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 September 30, 2019.

 

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) 

 

Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:

 

 

 

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, $0.001 par value

PMTS

Nasdaq Capital Market

 

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 every Interactive Data File required to be submitted 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 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

☒

 

 

 

 

 

 

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 October 25, 2019: 11,224,191

 

 

 

Table of Contents

 

 

 

 

 

 

    

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 

 

23

 

 

 

 

 

Item 3 — Quantitative and Qualitative Disclosures About Market Risk 

 

33

 

 

 

 

 

Item 4 — Controls and Procedures 

 

33

 

 

 

 

 

 

 

 

 

Part II — Other Information 

 

 

 

 

 

 

 

Item 1 — Legal Proceedings 

 

34

 

 

 

 

 

Item 1A — Risk Factors 

 

35

 

 

 

 

 

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

 

35

 

 

 

 

 

Item 5 — Other Information 

 

35

 

 

 

 

 

Item 6 — Exhibits 

 

36

 

 

 

 

 

Signatures 

 

37

 

 

2

Item 1. Financial Statements

 

CPI Card Group Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

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

 

 

 

 

 

 

 

 

 

 

September 30, 

 

December 31, 

 

 

2019

 

2018

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

Cash and cash equivalents

 

$

14,290

 

$

20,291

Accounts receivable, net of allowances of $370 and $211, respectively

 

 

44,806

 

 

43,794

Inventories

 

 

22,105

 

 

9,827

Prepaid expenses and other current assets

 

 

3,974

 

 

4,997

Income taxes receivable

 

 

5,202

 

 

5,564

Total current assets

 

$

90,377

 

$

84,473

Plant, equipment and leasehold improvements, net

 

 

43,655

 

 

39,110

Intangible assets, net

 

 

31,951

 

 

35,437

Goodwill

 

 

47,150

 

 

47,150

Other assets

 

 

616

 

 

1,034

Total assets

 

$

213,749

 

$

207,204

Liabilities and stockholders’ deficit

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Accounts payable

 

$

14,844

 

$

16,511

Accrued expenses

 

 

21,571

 

 

23,853

Deferred revenue and customer deposits

 

 

442

 

 

912

Total current liabilities

 

$

36,857

 

$

41,276

Long-term debt

 

 

307,287

 

 

305,818

Deferred income taxes

 

 

8,357

 

 

5,749

Other long-term liabilities

 

 

11,388

 

 

3,937

Total liabilities

 

$

363,889

 

$

356,780

Commitments and contingencies (Note 13)

 

 

 

 

 

 

Stockholders’ deficit:

 

 

 

 

 

 

Common stock; $0.001 par value—100,000,000 shares authorized; 11,224,191 and 11,160,377 shares issued and outstanding at September 30, 2019 and December 31, 2018, respectively

 

 

11

 

 

11

Capital deficiency

 

 

(111,930)

 

 

(112,223)

Accumulated loss

 

 

(38,221)

 

 

(36,004)

Accumulated other comprehensive loss

 

 

 —

 

 

(1,360)

Total stockholders’ deficit

 

$

(150,140)

 

$

(149,576)

Total liabilities and stockholders’ deficit

 

$

213,749

 

$

207,204

 

See accompanying notes to condensed consolidated financial statements

 

 

 

3

CPI Card Group Inc. and Subsidiaries

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)

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

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 

 

Nine Months Ended September 30, 

 

 

2019

 

2018

    

2019

    

2018

Net sales:

 

 

 

 

 

 

 

 

 

 

 

 

Products

 

$

