example, as we enter the first quarter of 2020, I want to remind you that our U.S. prepaid debit segment net sales for the first quarter of 2019 benefited from the timing of larger than expected customer sales as we supported existing customers through changing regulatory requirements in the industry. In addition, in recent years, net sales and EBITDA have been lower in the first half and higher in the second half of the year resulting in a use of cash until the latter part of the year due in part to the seasonality of our business. On an ongoing basis, we proactively manage our business to mitigate risk. CPI is closely monitoring the news and information available regarding the coronavirus to understand its potential impacts to our supply chain and operations. Our ability to meet our customer commitments from this developing situation has not experienced an impact. We will continue to monitor the situation and take actions as needed.
Turning to Slide 14, before I wrap up, I want to give a few thoughts about our current outlook for the U.S. markets in 2020. First, looking at our U.S. debit and credit segment, which include SecureCard, Card@Once and personalization. In SecureCard, we expect steady card manufacturing market growth. We also expect the migration to dual interface and contactless products will continue its strong growth and become a larger part of the overall card market. For example, just recently, in February, these have reported they have 145 million tap-to-pay cards in the U.S., up from 100 million tap-to-pay cards reported in September of 2019. In addition, they stated they expect these numbers to continue to grow to 300 million tap-to-pay cards in the U.S. by the end of 2020. For Card@Once, we expect strong market growth in the number of small and medium-sized financial institution locations offering instant issuance. For personalization, we expect low, but steady market volume growth in the small and medium-sized financial institution personalization market driven by card re-issuances and the broader dual interface market conversion. For our U.S. prepaid debit segment, we expect open-loop prepaid card market to be directionally flat in 2020.
In summary, the success we have had in driving our top loan growth and margin expansion underscores the operating leverage in our business model and our continued success in winning new business and market share. I look forward to updating you on our progress as we continue to execute on our strategies.
I will now turn the call back to Scott for some closing remarks. Scott?
Thanks, John. In wrapping up, I want to thank all of our employees for their commitment and dedications delivering excellence and serving our customers well. The results from this focused hardware underscore my confidence in our ability to continue to execute well for our customers and all of our stakeholders in 2020 and beyond. With the success we have had over the last 2 years first in getting the company ready for growth and then growing through targeted initiatives, I believe we are well-positioned to embark on our next stage of scaling our solutions, diversifying our products and expanding our customer base through continued crisp execution on our key strategies. I look forward to updating you on our progress. Operator, you may now end the call.
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.