UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

(Mark One)

 

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities and Exchange Act of 1934

 

For the Quarterly Period Ended June 30, 2018.

 

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 001-37584

 

CPI Card Group Inc.

(Exact name of the registrant as specified in its charter)

 

 

 

 

Delaware

 

26-0344657

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. employer identification no.)

 

 

 

10026 West San Juan Way

 

 

Littleton, CO

 

80127

( Address of principal executive offices )

 

( Zip Code )

(303) 973-9311

(Registrant’s telephone number, including area code)  

 

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.     Yes☒     No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).     Yes☒     No☐

 

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

Accelerated filer

 

 

 

 

Non-accelerated filer

Smaller reporting company

(Do not check if a 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☐     No☒

 

Number of shares of Common Stock, $0.001 par value, outstanding as of July 25, 2018: 11,159,71 4

 

 

 


 

Table of Content s

 

 

 

 

 

 

    

Page

 

Part I — Financial Information

 

 

 

 

 

 

 

Item 1 — Financial Statements (Unaudited)  

 

3

 

 

 

 

 

Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations  

 

24

 

 

 

 

 

Item 3 — Quantitative and Qualitative Disclosures About Market Risk  

 

35

 

 

 

 

 

Item 4 — Controls and Procedures  

 

35

 

 

 

 

 

 

 

 

 

Part II — Other Information  

 

 

 

 

 

 

 

Item 1 — Legal Proceedings  

 

36

 

 

 

 

 

Item 1A — Risk Factors  

 

37

 

 

 

 

 

Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds  

 

37

 

 

 

 

 

Item 5 — Other Information  

 

37

 

 

 

 

 

Item 6 — Exhibits  

 

38

 

 

 

 

 

Signatures  

 

39

 

 

2


 

Item 1. Financial Statement s

 

CPI Card Group Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(Dollars in Thousands, Except Share and Per Share Amounts)

 

 

 

 

 

 

 

 

 

 

June 30, 

 

December 31, 

 

 

2018

 

2017

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

Cash and cash equivalents

 

$

17,750

 

$

23,205

Accounts receivable, net

 

 

43,601

 

 

32,531

Inventories

 

 

10,455

 

 

13,799

Prepaid expenses and other current assets

 

 

3,901

 

 

3,681

Income taxes receivable

 

 

6,718

 

 

8,208

Assets of discontinued operation

 

 

8,016

 

 

20,651

Total current assets

 

 

90,441

 

 

102,075

Plant, equipment and leasehold improvements, net

 

 

40,038

 

 

44,436

Intangible assets, net

 

 

37,765

 

 

40,093

Goodwill

 

 

47,150

 

 

47,150

Other assets

 

 

205

 

 

251

Total assets

 

$

215,599

 

$

234,005

Liabilities and stockholders’ deficit

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Accounts payable

 

$

15,678

 

$

13,239

Accrued expenses

 

 

15,705

 

 

12,789

Income taxes payable

 

 

678

 

 

 —

Deferred revenue and customer deposits

 

 

509

 

 

3,342

Liabilities of discontinued operation

 

 

7,807

 

 

5,669

Total current liabilities

 

 

40,377

 

 

35,039

Long-term debt

 

 

304,841

 

 

303,869

Deferred income taxes

 

 

7,925

 

 

12,168

Other long-term liabilities

 

 

2,716

 

 

2,503

Total liabilities

 

 

355,859

 

 

353,579

Commitments and contingencies (Note 13)

 

 

 

 

 

 

Stockholders’ deficit:

 

 

 

 

 

 

Common stock; $0.001 par value—100,000,000 shares authorized; 11,159,714 and 11,134,714 shares issued and outstanding at June 30, 2018 and December 31, 2017, respectively

 

 

11

 

 

11

Capital deficiency

 

 

(112,377)

 

 

(113,081)

Accumulated loss

 

 

(22,571)

 

 

(1,366)

Accumulated other comprehensive loss

 

 

(5,323)

 

 

(5,138)

Total stockholders’ deficit

 

 

(140,260)

 

 

(119,574)

Total liabilities and stockholders’ deficit

 

$

215,599

 

$

234,005

 

See accompanying notes to condensed consolidated financial statements

 

 

3


 

CPI Card Group Inc. and Subsidiaries

Condensed Consolidated Statements of Operations and Comprehensive Loss

(Dollars in Thousands, Except Share and Per Share Amounts)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 

 

Six Months Ended June 30, 

 

 

2018

    

2017

    

2018

    

2017

Net sales:

 

 

 

 

 

 

 

 

 

 

 

 

Products

 

$

31,494

 

$

26,640

 

$

56,238

 

$

52,866

Services

 

 

29,960

 

 

28,196

 

 

60,073

 

 

52,391

Total net sales

 

 

61,454

 

 

54,836

 

 

116,311

 

 

105,257

Cost of sales:

 

 

 

 

 

 

 

 

 

 

 

 

Products (exclusive of depreciation and amortization shown below)

 

 

18,962

 

 

17,943

 

 

35,280

 

 

35,106

Services (exclusive of depreciation and amortization shown below)

 

 

19,116

 

 

17,533

 

 

39,780

 

 

33,444

Depreciation and amortization

 

 

3,501

 

 

2,694

 

 

6,949

 

 

5,393

Total cost of sales

 

 

41,579

 

 

38,170

 

 

82,009

 

 

73,943

Gross profit

 

 

19,875

 

 

16,666

 

 

34,302

 

 

31,314

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative (exclusive of depreciation and amortization shown below)

 

 

15,756

 

 

14,304

 

 

31,084

 

 

29,228

Depreciation and amortization

 

 

1,465

 

 

1,641

 

 

2,927

 

 

3,277

Total operating expenses

 

 

17,221

 

 

15,945

 

 

34,011

 

 

32,505

Income (loss) from operations

 

 

2,654

 

 

721

 

 

291

 

 

(1,191)

Other expense, net:

 

 

 

 

 

 

 

 

 

 

 

 

Interest, net

 

 

(5,586)

 

 

(5,165)

 

 

(11,092)

 

 

(10,228)

Foreign currency (loss) gain

 

 

(466)

 

 

153

 

 

(264)

 

 

172

Other income, net

 

 

 3

 

 

 4

 

 

 7

 

 

 6

Total other expense, net

 

 

(6,049)

 

 

(5,008)

 

 

(11,349)

 

 

(10,050)

Loss from continuing operations before income taxes

 

 

(3,395)

 

 

(4,287)

 

 

(11,058)

 

 

(11,241)

Income tax benefit

 

 

2,593

 

 

1,014

 

 

4,578

 

 

3,371

Net loss from continuing operations

 

 

(802)

 

 

(3,273)

 

 

(6,480)

 

 

(7,870)

Net (loss) income from discontinued operation, net of tax (see Note 3)

 

 

(15,907)

 

 

1,112

 

 

(17,521)

 

 

1,202

Net loss

 

$

(16,709)

 

$

(2,161)

 

$

(24,001)

 

$

(6,668)

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted loss per share:

 

 

 

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

(0.07)

 

$

(0.30)

 

$

(0.58)

 

$

(0.71)

Discontinued operation

 

 

(1.43)

 

 

0.10

 

 

(1.57)

 

 

0.11

Net loss per share

 

$

(1.50)

 

$

(0.20)

 

$

(2.15)

 

$

(0.60)

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted weighted-average shares outstanding

 

 

11,143,230

 

 

11,122,436

 

 

11,138,972

 

 

11,103,655

 

 

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

$

 —

 

$

0.225

 

$

 —

 

$

0.45

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(16,709)

 

$

(2,161)

 

$

(24,001)

 

$

(6,668)

Currency translation adjustment

 

 

(495)

 

 

586

 

 

(185)

 

 

787

Total comprehensive loss

 

$

(17,204)

 

$

(1,575)

 

$

(24,186)

 

$

(5,881)

 

See accompanying notes to condensed consolidated financial statements

 

4


 

CPI Card Group Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Dollars in Thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 

 

    

2018

    

2017

Operating activities

 

 

 

 

 

 

Net loss

 

$

(24,001)

 

$

(6,668)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

Loss (income) from discontinued operation

 

 

17,521

 

 

(1,202)

Depreciation and amortization expense

 

 

9,876

 

 

8,670

Stock-based compensation expense

 

 

784

 

 

860

Amortization of debt issuance costs and debt discount

 

 

972

 

 

975

Deferred income taxes

 

 

(4,782)

 

 

(540)

Other, net

 

 

158

 

 

94

Changes in operating assets and liabilities:

 

 

 

 

 

 

Accounts receivable

 

 

(6,577)

 

 

(6,964)

Inventories

 

 

(2,466)

 

 

(1,776)

Prepaid expenses and other assets

 

 

(299)

 

 

(31)

Income taxes

 

 

2,284

 

 

(3,987)

Accounts payable

 

 

2,271

 

 

3,399

Accrued expenses

 

 

3,093

 

 

(1,228)

Deferred revenue and customer deposits

 

 

25

 

 

555

Other liabilities

 

 

(212)

 

 

422

Cash used in operating activities - continuing operations

 

 

(1,353)

 

 

(7,421)

Cash used in operating activities - discontinued operation

 

 

(1,152)

 

 

(841)

Investing activities

 

 

 

 

 

 

Acquisitions of plant, equipment and leasehold improvements

 

 

(2,109)

 

 

(4,343)

Cash used in investing activities - continuing operations

 

 

(2,109)

 

 

(4,343)

Cash used in investing activities - discontinued operation

 

 

(536)

 

 

(1,440)

Financing activities

 

 

 

 

 

 

Payments on capital lease obligations

 

 

(306)

 

 

 —

Dividends paid on common stock

 

 

 —

 

 

(5,026)

Taxes withheld and paid on stock-based compensation awards

 

 

 —

 

 

(339)

Cash used in financing activities

 

 

(306)

 

 

(5,365)

Effect of exchange rates on cash

 

 

 1

 

 

386

Net decrease in cash and cash equivalents

 

 

(5,455)

 

 

(19,024)

Cash and cash equivalents, beginning of period

 

 

23,205

 

 

36,955

Cash and cash equivalents, end of period

 

$

17,750

 

$

17,931

Supplemental disclosures of cash flow information

 

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

 

Interest

 

$

9,783

 

$

9,096

Income taxes, net (refunds) payments

 

$

(1,504)

 

$

1,068

Capital lease obligations incurred for certain machinery and equipment leases

 

$

821

 

$

 —

Accounts payable for acquisitions of plant, equipment and leasehold improvements

 

$

970

 

$

1,233

 

See accompanying notes to condensed consolidated financial statements

5


 

CPI Card Group Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Dollars in Thousands, Except Share and Per Share Amounts or as Otherwise Indicated)

(Unaudited)

 

1. Business Overview and Summary of Significant Accounting Policies

 

Business Overview

 

CPI Card Group Inc. (which, together with its subsidiaries, is referred to herein as “CPI” or the “Company”) is engaged in the design, production, data personalization, packaging and fulfillment of Financial Payment Cards, which the Company defines as credit cards, debit cards and prepaid debit cards issued on the networks of the Payment Card Brands (Visa, MasterCard, American Express, Discover and Interac (in Canada)) in the United States and Canada. The Company also is engaged in the design, production, data personalization, packaging and fulfillment of retail gift and loyalty cards (primarily in Canada).  

 

As a producer and provider of services for Financial Payment Cards, each of the Company’s secure facilities must be certified by one or more of the Payment Card Brands and is therefore subject to specific requirements and conditions. Noncompliance with these requirements would prohibit the individual facilities of the Company from producing Financial Payment Cards for these entities’ payment card issuers.

 

During February 2018, the Company made the decision to consolidate three personalization operations in the United States into two facilities to better enable the Company to optimize operations and achieve market-leading quality and service with a cost-competitive business model. In conjunction with this decision, the Company accelerated the depreciation of certain related assets, which totaled $1,332 for the three months ended June 30, 2018 and $2,132 for the six months ended June 30, 2018, and recorded severance charges of $223 and $552 for these same respective time periods. The Company recorded a lease termination charge of $432 in the three months ended June 30, 2018. The charges were recorded in the U.S. Debit and Credit segment and primarily included in “Cost of sales” on the Condensed Consolidated Statement of Operations.

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 10 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, 2017 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, 2017.

 

During the second quarter of 2018, the Company met the criteria to report a probable business sale of the UK Limited segment as a discontinued operation. On August 3, 2018, the Company completed the sale. See Note 16 “Subsequent Event” for further information. The Company has restated the comparative financial information in conformity with GAAP. Unless otherwise indicated, information in these notes to the unaudited condensed consolidated financial statements relate to continuing operations. See Note 3.

 

On December 20, 2017, the Company effected a one-for-five reverse stock split of its common stock, whereby each lot of five shares of common stock issued and outstanding immediately prior to the reverse stock split was converted into and became one share of common stock. Share and per share amounts reflect the one-for-five reverse stock split for all periods presented.

Use of Estimates

 

Management uses estimates and assumptions relating to the reporting of assets and liabilities in its 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, valuation allowances for inventories and

6


 

deferred tax assets, debt, discontinued operations, revenue recognized for period-end work in process and stock-based compensation expense. Actual results could differ from those estimates.

 

Machinery and Equipment Financing

 

The Company leases certain machinery and equipment under capital leases. The assets and liabilities under these capital leases are recorded at the lower of the present value of the minimum lease payments or the fair value of the asset. Once ready for their intended use, the assets are depreciated over the lower of their related lease term or their estimated productive lives.

 

Adoption of New Accounting Standard

 

As of January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers , as amended (“ASU 2014-09”), which requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also requires an entity to disclose sufficient quantitative and qualitative information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The Company adopted ASU 2014-09 as of January 1, 2018 to all its contracts using the modified retrospective method and recognized the cumulative effect of adoption as an adjustment to the opening balance of “Accumulated loss” on the Condensed Consolidated Balance Sheet. Under the new guidance, the Company recognizes certain performance obligations over time as the goods are produced, since those products provide value to only a specified customer, have no alternative use and the Company has the right to payment for work completed on such items. This accelerates the timing of revenue recognition for these arrangements, as revenue is recognized as goods are produced rather than upon shipment or delivery of goods. In addition, as a result of adopting the new guidance, the Company has recorded decreases to deferred revenue, and work in process and finished goods inventories, and an increase to accounts receivable.  These changes are reflected in the adoption adjustments table below. The comparative financial information has not been restated and continues to be reported under the accounting standards in effect for those periods.

See Note 2 “Revenue” for revenue recognition timing and methodology under ASU 2014-09.

The cumulative effects of the adjustments made to the Company’s January 1, 2018 Condensed Consolidated Balance Sheet upon adoption of ASU 2014-09 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

    

Adoption

    

January 1,

 

 

2017

 

Adjustments

 

2018

Assets:

 

 

 

 

 

 

 

 

 

Accounts receivable, net

 

$

32,531

 

$

5,991

 

$

38,522

Inventories

 

 

13,799

 

 

(5,929)

 

 

7,870

Assets of discontinued operation

 

 

20,651

 

 

(357)

 

 

20,294

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Deferred revenue and customer deposits

 

 

3,342

 

 

(3,063)

 

 

279

Liabilities of discontinued operation

 

 

5,669

 

 

(535)

 

 

5,134

Deferred income taxes

 

 

12,168

 

 

479

 

 

12,647

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders' deficit:

 

 

 

 

 

 

 

 

 

Accumulated (loss) earnings

 

 

(1,366)

 

 

2,824

 

 

1,458

 

7


 

In accordance with ASU 2014-09, the impact on the Company’s Condensed Consolidated Balance Sheet and Statement of Operations and Comprehensive Loss was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances

 

 

As Reported

 

 

 

Without

 

 

June 30,

    

 

    

Adoption of

Balance Sheet

 

2018

 

Adjustments

 

ASU 2014-09

Assets:

 

 

 

 

 

 

 

 

 

Accounts receivable, net

 

$

43,601

 

$

(7,115)

 

$

36,486

Inventories

 

 

10,455

 

 

5,217

 

 

15,672

Assets of discontinued operation

 

 

8,016

 

 

229

 

 

8,245

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Deferred revenue and customer deposits

 

 

509

 

 

 —

 

 

509

Liabilities of discontinued operation

 

 

7,807

 

 

390

 

 

8,197

Deferred income taxes

 

 

7,925

 

 

(479)

 

 

7,446

 

 

 

 

 

 

 

 

 

 

Stockholders' deficit:

 

 

 

 

 

 

 

 

 

Accumulated loss

 

 

(22,571)

 

 

(1,580)

 

 

(24,151)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 2018

 

Six Months Ended June 30, 2018

 

 

 

 

 

 

 

Balances

 

 

 

 

 

 

Balances

 

 

As Reported

 

 

 

Without

 

As Reported

 

 

 

Without

Statement of Operations and

 

June 30,

    

 

    

Adoption of

 

June 30,

    

 

    

Adoption of

Comprehensive Loss

 

2018

 

Adjustments

 

ASU 2014-09

 

2018

 

Adjustments

 

ASU 2014-09

Net sales:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Products

 

$

31,494

 

$

158

 

$

31,652

 

$

56,238

 

$

(656)

 

$

55,582

Services

 

 

29,960

 

 

(588)

 

 

29,372

 

 

60,073

 

 

(365)

 

 

59,708

Cost of sales:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Products (exclusive of depreciation and amortization)

 

 

18,962

 

 

 1

 

 

18,963

 

 

35,280

 

 

(918)

 

 

34,362

Services (exclusive of depreciation and amortization)

 

 

19,116

 

 

(248)

 

 

18,868

 

 

39,780

 

 

(68)

 

 

39,712

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

 

19,875

 

 

(183)

 

 

19,692

 

 

34,302

 

 

(35)

 

 

34,267

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income tax benefit

 

 

2,593

 

 

38

 

 

2,631

 

 

4,578

 

 

 7

 

 

4,585

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss from continuing operations

 

 

(802)

 

 

(145)

 

 

(947)

 

 

(6,480)

 

 

(28)

 

 

(6,508)

Net loss from discontinued operation, net of tax

 

 

(15,907)

 

 

(28)

 

 

(15,935)

 

 

(17,521)

 

 

(19)

 

 

(17,540)

 

Recently Issued Accounting Pronouncements

 

In February 2016, the Financial Accounting Standards Board (the “FASB”) issued ASU 2016-02, Leases (“ASU 2016-02”), which provides guidance for accounting for leases. The new guidance requires companies to recognize the assets and liabilities for the rights and obligations created by leased assets. ASU 2016-02 is effective for annual and interim periods beginning after December 15, 2018 (the Company’s fiscal year 2019) with early adoption permitted. The new guidance requires the recognition and measurement of leases at the beginning of the earliest comparative period presented in the financial statements using a modified retrospective approach, with an option to apply the transition provisions of the new guidance at the adoption date without adjusting the comparative periods presented. The Company is considering the method of transition upon adoption of this guidance.  The Company is in the process of assessing the impact of ASU 2016-02 on its results of operations, financial position and consolidated financial statements.

8


 

During 2017, the Company early adopted ASU 2017-04,   Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (“ASU 2017-04”) in conjunction with its annual impairment testing effective October 1, 2017. In accordance with ASU 2017-04, an entity should perform its goodwill impairment test by comparing the fair value of the reporting unit with its carrying amount, and recognize an impairment charge for the amount by which the carrying amount of the reporting unit exceeds its fair value.

2. Revenue

 

The Company disaggregates its revenue by major source as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 2018

 

Six Months Ended June 30, 2018

 

 

Products

 

Services

 

Total

 

Products

 

Services

 

Total

U.S. Debit and Credit

 

$

30,444

 

$

13,399

 

$

43,843

 

$

54,164

 

$

26,827

 

$

80,991

U.S. Prepaid Debit

 

 

 —

 

 

15,427

 

 

15,427

 

 

 —

 

 

30,938

 

 

30,938

Other

 

 

1,625

 

 

1,355

 

 

2,980

 

 

3,000

 

 

2,679

 

 

5,679

Intersegment eliminations

 

 

(575)

 

 

(221)

 

 

(796)

 

 

(926)

 

 

(371)

 

 

(1,297)

Total

 

$

31,494

 

$

29,960

 

$

61,454

 

$

56,238

 

$

60,073

 

$

116,311

 

For periods after January 1, 2018, the Company accounts for its revenue as follows:

Products Revenue

Products” revenue is recognized when obligations under the terms of a contract with a customer are satisfied. In most instances, this occurs over time as cards are manufactured for specific customers and have no alternative use and the Company has an enforceable right to payment for work performed. For work performed but not completed and unbilled, the Company estimates revenue by taking actual costs incurred and applying historical margins for similar types of contracts. Items included in “Products” revenue are manufactured Financial Payment Cards, including in contact-EMV®, Dual-Interface EMV®, contactless and magnetic stripe cards, private label credit cards and retail gift cards. Card@Once® printers and consumables are also included in “Products” revenue, and their associated revenues are recognized at the time of shipping.

 

Services Revenue

 

Revenue is recognized for “Services” as the services are performed. Items included in “Services” revenue 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. For work performed but not completed and unbilled, 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, an MSA requires a customer to place subsequent purchase orders or statements of work to obtain goods or services, thus creating enforceable rights and obligations for goods and services for the parties. The contract term as defined by ASU 2014-09 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.

 

3. Discontinued Operation

 

During the second quarter of 2018, the Company met the criteria to report a probable business sale in the U.K. Limited segment as a discontinued operation. On August 3, 2018, the Company completed the sale. See Note 16 “Subsequent Event” for further information. The financial position, results of operations and cash flows have been restated for all periods to conform with the discontinued operation presentation. The Company is not expected to retain significant continuing involvement with the discontinued operation subsequent to the disposal. In connection with the planned sale, the Company performed a goodwill impairment test and recorded a charge of $6,366. The impairment was

9


 

a result of continued market softness in the U.K. Limited segment, resulting in lower sales and margins and an expected sales price below the carrying value of the segment. The Company also recorded an impairment charge of $1,249 to customer relationship intangible assets related to the U.K. Limited segment. The Company measured the net assets of the discontinued operation at their fair values less costs to sell, and recorded an additional $7,244 loss on the discontinued operation classification.

 

The balances of assets and liabilities as presented in the table below are comprised primarily of the discontinued operation. The carrying amounts of the major classes of assets and liabilities of the discontinued operation as of June 30, 2018 were as follows:

 

 

 

 

 

 

 

 

 

    

June 30, 2018

    

December 31, 2017

 

 

 

 

 

    

 

Assets:

 

 

 

 

 

 

Accounts receivable

 

$

5,244

 

$

5,006

Inventories

 

 

1,626

 

 

2,438

Other assets

 

 

506

 

 

506

Plant, equipment and leasehold improvements

 

 

7,884

 

 

4,864

Intangible assets

 

 

 —

 

 

1,379

Goodwill

 

 

 —

 

 

6,458

Loss recognized on discontinued operation classification

 

 

(7,244)

 

 

 —

Total assets of discontinued operation

 

 

8,016

 

 

20,651

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

Accounts payable

 

 

3,754

 

 

3,307

Other current liabilities

 

 

1,499

 

 

1,866

Other long-term liabilities

 

 

2,554

 

 

496

Total liabilities of discontinued operation

 

$

7,807

 

$

5,669

 

The major line items constituting the (loss) income of the discontinued operation for the three and six months ended June 30, 2018 and 2017 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

June 30, 

 

June 30, 

 

 

2018

 

2017

 

2018

 

2017

Total net sales

 

$

4,587

 

$

11,010

 

$

8,799

 

$

16,597

Total cost of sales

 

 

4,300

 

 

8,391

 

 

8,498

 

 

12,530

Selling, general and administrative

 

 

1,446

 

 

1,373

 

 

3,066

 

 

2,716

Impairments

 

 

7,615

 

 

 —

 

 

7,615

 

 

 —

Other expense (income), net

 

 

21

 

 

(31)

 

 

29

 

 

(85)

Pretax (loss) income from discontinued operation

 

 

(8,795)

 

 

1,277

 

 

(10,409)

 

 

1,436

  Pretax loss on discontinued operation classification

 

 

(7,244)

 

 

 —

 

 

(7,244)

 

 

 —

Total pretax (loss) income on discontinued operation

 

 

(16,039)

 

 

1,277

 

 

(17,653)

 

 

1,436

Income tax benefit (expense)

 

 

132

 

 

(165)

 

 

132

 

 

(234)

Net (loss) income from discontinued operation

 

$

(15,907)

 

$

1,112

 

$

(17,521)

 

$

1,202

 

 

4.   Accounts Receivable

 

Accounts receivable consisted of the following:

 

 

 

 

 

 

 

 

    

June 30, 2018

    

December 31, 2017

 

 

 

 

 

 

    

Trade accounts receivable

 

$

37,049

 

$

32,579

Unbilled accounts receivable

 

 

6,699

 

 

 —

 

 

 

43,748

 

 

32,579

Less allowance for doubtful accounts

 

 

(147)

 

 

(48)

 

 

$

43,601

 

$

32,531

 

 

 

10


 

5 .   Inventories

 

Inventories are summarized below:

 

 

 

 

 

 

 

 

 

    

June 30, 2018

    

December 31, 2017

 

 

 

 

 

 

 

Raw materials

 

$

7,974

 

$

5,718

Work-in-process

 

 

 —

 

 

5,107

Finished goods

 

 

2,481

 

 

2,974

 

 

$

10,455

 

$

13,799

 

 

6. Plant, Equipment and Leasehold Improvements

 

Plant, equipment and leasehold improvements consisted of the following:

 

 

 

 

 

 

 

 

 

    

June 30, 2018

    

December 31, 2017

 

 

 

 

 

 

 

Machinery and equipment

 

$

54,722

 

$

58,595

Machinery and equipment under capital leases

 

 

821

 

 

 —

Furniture, fixtures and computer equipment

 

 

3,960

 

 

6,288

Leasehold improvements

 

 

18,158

 

 

19,601

Construction in progress

 

 

2,318

 

 

1,512

 

 

 

79,979

 

 

85,996

Less accumulated depreciation

 

 

(39,941)

 

 

(41,560)

 

 

$

40,038

 

$

44,436

 

Depreciation of plant, equipment and leasehold improvements, including depreciation of assets under capital leases, was $3,802 and $3,163 for the three months ended June 30, 2018 and 2017, respectively, and $7,548 and $6,327 for the six months ended June 30, 2018 and 2017, respectively.

 

7. Goodwill and Other Intangible Assets

 

The Company reports all of its goodwill in its U.S. Debit and Credit segment at June 30, 2018 and December 31, 2017.

 

Intangible assets consist of customer relationships, technology and software, non-compete agreements and trademarks. The changes in the cost basis of the intangibles from December 31, 2017 to June 30, 2018 were related to foreign currency translation adjustments. Intangible amortization expense was $1,164 and $1,172 for the three months ended June 30, 2018 and 2017, respectively, and $2,328 and $2,343 for the six months ended June 30, 2018 and 2017, respectively. 

 

At June 30, 2018 and December 31, 2017, intangible assets, excluding goodwill, were comprised of the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2018

 

December 31, 2017

 

 

Average Life

 

 

 

 

Accumulated

 

Net Book

 

 

 

 

Accumulated

 

Net Book

 

 

(Years)

 

Cost

 

Amortization

 

Value

 

Cost

 

Amortization

 

Value

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer relationships

    

12

to

20

    

$

55,454

    

$

(23,949)

    

$

31,505

    

$

55,454

    

$

(22,311)

    

$

33,143

Technology and software

 

 7

to

10

 

 

7,101

 

 

(3,560)

 

 

3,541

 

 

7,101

 

 

(3,095)

 

 

4,006

Trademarks

 

7.5

to

10

 

 

3,330

 

 

(682)

 

 

2,648

 

 

3,330

 

 

(487)

 

 

2,843

Non-compete agreements

 

 5

to

 8

 

 

491

 

 

(420)

 

 

71

 

 

491

 

 

(390)

 

 

101

Intangible assets subject to amortization

 

 

 

 

 

$

66,376

 

$

(28,611)

 

$

37,765

 

$

66,376

 

$

(26,283)

 

$

40,093

 

11


 

The estimated future aggregate amortization expense for the identified amortizable intangibles noted above as of June 30, 2018 was as follows:

 

 

 

 

 

2018 (remaining 6 months)

 

$

2,343

2019

    

 

4,620

2020

 

 

4,595

2021

 

 

4,352

2022

 

 

3,867

Thereafter

 

 

17,988

 

 

$

37,765

 

 

 

8. 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.

 

    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 measurement date.

 

The Company’s financial assets and liabilities that are not required to be remeasured at fair value in the Condensed Consolidated Balance Sheets were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Carrying

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Value as of 

 

Fair Value as of 

 

Fair Value Measurement at June 30, 2018

 

 

June 30, 

 

June 30, 

 

 (Using Fair Value Hierarchy)

 

 

2018

 

2018

 

Level 1

 

Level 2

 

Level 3

Liabilities:

    

 

                 

    

 

                 

    

 

                 

    

 

                 

    

 

                 

First Lien Term Loan

 

$

312,500

 

$

196,875

 

$

 —

 

$

196,875

 

$

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Carrying

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 Value as of

 

Fair Value as of

 

Fair Value Measurement at December 31, 2017

 

 

December 31, 

 

December 31, 

 

 (Using Fair Value Hierarchy)

 

 

2017

 

2017

 

Level 1

 

Level 2

 

Level 3

Liabilities:

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

First Lien Term Loan

 

$

312,500

 

$

228,125

 

$

 —

 

$

228,125

 

$

 —

 

The aggregate fair value of the Company’s First Lien Term Loan, as defined in Note 9 “Long-Term Debt and Credit Facility,” was based on bank quotes.

 

The carrying amounts for cash and cash equivalents, accounts receivable and accounts payable each approximate fair value.

 

Nonrecurring fair value measurements include the Company’s goodwill and intangible asset impairments recognized during the quarter ended June 30, 2018 as determined based on unobservable Level 3 inputs. Refer to Note 3 “Discontinued Operation.”

 

 

12


 

9. Long-Term Debt and Credit Facility

 

At June 30, 2018 and December 31, 2017, long-term debt and credit facilities consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

 

    

Interest

    

 

June 30, 

    

December 31, 

 

 

Rate  (1)

 

 

2018

 

2017

First Lien Term Loan (1)

 

6.36

%  

 

$

312,500

 

$

312,500

Unamortized discount

 

 

 

 

 

(2,786)

 

 

(3,122)

Unamortized deferred financing costs

 

 

 

 

 

(4,873)

 

 

(5,509)

Long-term debt

 

 

 

 

$

304,841

 

$

303,869


(1 )    Interest rate at June 30, 2018.  Interest rate at December 31, 2017 was 5.96%.

 

First Lien Credit Facility

 

On August 17, 2015, the Company entered into a first lien credit facility (the “First Lien Credit Facility”) with a syndicate of lenders providing for a $435,000 first lien term loan (the “First Lien Term Loan”) and a $40,000 revolving credit facility (the “Revolving Credit Facility”). The First Lien Term Loan and the Revolving Credit Facility have maturity dates of August 17, 2022 and August 17, 2020, respectively.

 

The First Lien Credit Facility is secured by a first-priority security interest in substantially all of the Company’s assets constituting equipment, inventory, receivables, cash and other tangible and intangible property.

 

Interest rates under the First Lien Credit Facility are based, at the Company’s election, on a Eurodollar rate, subject to an interest rate floor of 1.0%, plus a margin of 4.50%, or a base rate plus a margin of 3.50%.

 

The First Lien Credit Facility contains customary nonfinancial covenants, including among other things, restrictions on indebtedness, issuance of liens, investments, dividends, redemptions and other distributions to equity holders, asset sales, certain mergers or consolidations, sales, transfers, leases or dispositions of substantially all of the Company’s assets and affiliate transactions. The First Lien Credit Facility also contains a requirement that, as of the last day of any fiscal quarter, if the amount the Company has drawn under the Revolving Credit Facility is greater than 50% of the aggregate principal amount of all commitments of the lenders thereunder, the Company maintain a first lien net leverage ratio not in excess of 7.0 times trailing twelve month Adjusted EBITDA, as defined in the agreement. As of June 30, 2018, the Company was in compliance with all covenants under the First Lien Credit Facility.

 

The First Lien Credit Facility also requires prepayment in advance of the maturity date upon the occurrence of certain customary events, including based on an annual excess cash flow calculation, pursuant to the terms of the agreement, with any required payments to be made after the issuance of the Company’s annual financial statements. As of June 30, 2018, the Company did not expect to have a required excess cash flow payment related to 2018.

 

At June 30, 2018, the Company did not have any outstanding amounts under the Revolving Credit Facility and has $19,950 available for borrowing. Additional amounts may be available for borrowing under the term of the Revolving Credit Facility, up to the full $40,000, to the extent the Company’s net leverage ratio does not exceed 7.0 times Adjusted EBITDA, as defined in the agreement. The Company has one outstanding letter of credit for $50 relating to the security deposit on a real property lease agreement. The Company pays a fee on outstanding letters of credit at the applicable margin, which was 4.50% as of June 30, 2018 and December 31, 2017, in addition to a fronting fee of 0.125% per annum. In addition, the Company is required to pay an unused commitment fee ranging from 0.375% per annum to 0.50% per annum of the average unused portion of the revolving commitments. The unused commitment fee is determined on the basis of a grid that results in a lower unused commitment fee as the Company’s total net leverage ratio declines. The Company recorded accrued interest of $4,526 and $4,296 within “Accrued expenses” on the Condensed Consolidated Balance Sheets at June 30, 2018 and December 31, 2017, respectively.

 

Deferred Financing Costs

 

Certain costs incurred with borrowings or the establishment or modification of credit facilities 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.      

 

13


 

10. Income Taxes – Continuing Operations

 

During the three months ended June 30, 2018, the Company recognized an income tax benefit of $2,593 on a pre-tax loss of $3,395, representing an effective income tax rate of 76.4%, compared to an income tax benefit of $1,014 on a pre-tax loss of $4,287, representing an effective tax rate of 23.7% during the three months ended June 30, 2017.  During the six months ended June 30, 2018, the Company recognized an income tax benefit of $4,578 on a pre-tax loss of $11,058, representing an effective income tax rate of 41.4%, compared to an income tax benefit of $3,371 on a pre-tax loss of $11,241, representing an effective tax rate of 30.0% during the six months ended June 30, 2017. On December 22, 2017, the U.S. government enacted comprehensive tax reform legislation ( the “Tax Act”). In conjunction with the Tax Act, the U.S. federal tax rate reduced from 35.0% in 2017 to 21.0% in 2018. The effective tax rate differs from the federal U.S. statutory rate primarily due to the impact of a tax benefit recorded in the second quarter of 2018 in connection with the U.K. Limited discontinued operation. Partially offsetting the increased tax benefit in the second quarter of 2018 was the establishment of a partial valuation allowance on certain U.S. deferred tax assets primarily related to the limitation on the deductibility of business interest expense.

 

On March 30, 2018, the Company received a proposed determination regarding a previously unrecognized tax benefit related to state income tax matters. Based on this proposal, the Company expects to pay $678 in the next 12 months and has included this item in “Income taxes payable” in its Condensed Consolidated Balance Sheet as of June 30, 2018.

 

2017 Tax Reform

 

The Tax Act includes significant changes to taxation of business entities. These changes include, among others, (i) a permanent reduction to the corporate income tax rate, (ii) a partial limitation on the deductibility of business interest expense, (iii) elimination of deduction for income attributable to domestic production activities and (iv) a partial shift of the U.S. taxation of multinational corporations from a tax on worldwide income to a territorial system (along with a transitional rule that taxes certain historic foreign accumulated earnings and certain rules that aim to prevent erosion of U.S. income tax base). In conjunction with the Tax Act’s reduction of the U.S. federal tax rate from 35.0% to 21.0%, the Company accrued a $7,057 tax benefit during the year ended December 31, 2017 related to the net change in deferred tax liabilities.

   

Due to the complexities involved in accounting for the recently enacted Tax Act, the U.S. Securities and Exchange Commission’s Staff Accounting Bulletin (“SAB”) 118 requires that the Company include in its financial statements the reasonable estimate of the impact of the Tax Act on earnings to the extent such reasonable estimate has been determined. Accordingly, the Company is currently estimating a zero tax liability on foreign unremitted earnings due to a net earnings and profits (“E&P”) deficit on accumulated post-1986 deferred foreign income. Therefore, as of June 30, 2018, the Company has not accrued any amount of tax expense for the Tax Act’s one-time transition tax on the foreign subsidiaries’ accumulated, unremitted earnings going back to 1986. The Company will continue to analyze historical E&P on accumulated post-1986 deferred foreign income and will record any resulting tax adjustment during 2018.

 

11. Stockholders’ Deficit

 

During the three and six months ended June 30, 2017, the Company paid dividends of $2,499 and $5,026, respectively, representing $0.225 and $0.45 per share, respectively. During August 2017, the Company discontinued its quarterly dividend of $0.225 per share.

 

14


 

12. Loss per Share

 

Basic and diluted loss per share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period.

 

The following table sets forth the computation of basic and diluted loss per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 

 

June 30, 

 

 

 

2018

 

2017

 

2018

 

2017

 

Numerator:

    

 

    

    

 

    

    

 

    

    

 

    

 

Net loss from continuing operations

 

$

(802)

 

$

(3,273)

 

$

(6,480)

 

$

(7,870)

 

Net (loss) income from discontinued operation

 

 

(15,907)

 

 

1,112

 

 

(17,521)

 

 

1,202

 

Net loss

 

$

(16,709)

 

$

(2,161)

 

$

(24,001)

 

$

(6,668)

 

Denominator: 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted weighted-average common shares outstanding

 

 

11,143,230

 

 

11,122,436

 

 

11,138,972

 

 

11,103,655

 

Basic and diluted loss per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

(0.07)

 

$

(0.30)

 

$

(0.58)

 

$

(0.71)

 

Discontinued operation

 

 

(1.43)

 

 

0.10

 

 

(1.57)

 

 

0.11

 

Net loss

 

$

(1.50)

 

$

(0.20)

 

$

(2.15)

 

$

(0.60)

 

 

The Company reported a net loss for the three and six months ended June 30, 2018 and 2017. Accordingly, the potentially dilutive effect of 957,840 and 417,418 stock options and 98,535 and 54,610 restricted stock units were excluded from the computation of diluted earnings per share as of June 30, 2018 and 2017, respectively, as their inclusion would be anti-dilutive.

 

13. Commitments and Contingencies

 

Commitments

 

The Company incurred rent expense under non-cancellable operating leases of $908 and $880 for the three months ended June 30, 2018 and 2017, respectively, and $1,776 and $1,770 for the six months ended June 30, 2018 and 2017, respectively. During the first quarter of 2018, the Company leased certain machinery and equipment under capital lease obligations, which consisted of the following at June 30, 2018:

 

 

 

 

June 30, 

 

2018

Machinery and equipment

$

748

Less current portion of capital lease obligations

 

(147)

Total long-term capital lease obligations

$

601

 

In its Condensed Consolidated Balance Sheet at June 30, 2018, the Company has recorded the current portion of capital lease obligations in “Accrued expenses” and the long-term capital lease obligations in “Other long-term liabilities”.

 

Contingencies  

 

In accordance with applicable accounting guidance, the Company establishes an accrued liability 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 liability and record a corresponding amount of litigation-related expense. The Company expenses professional fees associated with litigation claims and assessments as incurred.

 

 

15


 

In Re CPI Card Group Inc. Securities Litigation , Case No. 1:16-CV-04531 (S.D.N.Y.) (the “Class Action”)

On June 15, 2016, two purported CPI stockholders filed putative class action lawsuits captioned Vance, et al. v. CPI Card Group Inc., et al. and Chipman, et al. v. CPI Card Group Inc. in the United States District Court for the Southern District of New York (the “Court”) against CPI, certain of its former officers and current and former directors, along with the sponsors of and the financial institutions who served as underwriters for CPI’s October 2015 initial public offering (“IPO”). The complaints, purportedly brought on behalf of all purchasers of CPI common stock pursuant to the October 8, 2015 Registration Statement filed in connection with the IPO, assert claims under §§11 and 15 of the Securities Act of 1933, as amended (the “Securities Act”) and seek, among other things, damages and costs. In particular, the complaints allege that the Registration Statement contained false or misleading statements or omissions regarding CPI’s customers’ (i) purchases of Europay, MasterCard and VISA chip cards (collectively, “EMV® cards”) during the first half of fiscal year 2015 and resulting EMV® card inventory levels; and (ii) capacity to purchase additional EMV® cards in the fourth quarter of fiscal year 2015, and the remainder of the fiscal year ended December 31, 2015. The complaints allege that these actions artificially inflated the price of CPI common stock issued pursuant to the IPO.

 

On August 30, 2016, the Court consolidated the Vance and Chipman actions and appointed lead plaintiff and lead counsel pursuant to the Private Securities Litigation Reform Act (the “PSLRA”). On October 17, 2016, lead plaintiff filed a consolidated amended complaint, asserting the same claims for violations of §§11 and 15 of the Securities Act. The amended complaint is based principally on the same theories as the original complaints, but adds allegations that the Registration Statement contained inadequate risk disclosures and failed to disclose (i) small and mid-size issuers’ slower-than-anticipated conversion to EMV® technology and (ii) increased pricing pressure and competition CPI faced in the EMV® market.

 

On November 16, 2016, the Company filed a motion to dismiss the amended complaint, which was denied by the Court on October 30, 2017.   On January 12, 2018, the Company filed an answer to the amended complaint. On March 23, 2018, lead plaintiff filed his motion for class certification.  On June 11, 2018, the Company filed an opposition to lead plaintiff’s motion for class certification. 

On July 31, 2018, the parties notified the Court that they had reached an agreement in principle to settle the Class Action. The agreement in principle is subject to confirmatory discovery by the plaintiff, execution of a definitive settlement agreement and supporting documentation and final approval by the Court. The Company recorded an accrued liability as of June 30, 2018, which is not material to the financial statements, and reflects our estimate of the probable loss pursuant to an allocation of the total agreed settlement amount. There was no liability recorded as of December 31, 2017.

Heckermann v. Montross et al. , Case No. 1:17-CV-01673 (D. Del.) (the “Derivative Suit”)

 

On November 20, 2017, a purported CPI stockholder filed a stockholder derivative complaint in the United States District Court for the District of Delaware (the “Court”) against certain of CPI’s former officers and current and former directors, along with the sponsors of the IPO. CPI is also named as a nominal defendant. The derivative complaint asserts claims under §§10(b) and 20(a) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 and seeks, among other things, injunctive relief, damages and costs. It alleges false or misleading statements and omissions in the Registration Statement filed by CPI in connection with its IPO and subsequent public filings and statements. The derivative complaint also asserts claims for purported breaches of fiduciary duties, unjust enrichment, mismanagement and waste of corporate assets.

 

On March 28, 2018, the Court entered the parties’ stipulated order staying the Derivative Suit pending final determination of the Class Action.

 

The Company believes these claims are without merit and is defending the Derivative Suit vigorously. Given the current stage of these matters, the range of any potential loss is not probable or estimable and no liability has been recorded as of June 30, 2018 or December 31, 2017.

 

In addition to the matters described above, the Company is subject to routine legal proceedings in the ordinary course of business. The Company believes that the ultimate resolution of these matters will not have a material adverse effect on its business, financial condition or results of operations.

16


 

14. Stock-Based Compensation

 

CPI Card Group Inc. Omnibus Incentive Plan

 

On December 20, 2017, the Company effected a one-for-five reverse stock split of its common stock, whereby each lot of five shares of common stock issued and outstanding immediately prior to the reverse stock split was converted into and became one share of common stock. Share and per share amounts below reflect the one-for-five reverse stock split for all periods presented.

 

During 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. The Company had reserved 800,000 shares of common stock for issuance under the Omnibus Plan. Effective September 25, 2017, the Omnibus Plan was amended and restated, providing for an increase in the number of shares of common stock authorized for issuance thereunder by 400,000. The increase was made effective in the fourth quarter of 2017 by stockholder approval in accordance with applicable law, after which the Company had reserved 1,200,000 shares of common stock for issuance. As of June 30, 2018, there were 87,346 shares available for grant under the Omnibus Plan. 

During the six months ended June 30, 2018, the Company granted awards of non-qualified stock options for 52,755 shares of common stock. All stock option grants have a 10-year term and will generally vest ratably over a three-year period beginning on the first anniversary of the grant date.

The following is a summary of the activity in outstanding stock options under the Omnibus Plan:

 

 

 

 

 

 

 

 

 

    

 

    

 

    

Weighted-

 

 

 

 

Weighted-

 

Average

 

 

 

 

Average

 

Remaining

 

 

 

 

Exercise

 

Contractual Term

 

 

Options

 

Price

 

(in Years)

Outstanding as of December 31, 2017

 

937,310

 

$

17.11

 

 

Granted

 

52,755

 

 

4.16

 

 

Forfeited

 

(38,825)

 

 

19.72

 

 

Outstanding as of June 30, 2018

 

951,240

 

$

16.28

 

8.75

Options vested and exercisable as of June 30, 2018

 

116,897

 

 

34.53

 

7.90

Options vested and expected to vest as of June 30, 2018

 

951,240

 

 

16.28

 

8.75

 

The following is a summary of the activity in non-vested stock options under the Omnibus Plan:

 

 

 

 

 

 

 

 

 

 

 

Weighted-Average

 

    

Number

    

Grant-Date Fair Value

 

 

 

 

 

 

Non-vested as of December 31, 2017

 

876,903

 

$

4.08

Granted

 

52,755

 

 

1.65

Forfeited

 

(26,616)

 

 

4.75

Vested

 

(68,699)

 

 

4.60

Non-vested as of June 30, 2018

 

834,343

 

$

3.86

 

Unvested options as of June 30, 2018 will vest as follows:

 

 

 

 

2018

    

238,126

2019

 

315,036

2020

 

262,538

2021

 

18,643

Total unvested options as of June 30, 2018

 

834,343

 

17


 

The fair value of the stock option awards granted during the six months ended June 30, 2018 was determined at the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions:

 

 

 

 

 

 

 

Three Months

 

 

Ended

 

 

June 30,

 

 

2018

Expected term in years (1)

 

6.0

 

Volatility (2)

 

48.8

%

Risk-free interest rate (3)

 

2.5

%

Dividend yield (4)

 

 —

%


(1)

The Company estimated the expected term based on the average of the weighted-average vesting period and the contractual term of the stock option awards by utilizing the “simplified method”, as the Company does not have sufficient available historical data to estimate the expected term of these stock option awards.

(2)

During the first half of 2018, the Company considered the volatility of its own common stock in determining the fair value of stock option awards, in addition to a peer group average historical volatility over the expected option term. The peer group was based on financial technology companies that completed an initial public offering of common stock within the last 10 years.

(3)

The risk-free interest rate was determined by using the United States Treasury rate for the period that coincided with the expected option term.

(4)

The Company discontinued its quarterly dividend program during August 2017.

 

The weighted-average grant-date fair value of options granted was as follows:

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 

 

 

2018

 

2017

Weighted-average grant-date fair value of options granted

 

$

1.65

 

$

4.31

 

The following table summarizes the changes in the number of outstanding restricted stock units for the six-month period ended June 30, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-

 

 

 

 

 

 

 

Average

 

 

 

 

Weighted-

 

Remaining

 

    

 

    

Average

 

Amortization

 

 

 

 

Grant-Date

 

Period

 

 

Units

 

Fair Value

 

(in Years)

Outstanding as of December 31, 2017

 

49,677

 

$

16.20

 

 

Granted

 

75,188

 

 

2.66

 

 

Vested

 

(25,000)

 

 

10.00

 

 

Forfeited

 

(1,330)

 

 

22.44

 

 

Outstanding as of June 30, 2018

 

98,535

 

$

7.36

 

1.35

 

During the six months ended June 30, 2018, the Company granted awards of restricted stock units for 75,188 shares of common stock. The restricted stock units contain conditions associated with continued employment or service and generally vest one year from the date of grant. On the vesting dates, shares of common stock will be issued to the award recipients.

 

Unvested restricted stock units as of June 30, 2018 will vest as follows:

 

 

 

 

2018

    

 —

2019

 

75,188

2020

 

23,347

Total unvested restricted stock units as of June 30, 2018

 

98,535

 

18


 

 

The following table summarizes the changes in the number of outstanding cash performance units for the six-month period ended June 30, 2018:

 

 

 

 

    

Units

Outstanding as of December 31, 2017

 

822,915

Granted

 

 —

Vested

 

(260,093)

Forfeited

 

(42,636)

Outstanding as of June 30, 2018

 

520,186

 

There were no awards of cash performance units during the six months ended June 30, 2018. These awards will settle in cash in three annual payments on the first, second and third anniversaries of the date of grant. The cash performance units are based on the performance of the Company’s stock, measured based on the Company’s stock price at each of the first, second and third anniversaries of the grant date compared to the Company’s stock price on the date of grant. During the first half of 2018, the first tranche of the cash performance units vested. Accordingly, the Company made a cash payment of $137 to the award recipients.

 

The Company recognizes compensation expense on a straight-line basis for each annual performance period. The cash performance units are accounted for as a liability and remeasured to fair value at the end of each reporting period. As of June 30, 2018, the Company recognized a liability of $83 in “Accrued expenses” and $55 in “Other long-term liabilities” in the Condensed Consolidated Balance Sheet for unsettled cash performance units.

Compensation expense for the Omnibus Plan for the three months ended June 30, 2018 and 2017 was $389 and $546, respectively, and $784 and $860 for the six months ended June 30, 2018 and 2017, respectively. As of June 30, 2018, the total unrecognized compensation expense related to unvested options, restricted stock units and cash performance unit awards under the Omnibus Plan was $1,558, which the Company expects to recognize over an estimated weighted-average period of 1.4 years.

 

CPI Holdings I, Inc. Amended and Restated 2007 Stock Option Plan

 

In 2007, the Company’s Board of Directors adopted the CPI Holdings I, Inc. Amended and Restated 2007 Stock Option Plan (the “Option Plan”). Under the provisions of the Option Plan, stock options may be granted to employees, directors and consultants at an exercise price greater than or equal to (and not less than) the fair market value of a share on the date the option is granted.

 

As a result of the Company’s adoption of the Omnibus Plan, as further described above, no further awards will be made under the Option Plan. The outstanding stock options under the Option Plan are non-qualified, have a 10-year life and are fully vested as of June 30, 2018. 

 

During the six months ended June 30, 2018, there was no activity under the Option Plan. As such, total shares outstanding and exercisable were 6,600 shares with a weighted-average exercise price of $0.002 per share and a weighted-average remaining contract term of 4.91 years at June 30, 2018.

 

Compensation expense and unrecorded compensation expense related to options previously granted under the Option Plan, for the three and six months ended June 30, 2018 and 2017, were de minimis.

 

Other Stock-Based Compensation Awards

 

During June 2015, the Company issued 38,332 restricted shares of common stock to certain executives of the Company at a weighted-average grant-date fair value of $47.40. There were no outstanding unvested restricted shares of common stock as of June 30, 2018. There was no compensation expense recorded for these awards during the three or six months ended June 30, 2018. During the first quarter of 2017, the executive holding the restricted shares changed employment status to a consultant and the Company remeasured the awards and reduced stock-based compensation expense by $143. Compensation expense recorded for these awards for the three and six months ended June 30, 2017 was $(228) and $(371), respectively. 

 

19


 

15. Segment Reporting

 

The Company has identified reportable segments as those consolidated subsidiaries that represent 10% or more of its revenue, 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 revenue 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 superior to available 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 identify strategies to improve the allocation of resources amongst segments.

 

During the second quarter of 2018, the Company met the criteria to report a probable business sale in the U.K. Limited segment as a discontinued operation. On August 3, 2018, the Company completed the sale. See Note 16 “Subsequent Event” for further information. The Company no longer includes U.K. Limited as a reportable segment, and has restated all periods presented within these financial statements. 

 

During the first quarter of 2018, the Company reorganized its United States business operations and realigned its United States reporting segments to correspond with the manner with which the Company’s chief operating decision maker evaluates operating performance and makes decisions as to the allocation of resources. As a result of this realignment, the Company’s CPI on Demand business operations have been moved from the U.S. Prepaid Debit segment into the U.S. Debit and Credit reporting segment, consistent with the other related personalization operations. Segment information for previous periods has been restated to conform with this realignment and current period presentation. The restatement of the segment information for the three- and six-month periods ended June 30, 2017 was not material. 

 

As of June 30, 2018, the Company’s reportable segments were as follows:

 

    U.S. Debit and Credit,

    U.S. Prepaid Debit, and

    Other.

 

The Other category includes the Company’s corporate headquarters and a less significant operating segment that derives its revenue from the production of Financial Payment Cards and retail gift cards in Canada.

 

20


 

Performance Measures of Reportable Segments

 

Revenue and EBITDA of the Company’s reportable segments for the three and six months ended June 30, 2018 and 2017 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

 

Three Months Ended June 30, 

 

Six Months Ended June 30, 

 

 

2018

 

2017

 

2018

 

2017

U.S. Debit and Credit

    

$

43,843

    

$

42,369

    

$

80,991

    

$

82,120

U.S. Prepaid Debit

 

 

15,427

 

 

12,258

 

 

30,938

 

 

21,757

Other

 

 

2,980

 

 

3,226

 

 

5,679

 

 

5,729

Intersegment eliminations

 

 

(796)

 

 

(3,017)

 

 

(1,297)

 

 

(4,349)

Total

 

$

61,454

 

$

54,836

 

$

116,311

 

$

105,257

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

EBITDA

 

 

Three Months Ended June 30, 

 

Six Months Ended June 30, 

 

 

2018

 

2017

 

2018

 

2017

U.S. Debit and Credit

    

$

9,933

    

$

7,943

    

$

15,651

    

$

15,346

U.S. Prepaid Debit

 

 

4,687

 

 

3,636

 

 

9,506

 

 

5,649

Other

 

 

(7,463)

 

 

(6,366)

 

 

(15,247)

 

 

(13,338)

Total

 

$

7,157

 

$

5,213

 

$

9,910

 

$

7,657

 

The following table provides a reconciliation of total segment EBITDA from continuing operations to net loss for the three and six months ended June 30, 2018 and 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

June 30, 

 

June 30, 

 

    

2018

    

2017

    

2018

    

2017

Total segment EBITDA from continuing operations

 

$

7,157

 

$

5,213

 

$

9,910

 

$

7,657

Interest, net

 

 

(5,586)

 

 

(5,165)

 

 

(11,092)

 

 

(10,228)

Income tax benefit

 

 

2,593

 

 

1,014

 

 

4,578

 

 

3,371

Depreciation and amortization

 

 

(4,966)

 

 

(4,335)

 

 

(9,876)

 

 

(8,670)

Net (loss) income from discontinued operation

 

 

(15,907)

 

 

1,112

 

 

(17,521)

 

 

1,202

Net loss

 

$

(16,709)

 

$

(2,161)

 

$

(24,001)

 

$

(6,668)

 

Balance Sheet Data of Reportable Segments

 

Total assets of the Company’s reportable segments at June 30, 2018 and December 31, 2017 were as follows:

 

 

 

 

 

 

 

 

 

    

June 30, 2018

    

December 31, 2017

 

 

 

 

 

 

 

U.S. Debit and Credit

 

$

162,554

 

$

164,397

U.S. Prepaid Debit

 

 

34,352

 

 

33,130

Other

 

 

10,677

 

 

15,827

Total assets - reportable segments

 

 

207,583

 

 

213,354

Assets of discontinued operation

 

 

8,016

 

 

20,651

Total assets

 

$

215,599

 

$

234,005

 

21


 

Plant, Equipment and Leasehold Improvement Additions of Geographic Locations

 

Plant, equipment and leasehold improvement additions of the Company’s geographical locations for the three and six months ended June 30, 2018 and 2017 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

June 30, 

 

June 30, 

 

    

2018

    

2017

    

2018

    

2017

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S.

 

$

2,191

 

$

2,775

 

$

3,773

 

$

5,050

Canada

 

 

44

 

 

51

 

 

46

 

 

123

Total plant, equipment and leasehold improvement additions

 

$

2,235

 

$

2,826

 

$

3,819

 

$

5,173

 

Net Sales to Geographic Locations

 

Net sales to geographic locations for the three and six months ended June 30, 2018 and 2017 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

June 30, 

 

June 30, 

 

    

2018

    

2017

    

2018

    

2017

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S.

 

$

58,643

 

$

52,339

 

$

111,726

 

$

100,150

Other (a)

 

 

2,811

 

 

2,497

 

 

4,585

 

 

5,107

Total net sales

 

$

61,454

 

$

54,836

 

$

116,311

 

$

105,257


(a)    Amounts in Other include sales to various countries that individually are not material.

 

Long-Lived Assets of Geographic Segments

 

Long-lived assets of the Company’s geographic segments at June 30, 2018 and December 31, 2017 were as follows:

 

 

 

 

 

 

 

 

 

    

June 30, 2018

    

December 31, 2017

 

 

 

 

 

 

 

U.S.

 

$

124,402

 

$

130,768

Canada

 

 

551

 

 

911

Total long-lived assets

 

$

124,953

 

$

131,679

 

Net Sales by Products and Services

 

Net sales from products and services sold by the Company for the three and six months ended June 30, 2018 and 2017 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended 

 

Six Months Ended

 

 

June 30, 

 

June 30, 

 

    

2018

    

2017

    

2018

    

2017

 

 

 

 

 

 

 

 

 

 

 

 

 

Products net sales (a)

 

$

31,494

 

$

26,640

 

$

56,238

 

$

52,866

Services net sales (b)

 

 

29,960

 

 

28,196

 

 

60,073

 

 

52,391

Total net sales

 

$

61,454

 

$

54,836

 

$

116,311

 

$

105,257


(a)   “ Products” net sales include the design and production of Financial Payment Cards in contact-EMV ® , Dual-Interface EMV ® , contactless and magnetic stripe card formats. The Company also generates “Products” revenue from the sale of Card@Once ® instant issuance systems, private label credit cards and retail gift cards.

 

(b)    “ Services” net sales include revenue from the personalization and fulfillment of Financial Payment Cards, providing tamper-evident security packaging and fulfillment services to Prepaid Debit Card program managers and software as a service personalization of instant issuance debit cards. The Company also generates “Services” revenue from personalizing retail gift cards (primarily in Canada) and from click-fees generated from the Company’s patented card design software, known as MYCA, which provides customers and cardholders the ability to design cards on the internet and customize cards with individualized digital images.

 

22


 

16. Subsequent Event

 

On August 3, 2018, the Company completed the sale of its United Kingdom facilities that comprised the U.K. Limited reporting segment, which is reported as a discontinued operation in these financial statements. The Company sold all of the outstanding shares of CPI U.K. Limited to an affiliate of SEA Equity Limited, a private investment firm focused in the United Kingdom and Europe. See Note 3 for further information and financial statement impact from the discontinued operation.

 

 

 

23


 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation s

 

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 report. 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, 2017 filed with the Securities and Exchange Commission (“SEC”).

 

Cautionary Statement Regarding Forward-Looking Information

 

Certain statements and information in this Form 10-Q may 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 (the “1933 Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “1934 Act”). The words “believe,” “estimate,” “project,” “expect,” “anticipate,” “plan,” “intend,” “foresee,” “should,” “would,” “could” or other similar expressions are intended to identify forward-looking statements, which are generally not historical in nature. These forward-looking statements are based on our current expectations and beliefs concerning future developments and their potential effect on us, and other information currently available. Such statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected or intended. We are making investors aware that such forward-looking statements, because they relate to future events, are by their very nature subject to many important factors that could cause actual results to differ materially from those contemplated. These risks and uncertainties include, but are not limited to: system security risks, data protection breaches and cyber-attacks; interruptions in our operations, including our IT systems; defects in our software; failure to identify and attract new customers or to retain our existing customers; problems in production quality and process; failure to meet our customers’ demands in a timely manner; a loss of market share or a decline in profitability resulting from competition; developing technologies that make our existing technology solutions and products less relevant or a failure to introduce new products and services in a timely manner; disruptions relating to the development and execution of our strategy, or a failure to realize the anticipated benefits of such strategy; our inability to sell, exit, reconfigure or consolidate businesses or facilities that no longer meet with our strategy; 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 credit facility and covenants of future agreements governing indebtedness; our limited ability to raise capital in the future; our inability to adequately protect our trade secrets and intellectual property rights from misappropriation or infringement; our dependence on the timely supply of materials, products and specialized equipment from third-party suppliers; a competitive disadvantage resulting from chip operating systems developed by our competitors; price erosion in the financial payment card industry; failure to accurately predict demand for our products and services; quarterly variation in our operating results; the effect of legal and regulatory proceedings; infringement of our intellectual property rights, or claims that our technology is infringing on third-party intellectual property; our inability to realize the full value of our long-lived assets; the impact of U.S. tax reform legislation; our failure to operate our business in accordance with data privacy laws, the PCI Security Standards Council (“PCI”) security standards or other industry standards, such as Payment Card Brand certification standards; costs relating to product defects; a decline in U.S. and global market and economic conditions; potential imposition of tariffs and/or trade restrictions on goods imported into the United States; economic conditions and regulatory changes leading up to and following the United Kingdom’s exit from the European Union; our dependence on licensing arrangements; inability to renew leases for our facilities or renew leases at existing terms; dependence on our senior leadership team; inability to recruit, retain and develop qualified personnel; the continued viability of the Payment Card Brands; non-compliance with, and changes in, laws in the United States and in foreign jurisdictions in which we operate and sell our products; failure to maintain our listing on the NASDAQ and other risks and other risk factors or uncertainties identified from time to time in our filings with the SEC. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct. Reference is made to a more complete discussion of forward-looking statements and applicable risks contained under the captions “Cautionary Statement Regarding Forward-Looking Information” and “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017 filed with the SEC on March 13, 2018. CPI Card Group Inc. undertakes no obligation to update or revise any of its forward-looking statements, whether as a result of new information, future events or otherwise.

 

24


 

Overview

 

We are engaged in the design, production, data personalization, packaging and fulfillment of Financial Payment Cards, which we define as credit cards, debit cards and prepaid debit cards issued on the networks of the Payment Card Brands (Visa, MasterCard, American Express, Discover and Interac (in Canada)) in the United States and Canada. We also are engaged in the design, production, data personalization, packaging and fulfillment of retail gift and loyalty cards (primarily in Canada).  

 

As a producer and provider of services for Financial Payment Cards, each of our secure facilities must be certified by one or more of the Payment Card Brands and is therefore subject to specific requirements and conditions. Noncompliance with these requirements would prohibit the individual facilities from producing Financial Payment Cards for these entities’ payment card issuers.

 

During the second quarter of 2018, we met the criteria to report a probable business sale in the U.K. Limited segment as a discontinued operation. The financial position, results of operations and cash flows have been restated for all periods to conform with discontinued operations presentation. Unless otherwise indicated, information in Management’s Discussion and Analysis of Financial Condition and Results of Operations relates to continuing operations.

 

The major line items constituting the (loss) income of the discontinued operation for the three and six months ended June 30, 2018 and 2017 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

June 30, 

 

June 30, 

 

 

2018

 

2017

 

2018

 

2017

Total net sales

 

$

4,587

 

$

11,010

 

$

8,799

 

$

16,597

Total cost of sales

 

 

4,300

 

 

8,391

 

 

8,498

 

 

12,530

Selling, general and administrative

 

 

1,446

 

 

1,373

 

 

3,066

 

 

2,716

Impairments

 

 

7,615

 

 

 —

 

 

7,615

 

 

 —

Other expense (income), net

 

 

21

 

 

(31)

 

 

29

 

 

(85)

Pretax (loss) income from discontinued operation

 

 

(8,795)

 

 

1,277

 

 

(10,409)

 

 

1,436

  Pretax loss on discontinued operation classification

 

 

(7,244)

 

 

 —

 

 

(7,244)

 

 

 —

Total pretax (loss) income on discontinued operation

 

 

(16,039)

 

 

1,277

 

 

(17,653)

 

 

1,436

Income tax benefit (expense)

 

 

132

 

 

(165)

 

 

132

 

 

(234)

Net (loss) income from discontinued operation

 

$

(15,907)

 

$

1,112

 

$

(17,521)

 

$

1,202

 

U.K. Limited incurred a pre-tax loss from operations of $1.2 million and $2.8 million for the three and six months ended June 30, 2018, respectively, due primarily to the softness in our U.K. Limited retail sector and a decline in sales relating to certain customers. Additionally, we recorded impairment charges of $7.6 million associated with goodwill and customer relationship intangible assets, and recorded a $7.2 million loss on the discontinued operation classification.

 

During February 2018, we made the decision to consolidate three personalization operations in the United States into two facilities to better enable us to optimize operations and achieve market-leading quality and service with a cost-competitive business model. In conjunction with this decision, we accelerated the depreciation of certain related assets, which totaled $1.3 million for the three months ended June 30, 2018 and $2.1 million for the six months ended June 30, 2018, and recorded severance charges of $0.2 million, and $0.6 million for these same respective time periods.

25


 

We recorded a lease termination charge of $0.4 million in the three months ended June 30, 2018. The charges were recorded in our U.S. Debit and Credit segment.

 

Results of Continuing Operations

 

The following table presents the components of our condensed consolidated statements of continuing operations for each of the periods presented:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

June 30, 

 

June 30, 

 

    

2018

    

2017

    

2018

    

2017

 

 

(dollars in thousands)

Net sales:

 

 

 

 

 

 

 

 

 

 

 

 

Products

    

$

31,494

    

$

26,640

    

$

56,238

 

$

52,866

Services

 

 

29,960

 

 

28,196

 

 

60,073

 

 

52,391

Total net sales

 

 

61,454

 

 

54,836

 

 

116,311

 

 

105,257

Cost of sales

 

 

41,579

 

 

38,170

 

 

82,009

 

 

73,943

Gross profit

 

 

19,875

 

 

16,666

 

 

34,302

 

 

31,314

Operating expenses

 

 

17,221

 

 

15,945

 

 

34,011

 

 

32,505

Income (loss) from operations

 

 

2,654

 

 

721

 

 

291

 

 

(1,191)

Other expense, net:

 

 

 

 

 

 

 

 

 

 

 

 

Interest, net

 

 

(5,586)

 

 

(5,165)

 

 

(11,092)

 

 

(10,228)

Foreign exchange (loss) gain

 

 

(466)

 

 

153

 

 

(264)

 

 

172

Other income, net

 

 

 3

 

 

 4

 

 

 7

 

 

 6

Loss from continuing operations before taxes

 

 

(3,395)

 

 

(4,287)

 

 

(11,058)

 

 

(11,241)

Income tax benefit

 

 

2,593

 

 

1,014

 

 

4,578

 

 

3,371

Net loss from continuing operations

 

$

(802)

 

$

(3,273)

 

$

(6,480)

 

$

(7,870)

 

Segment Discussion

 

During the first quarter of 2018, the Company reorganized its United States business operations and realigned its United States reporting segments to correspond with the manner with which the Company’s chief operating decision maker evaluates operating performance and makes decisions as to the allocation of resources. As a result of this realignment, the Company’s CPI on Demand business operations have been moved from the U.S. Prepaid Debit segment into the U.S. Debit and Credit reporting segment, consistent with the other related personalization operations. Segment information for previous periods has been restated to conform with this realignment and current year presentation. The restatement of the segment information for the three- and six-month periods ended June 30, 2017 was not material.

 

Three Months Ended June 30, 2018 Compared With Three Months Ended June 30, 2017

 

Net Sales

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended  June 30, 

 

 

 

 

 

 

 

 

 

2018

    

2017

    

$ Change

    

% Change

 

 

 

 

(dollars in thousands)

 

 

Net sales by segment:

 

 

 

 

 

 

 

 

 

 

 

 

    

U.S. Debit and Credit

 

$

43,843

 

$

42,369

 

$

1,474

 

3.5

%

 

U.S. Prepaid Debit

 

 

15,427

 

 

12,258

 

 

3,169

 

25.9

%

 

Other

 

 

2,980

 

 

3,226

 

 

(246)

 

(7.6)

%

 

Eliminations

 

 

(796)

 

 

(3,017)

 

 

2,221

 

*

%

 

Total

 

$

61,454

 

$

54,836

 

$

6,618

 

12.1

%

 

* Not meaningful

 

Net sales for the three months ended June 30, 2018 increased $6.6 million, or 12.1%, to $61.5 million compared to $54.8 million for the three months ended June 30, 2017.

 

26


 

U.S. Debit and Credit:

 

Net sales for U.S. Debit and Credit for the three months ended June 30, 2018 increased $1.5 million, or 3.5%, to $43.8 million compared to $42.4 million for the three months ended June 30, 2017. The increase in net sales was primarily due to an approximate $4.0 million increase in revenue from our emerging products and solutions, including Card@Once® and metal cards, partially offset by a $2.5 million decrease in Non-EMV and other sales, card personalization and fulfillment, and EMV® card revenues due to lower average selling prices (“ASP”). 

 

For the three months ended June 30, 2018, we sold 19.1 million EMV® cards at an ASP of $0.82, compared to 18.8 million EMV® cards at an ASP of $0.86 for the three months ended June 30, 2017. The decrease in ASP during the three months ended June 30, 2018 compared to 2017 was due to lower pricing across our customer base and our customer mix.  

 

U.S. Prepaid Debit:

 

Net sales for U.S. Prepaid Debit for the three months ended June 30, 2018 increased $3.2 million, or 25.9%, to $15.4 million compared to $12.3 million for the three months ended June 30, 2017. The increase was the result of additional sales volumes from a new portfolio win with an existing customer, along with timing of certain customer sales.

 

Other:

 

Other net sales were $3.0 million for the three months ended June 30, 2018 compared to $3.2 million for the three months ended June 30, 2017.

 

Gross Profit and Gross Profit Margin

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended  June 30, 

 

 

 

 

 

 

 

 

 

 

 

 

% of 2018

 

 

 

 

% of 2017

 

 

 

 

 

  

 

 

 

2018

 

Net Sales

      

2017

    

Net Sales

      

$ Change

    

% Change

 

 

 

 

(dollars in thousands)

 

 

Gross profit by segment:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

U.S. Debit and Credit

 

$

13,856

 

31.6

%  

$

12,089

 

28.5

%  

$

1,767

 

14.6

%  

 

U.S. Prepaid Debit

 

 

5,305

 

34.4

%  

 

4,012

 

32.7

%  

 

1,293

 

32.2

%  

 

Other

 

 

714

 

24.0

%  

 

565

 

17.5

%  

 

149

 

*

%  

 

Total

 

$

19,875

 

32.3

%  

$

16,666

 

30.4

%  

$

3,209

 

19.3

%  

 

* Not meaningful; see Other category description in Note 15.

 

Gross profit for the three months ended June 30, 2018 increased $3.2 million, or 19.3%, to $19.9 million compared to $16.7 million for the three months ended June 30, 2017. Gross profit margin for the three months ended June 30, 2018 increased to 32.3% compared to 30.4% for the three months ended June 30, 2017.

 

U.S. Debit and Credit:

 

Gross profit for U.S. Debit and Credit for the three months ended June 30, 2018 increased $1.8 million, or 14.6%, to $13.9 million compared to $12.1 million during the three months ended June 30, 2017. The increase in gross profit for U.S. Debit and Credit was driven primarily by a more profitable sales mix, the increase in net sales and higher overhead cost absorption, partially offset by the acceleration of approximately $1.3 million of depreciation expense relating to the consolidation of our personalization operations. Gross profit margin for U.S. Debit and Credit for the three months ended June 30, 2018 increased to 31.6% compared to 28.5% for the same period in the prior year due to sales mix, higher overhead cost absorption attributed to increased sales, partially offset by the acceleration of depreciation expense.

   

U.S. Prepaid Debit:

 

Gross profit for U.S. Prepaid Debit during the three months ended June 30, 2018 increased 32.2% to $5.3 million compared to $4.0 million for the three months ended June 30, 2017. Gross profit margin for U.S. Prepaid Debit

27


 

for the three months ended June 30, 2018 increased to 34.4% compared to 32.7% for the three months ended June 30, 2017. The increase in gross profit and margin was attributed primarily to higher sales volumes and favorable overhead cost absorption.

 

Other:

 

Other gross profit was $0.7 million for the three months ended June 30, 2018 compared to $0.6 million for the three months ended June 30, 2017. 

 

Operating Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended  June 30, 

 

 

 

 

 

 

 

 

 

2018

    

2017

    

$ Change

    

% Change

 

 

 

 

(dollars in thousands)

 

 

Operating expenses by segment:

 

 

 

 

 

 

 

 

 

 

 

 

    

U.S. Debit and Credit

 

$

7,220

 

$

6,535

 

$

685

 

10.5

%

 

U.S. Prepaid Debit

 

 

1,087

 

 

954

 

 

133

 

13.9

%

 

Other

 

 

8,914

 

 

8,456

 

 

458

 

*

%

 

Total

 

$

17,221

 

$

15,945

 

$

1,276

 

8.0

%

 

* Not meaningful

 

Operating expenses for the three months ended June 30, 2018 increased $1.3 million, or 8.0%, to $17.2 million compared to $15.9 million for the three months ended June 30, 2017.

 

U.S. Debit and Credit:

 

U.S. Debit and Credit operating expenses increased to $7.2 million in the three months ended June 30, 2018 compared to $6.5 million in the three months ended June 30, 2017 primarily due to charges relating to the consolidation of our personalization operations.

 

U.S. Prepaid Debit:

 

U.S. Prepaid Debit operating expenses increased $0.1 million, or 13.9%, primarily due to administrative expenses.

 

Other:

 

Other operating expenses during the three months ended June 30, 2018 increased $0.5 million compared to the three months ended June 30, 2017. The net increase primarily resulted from increased compensation costs of $1.4 million and consulting and marketing costs of $0.5 million, partially offset by decreased legal costs of $1.4 million.

 

Income from Operations and Operating Margin

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended  June 30, 

 

 

 

 

 

 

 

 

 

 

 

 

% of 2018

 

 

 

 

% of 2017

 

 

 

 

 

 

 

 

 

2018

 

Net Sales

       

2017

    

Net Sales

       

$ Change

    

% Change

  

 

 

 

(dollars in thousands)

 

 

Income from operations by segment:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

U.S. Debit and Credit

 

$

6,636

 

15.1

%

$

5,554

 

13.1

%

$

1,082

 

19.5

%

 

U.S. Prepaid Debit

 

 

4,218

 

27.3

%

 

3,057

 

24.9

%

 

1,161

 

38.0

%

 

Other

 

 

(8,200)

 

*

%

 

(7,890)

 

*

%

 

(310)

 

*

%

 

Total

 

$

2,654

 

4.3

%

$

721

 

1.3

%

$

1,933

 

268.1

%

 

* Not meaningful

 

Income from operations for the three months ended June 30, 2018 was $2.7 million compared to income from operations of $0.7 million for the three months ended June 30, 2017. The Company’s operating profit margin for the

28


 

three months ended June 30, 2018 increased to 4.3% compared to an operating profit margin of 1.3% for the three months ended June 30, 2017.

 

U.S. Debit and Credit:

 

Income from operations for U.S. Debit and Credit for the three months ended June 30, 2018 increased $1.1 million, or 19.5%, to $6.6 million compared to $5.6 million for the three months ended June 30, 2017 due primarily to higher sales volume and the resulting increased overhead cost absorption discussed above, in connection with sales mix. Operating margins for the three months ended June 30, 2018 increased to 15.1% compared to 13.1% for the three months ended June 30, 2017.

 

U.S. Prepaid Debit:

 

Income from operations for U.S. Prepaid Debit for the three months ended June 30, 2018 increased 38.0% to $4.2 million compared to $3.1 million for the three months ended June 30, 2017 due to increased sales volumes and the resulting favorable overhead cost absorption discussed above. U.S. Prepaid Debit operating income margin for the three months ended June 30, 2018 increased to 27.3% from 24.9% for the same period in 2017.

 

Other :

 

The loss from operations in Other was $8.2 million for the three months ended June 30, 2018 compared to a loss from operations of $7.9 million for the same time period of 2017. The change in the loss from operations was attributable to higher operating expenses in the second quarter of 2018.

 

Interest, net :  

 

Interest expense for the three months ended June 30, 2018 increased to $5.6 million compared to $5.2 million for the three months ended June 30, 2017. The additional interest expense resulted from a higher average interest rate on the First Lien Term Loan during the three months ended June 30, 2018 compared to the three months ended June 30, 2017.

 

Income tax benefit:  

 

During the three months ended June 30, 2018, there was an income tax benefit of $2.6 million on pre-tax loss of $3.4 million, compared with an income tax benefit of $1.0 million on pre-tax loss of $4.3 million for the three months ended June 30, 2017. In c onjunction with the Tax Act, the U.S. federal tax rate reduced from 35.0% in 2017 to 21.0% in 2018. The effective tax rate differs from the federal U.S. statutory rate primarily due to the impact of a tax benefit recorded in the second quarter of 2018 in connection with the U.K. Limited discontinued operation. Partially offsetting the increased tax benefit in the second quarter of 2018 was the establishment of a partial valuation allowance on certain U.S. deferred tax assets.

 

Net loss:

 

During the three months ended June 30, 2018, net loss was $0.8 million, compared to a net loss of $3.3 million during the three months ended June 30, 2017. The change was primarily due to more profitable sales mix, higher sales volumes and improved resulting gross margin, offset by lower pricing and higher operating expenses as described above.

 

29


 

Six Months Ended June 30, 2018 Compared With Six Months Ended June 30, 2017

 

Net Sales

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 

 

 

 

 

 

 

 

    

2018

    

2017

    

$ Change

    

% Change

 

 

 

(dollars in thousands)

 

 

Net sales by segment:

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Debit and Credit

 

$

80,991

 

$

82,120

 

$

(1,129)

 

(1.4)

%

U.S. Prepaid Debit

 

 

30,938

 

 

21,757

 

 

9,181

 

42.2

%

Other

 

 

5,679

 

 

5,729

 

 

(50)

 

(0.9)

%

Eliminations

 

 

(1,297)

 

 

(4,349)

 

 

3,052

 

*

%

Total

 

$

116,311

 

$

105,257

 

$

11,054

 

10.5

%

* Not meaningful

 

Net sales for the six months ended June 30, 2018 increased $11.1 million, or 10.5%, to $116.3 million compared to $105.3 million for the six months ended June 30, 2017.

 

U.S. Debit and Credit:

 

Net sales for U.S. Debit and Credit for the six months ended June 30, 2018 decreased $1.1 million, or 1.4%, to $81.0 million compared to $82.1 million for the six months ended June 30, 2017. The decrease in net sales was primarily due to a $6.3 million decrease in EMV® card revenue, non-EMV and other sales and card personalization and fulfillment. These decreases were partially offset by a $5.2 million increase in revenue from our emerging products and solutions, including Card@Once® and metal cards.

 

For the six months ended June 30, 2018, we sold 35.9 million EMV® cards at an ASP of $0.81 compared to 37.1 million EMV® cards at an ASP of $0.85 for the six months ended June 30, 2017. The decrease in ASP during the six months ended June 30, 2018 compared to 2017 was due to lower pricing across our customer base and our customer mix.  

 

U.S. Prepaid Debit:

 

Net sales for U.S. Prepaid Debit for the six months ended June 30, 2018 increased $9.2 million, or 42.2%, to $30.9 million compared to $21.8 million for the six months ended June 30, 2017. The increase was the result of additional sales volumes predominately from new portfolio wins with two existing customers.

 

Other:

 

Other net sales were $5.7 million for both the six months ended June 30, 2018 and 2017.

 

Gross Profit and Gross Profit Margin

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended  June 30, 

 

 

 

 

 

 

 

 

 

 

 

% of 2018

 

 

 

 

% of 2017

 

 

 

 

 

 

 

 

2018

 

Net Sales

      

2017

    

Net Sales

      

$ Change

    

% Change

  

 

 

(dollars in thousands)

 

Gross profit by segment:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Debit and Credit

 

$

22,340

 

27.6

%  

$

23,599

 

28.7

%  

$

(1,259)

 

(5.3)

%  

U.S. Prepaid Debit

 

 

10,673

 

34.5

%  

 

6,555

 

30.1

%  

 

4,118

 

62.8

%  

Other

 

 

1,289

 

22.7

%  

 

1,160

 

20.2

%  

 

129

 

*

%  

Total

 

$

34,302

 

29.5

%  

$

31,314

 

29.8

%  

$

2,988

 

9.5

%  

* Not meaningful

 

30


 

Gross profit for the six months ended June 30, 2018 increased $3.0 million, or 9.5%, to $34.3 million compared to $31.3 million for the six months ended June 30, 2017. Gross profit margin for the six months ended June 30, 2018 decreased to 29.5% compared to 29.8% for the six months ended June 30, 2017.

 

U.S. Debit and Credit:

 

Gross profit for U.S. Debit and Credit for the six months ended June 30, 2018 decreased $1.3 million, or 5.3%, to $22.3 million compared to $23.6 million during the six months ended June 30, 2017. The decrease in gross profit for U.S. Debit and Credit was driven by the acceleration of depreciation expense relating to the consolidation of our personalization operations of $2.1 million, partially offset by higher margin on sales mix. Gross profit margin for U.S. Debit and Credit for the six months ended June 30, 2018 decreased to 27.6% compared to 28.7% for the same period in the prior year due to the acceleration of depreciation expense.

   

U.S. Prepaid Debit:

 

Gross profit for U.S. Prepaid Debit during the six months ended June 30, 2018 increased 62.8% to $10.7 million compared to $6.6 million for the six months ended June 30, 2017. Gross profit margin for U.S. Prepaid Debit for the six months ended June 30, 2018 increased to 34.5% compared to 30.1% for the six months ended June 30, 2017. The increase in gross profit and margin was attributed primarily to higher sales volumes and favorable overhead cost absorption.

 

Other:

 

Other gross profit was $1.3 million for the six months ended June 30, 2018 compared to $1.2 million for the six months ended June 30, 2017. 

 

Operating Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended  June 30, 

 

 

 

 

 

 

 

 

2018

    

2017

    

$ Change

    

% Change

 

 

 

(dollars in thousands)

 

Operating expenses by segment:

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Debit and Credit

 

$

13,182

 

$

13,025

 

$

157

 

1.2

%

U.S. Prepaid Debit

 

 

2,129

 

 

2,062

 

 

67

 

3.2

%

Other

 

 

18,700

 

 

17,418

 

 

1,282

 

*

%

Total

 

$

34,011

 

$

32,505

 

$

1,506

 

4.6

%

* Not meaningful

 

Operating expenses for the six months ended June 30, 2018 increased $1.5 million, or 4.6%, to $34.0 million compared to $32.5 million for the six months ended June 30, 2017.

 

U.S. Debit and Credit:

 

U.S. Debit and Credit operating expenses increased to $13.2 million in the six months ended June 30, 2018 compared to $13.0 million in the six months ended June 30, 2017 primarily due to charges relating to the consolidation of our personalization operations, offset partially by cost reduction efforts.

 

U.S. Prepaid Debit:

 

U.S. Prepaid Debit operating expenses increased $0.1 million, or 3.2%, primarily due to administrative expenses.

 

Other:

 

Other operating expenses during the six months ended June 30, 2018 increased $1.3 million compared to the six months ended June 30, 2017. The net increase primarily resulted from higher compensation costs of $1.7 million,

31


 

increased consulting and other administrative costs of $0.8 million, partially offset by a decrease in legal costs of $1.2 million.

 

Income from Operations and Operating Margin

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended  June 30, 

 

 

 

 

 

 

 

 

 

 

 

% of 2018

 

 

 

 

% of 2017

 

 

 

 

 

 

 

 

2018

 

Net Sales

       

2017

    

Net Sales

       

$ Change

    

% Change

  

 

 

(dollars in thousands)

 

Income (loss) from operations by segment:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Debit and Credit

 

$

9,158

 

11.3

%

$

10,574

 

12.9

%

$

(1,416)

 

(13.4)

%

U.S. Prepaid Debit

 

 

8,543

 

27.6

%

 

4,492

 

20.6

%

 

4,051

 

90.2

%

Other

 

 

(17,410)

 

*

%

 

(16,257)

 

*

%

 

(1,153)

 

*

%

Total

 

$

291

 

0.3

%

$

(1,191)

 

(1.1)

%

$

1,482

 

(124.4)

%

* Not meaningful

 

Income from operations for the six months ended June 30, 2018 was $0.3 million compared to a loss from operations of $1.2 million for the six months ended June 30, 2017. The Company’s operating profit margin for the six months ended June 30, 2018 increased to 0.3% compared to an operating loss margin of 1.1% for the six months ended June 30, 2017.

 

U.S. Debit and Credit:

 

Income from operations for U.S. Debit and Credit for the six months ended June 30, 2018 decreased $1.4 million, or 13.4%, to $9.2 million compared to $10.6 million for the six months ended June 30, 2017 due primarily to the acceleration of depreciation expense relating to the consolidation of our personalization operations, in addition to lower sales volume. Operating margins for the six months ended June 30, 2018 decreased to 11.3% compared to 12.9% for the six months ended June 30, 2017.

 

U.S. Prepaid Debit:

 

Income from operations for U.S. Prepaid Debit for the six months ended June 30, 2018 increased 90.2% to $8.5 million compared to $4.5 million for the six months ended June 30, 2017 due to increased sales volumes and the resulting favorable overhead cost absorption discussed above. U.S. Prepaid Debit operating income margin for the six months ended June 30, 2018 increased to 27.6% from 20.6% for the same period in 2017.

 

Other :

 

The loss from operations in Other was $17.4 million for the six months ended June 30, 2018 compared to a loss from operations of $16.3 million for the same time period of 2017. The comparatively larger operating loss was attributable to higher operating expenses in the first half of 2018.

 

Interest, net :  

 

Interest expense for the six months ended June 30, 2018 increased to $11.1 million compared to $10.2 million for the six months ended June 30, 2017. The additional interest expense resulted from a higher average interest rate on the First Lien Term Loan during the six months ended June 30, 2018 compared to the six months ended June 30, 2017.

 

Income tax benefit:  

 

During the six months ended June 30, 2018, there was an income tax benefit of $4.6 million on pre-tax loss of $11.1 million, compared with an income tax benefit of $3.4 million on pre-tax loss of $11.2 million for the six months ended June 30, 2017. In c onjunction with the Tax Act, the U.S. federal tax rate reduced from 35.0% in 2017 to 21.0% in 2018. The effective tax rate differs from the federal U.S. statutory rate primarily due to the impact of a tax benefit recorded in the second quarter of 2018 in connection with the U.K. Limited discontinued operation. Partially offsetting the increased tax benefit in the second quarter of 2018 was the establishment of a partial valuation allowance on certain U.S. deferred tax assets.

32


 

 

Net loss:

 

During the six months ended June 30, 2018, net loss was $6.5 million, compared to a net loss of $7.9 million during the six months ended June 30, 2017. The change was due to higher sales and profit, partially offset by interest expense, and increased operating expenses including costs incurred for the consolidation of our personalization operations.

 

Liquidity and Capital Resources

 

At June 30, 2018, we had $17.8 million of cash and cash equivalents. Of this amount, $1.7 million was held in accounts outside of the United States.

 

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, combined with our current cash levels and available borrowing capacity, 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.

 

At June 30, 2018, there was $312.5 million outstanding under the First Lien Term Loan, and we had a $40.0 million Revolving Credit Facility, of which $20.0 million is available for borrowing. Additional amounts may be available for borrowing during the term of the Revolving Credit Facility, up to the full $40.0 million, to the extent our net leverage ratio does not exceed 7.0 times Adjusted EBITDA, as defined in the agreement. The First Lien Term Loan and Revolving Credit Facility mature on August 17, 2022 and August 17, 2020, respectively.

 

Interest rates under the First Lien Term Loan, at the Company’s election, are based on either a Eurodollar rate, subject to an interest rate floor of 1.0%, plus a margin of 4.5%, or a base rate plus a margin of 3.5%. As of June 30, 2018, the interest rate on our First Lien Term Loan was 6.36%.

 

The First Lien Credit Facility contains customary covenants, including among other things, certain restrictions or limitations on indebtedness, issuance of liens, investments, dividends, redemptions and other distributions to equity holders, asset sales, certain mergers or consolidations, sales, transfers, leases or dispositions of substantially all of our assets and affiliate transactions. As of June 30, 2018, we were in compliance with all covenants under the First Lien Credit Facility. We may also be required to make repayments on the First Lien Term Loan in advance of the maturity date based on a calculation of excess cash flows, as defined in the agreement, with any required payments to be made after the issuance of the Company’s annual financial statements. As of June 30, 2018, we did not expect to have a required excess cash flow payment related to 2018.  

 

Operating Activities – Continuing Operations

 

Cash used in operating activities – continuing operations for the six months ended June 30, 2018 was $1.4 million compared to $7.4 million during the six months ended June 30, 2017. The year over year fluctuation was due primarily to working capital cash flow increases, including income taxes and accrued expenses.  Cash inflows from tax refunds of $1.5 million were received during the six months ended June 30, 2018.

 

Investing Activities – Continuing Operations

 

Cash used in investing activities – continuing operations for the six months ended June 30, 2018 of $2.1 million was lower than the comparative $4.3 million during the six months ended June 30, 2017. Cash used in investing activities – continuing operations during both periods was related to capital expenditures. In the current year period, capital leases were executed for the acquisition of certain machinery and equipment totaling $0.8 million. 

 

Financing Activities

 

During the six months ended June 30, 2018, cash used in financing activities was $0.3 million and related to principal payments on capital lease obligations. 

33


 

 

Cash used in financing activities during the six months ended June 30, 2017 was $5.4 million and primarily related to dividend payments of $5.0 million. The Company discontinued its quarterly dividend program during August 2017.

 

Contractual Obligations

 

During the six months ended June 30, 2018, there were no material changes in our contractual obligations from those reported in our Annual Report on Form 10-K for the year ended December 31, 2017.

 

Off-Balance Sheet Arrangements

 

We had no material off-balance sheet arrangements at June 30, 2018.

 

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 filed for the year ended December 31, 2017, for which there were no material changes as of June 30, 2018, included:

 

    Impairment Assessments of Goodwill and Long-Lived Assets,

    Inventory Valuation,

    Stock-Based Compensation and

    Income Taxes.

 

As of January 1, 2018, we adopted ASU 2014-09, Revenue from Contracts with Customers , as amended, which requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also requires an entity to disclose sufficient quantitative and qualitative information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. We adopted ASU 2014-09 as of January 1, 2018, to all of our contracts using the modified retrospective method and recognized the cumulative effect of application as an adjustment to the opening balance of “Accumulated loss” on the Condensed Consolidated Balance Sheet. The comparative financial information has not been restated and continues to be reported under the accounting standards in effect for those periods.

 

For periods after January 1, 2018, we account for our revenues as follows:

 

Products Revenue

Products” revenue is recognized when obligations under the terms of a contract with a customer are satisfied. In most instances, this occurs over time as cards are manufactured for specific customers and have no alternative use and the Company has an enforceable right to payment for work performed. For work performed but not completed and billed, we estimate revenue by taking actual costs incurred and applying historical margins for similar types of contracts. Items included in “Products” revenue are manufactured Financial Payment Cards, including in contact-EMV®, Dual-Interface EMV®, contactless and magnetic stripe cards, private label credit cards and retail gift cards. Card@Once® printers and consumables are also included in “Products” revenue, and their associated revenues are recognized at the time of shipping.

 

Services Revenue

 

Revenue is recognized for “Services” as the services are performed. Items included in “Services” revenue 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. For work performed but not completed and billed, we estimate revenue by taking actual costs incurred and applying historical margins for similar types of contracts.

34


 

 

Customer Contracts

The Company often enters into MSAs with our customers. Generally, a MSA requires a customer to place subsequent purchase orders or statements of work to obtain goods or services, thus creating enforceable rights and obligations for goods and services for the parties. The contract term as defined by ASU 2014-09 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.

 

Item 3. Quantitative and Qualitative Disclosures About Market Ris k

 

As of June 30, 2018, there have been no material changes in market risk for key input prices, labor and benefits costs or interest rate risk from those included in our Annual Report on Form 10-K for the year ended December 31, 2017.

 

Item 4. Controls and Procedure s

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended, (the "Exchange Act")) that are designed to assure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2018.

 

Changes in Internal Control Over Financial Reporting

 

Beginning January 1, 2018, we implemented ASU 2014-09, Revenue from Contracts with Customers . We developed new accounting policies based on the revenue recognition standard, and implemented changes to our processes related to revenue recognition and the related control activities. Other than as it relates to ASU 2014-09, there has been no change in the Company’s internal control over financial reporting during 2018 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

Limitations on Effectiveness of Controls

 

Our management, including our Chief Executive Officer and Chief Financial Officer, do not expect that our disclosure controls and procedures will prevent all errors and fraud. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable, not absolute, assurance of achieving the desired control objectives. Further, the design of a control system must reflect the fact that there are resource constraints, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management’s override of the control.

 

The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.    

 

35


 

PART II – Other Information

Item 1. Legal Proceedings

In Re CPI Card Group Inc. Securities Litigation , Case No. 1:16-CV-04531 (S.D.N.Y.) (the “Class Action”)

On June 15, 2016, two purported CPI stockholders filed putative class action lawsuits captioned Vance, et al. v. CPI Card Group Inc., et al. and Chipman, et al. v. CPI Card Group Inc. in the United States District Court for the Southern District of New York (the “Court”) against CPI, certain of its former officers and current and former directors, along with the sponsors of and the financial institutions who served as underwriters for CPI’s October 2015 initial public offering (“IPO”). The complaints, purportedly brought on behalf of all purchasers of CPI common stock pursuant to the October 8, 2015 Registration Statement filed in connection with the IPO, assert claims under §§11 and 15 of the Securities Act of 1933, as amended (the “Securities Act”) and seek, among other things, damages and costs. In particular, the complaints allege that the Registration Statement contained false or misleading statements or omissions regarding CPI’s customers’ (i) purchases of Europay, MasterCard and VISA chip cards (collectively, “EMV® cards”) during the first half of fiscal year 2015 and resulting EMV® card inventory levels: and (ii) capacity to purchase additional EMV® cards in the fourth quarter of fiscal year 2015, and the remainder of the fiscal year ended December 31, 2015. The complaints allege that these actions artificially inflated the price of CPI common stock issued pursuant to the IPO.

 

On August 30, 2016, the Court consolidated the Vance and Chipman actions and appointed lead plaintiff and lead counsel pursuant to the Private Securities Litigation Reform Act (the “PSLRA”). On October 17, 2016, lead plaintiff filed a consolidated amended complaint, asserting the same claims for violations of §§11 and 15 of the Securities Act. The amended complaint is based principally on the same theories as the original complaints, but adds allegations that the Registration Statement contained inadequate risk disclosures and failed to disclose (i) small and mid-size issuers’ slower-than-anticipated conversion to EMV® technology and (ii) increased pricing pressure and competition CPI faced in the EMV® market.

 

On November 16, 2016, the Company filed a motion to dismiss the amended complaint, which was denied by the Court on October 30, 2017.   On January 12, 2018, the Company filed an answer to the amended complaint. On March 23, 2018, lead plaintiff filed his motion for class certification.  On June 11, 2018, the Company filed an opposition to lead plaintiff’s motion for class certification.

On July 31, 2018, the parties notified the Court that they had reached an agreement in principle to settle the Class Action. The agreement in principle is subject to confirmatory discovery by the plaintiff, execution of a definitive settlement agreement and supporting documentation and final approval by the Court.

Heckermann v. Montross et al. , Case No. 1:17-CV-01673 (D. Del.) (the “Derivative Suit”)

 

On November 20, 2017, a purported CPI stockholder filed a stockholder derivative complaint in the United States District Court for the District of Delaware (the “Court”) against certain of CPI’s former officers and current and former directors, along with the sponsors of the IPO. CPI is also named as a nominal defendant. The derivative complaint asserts claims under §§10(b) and 20(a) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 and seeks, among other things, injunctive relief, damages and costs. It alleges false or misleading statements and omissions in the Registration Statement filed by CPI in connection with its IPO and subsequent public filings and statements. The derivative complaint also asserts claims for purported breaches of fiduciary duties, unjust enrichment, mismanagement and waste of corporate assets.

 

On March 28, 2018, the Court entered the parties’ stipulated order staying the Derivative Suit pending final determination of the Class Action.

 

The Company believes these claims are without merit and is defending the Derivative Suit vigorously.

 

 

36


 

CPI Card Group Inc. v. Multi Packaging Solutions, Inc., et al. (2 cases)

 

First case.  On October 11, 2016, the Company filed a patent infringement suit against Multi Packaging Solutions, Inc. (“MPS”) in the United States District Court for the District of Colorado. The complaint asserts that MPS ultrasecure gift card packages sold to at least one customer infringe a Company patent on ultrasecure gift card packages. MPS has answered the complaint and counterclaimed for invalidity and noninfringement. The Company’s preliminary injunction request was denied without prejudice after MPS represented that it had voluntarily ceased using the accused technology and will notify CPI before it re-starts. Discovery is underway. MPS’s early motion for summary judgment was denied in August 2017 and its motion to dismiss on jurisdictional grounds was denied in July 2018. The Company’s subsidiary CPI Card Group-Minnesota, Inc., has been added to the case as plaintiff. The Company’s patent will expire in 2028.

 

               In June 2017, MPS filed an Inter Partes Review (“IPR”) petition with the United States Patent & Trademark Office’s Patent Trial & Appeal Board (“PTAB”). The PTAB instituted the IPR on January 9, 2018. The IPR is now fully briefed. A hearing is scheduled in October 2018, and the Company anticipates a decision by the PTAB by January 2019.

 

               The Company intends to vigorously assert its intellectual property rights in connection with this litigation and the IPR.

 

Second case.     During the summer of 2017, the Company commenced a lawsuit in the District of Minnesota against a former employee, MPS, and two MPS employees (collectively, the Defendants). The former employee was a sales executive who left the Company in 2017 to join MPS. In the lawsuit, the Company alleges that the Defendants misappropriated the Company's trade secrets and confidential information, that the former employee violated his employment agreements with the Company, and that Defendants committed various related business torts. After some early discovery, the Company moved for a preliminary injunction, which the Court granted in December, 2017. The litigation is ongoing .

 

In addition to the matters described above, the Company is subject to routine legal proceedings in the ordinary course of business. The Company believes that the ultimate resolution of these matters will not have a material adverse effect on our business, financial condition or results of operations.

 

Item 1A. Risk Factor s

The risk factors disclosed in the section entitled “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017 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 no material changes with respect to such risk factors.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds  

 

Unregistered Sales of Equity Securities

 

      None.

 

Issuer Purchases of Equity Securities

 

None.

 

Item 5. Other Information

 

On August 3, 2018, we completed the sale of our three facilities in the United Kingdom that produce retail cards, such as gift and loyalty cards, for customers in the United Kingdom and continental Europe, and provide personalization, packaging and fulfillment services. The facilities sold included our Colchester, Liverpool and Derby locations. The transaction was structured as a sale of all of the outstanding shares of CPI Card Group – UK Limited, for total consideration of approximately $4.5 million, to an affiliate of SEA Equity Limited, a private investment firm focused on investments in companies in the United Kingdom and Europe. We expect to receive net cash proceeds

37


 

of approximately $0.3 million after the repayment of liabilities associated with the United Kingdom facilities, excluding tax benefits related to the structure of the sale.

 

Item 6. Exhibit s

 

 

 

 

 

 

 

Exhibit
Number

    

Exhibit Description

2.1*

 

Share Purchase Agreement, dated August 1, 2018, by and between CPI Card Group – Europe Limited, SEAFOX BIDCO Limited and CPI Acquisition, Inc.

31.1

 

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2

 

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1

 

Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

 

Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS    

 

XBRL Instance Document.

101.SCH

 

XBRL Taxonomy Extension Schema Document.

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document.

101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document.

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document.

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document.

 

 

 


* Annexes, schedules and/or exhibits have been omitted pursuant to Item 601(b)(2) of Regulation S-K. We hereby undertake to furnish supplementally a copy of any of the omitted schedules and exhibits to the SEC on a confidential basis upon request.

38


 

SIGNATURE S

 

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.

 

 

 

 

 

/s/ John Lowe

 

John Lowe

 

Chief Financial Officer

 

 

August 9, 2018

 

 

 

39


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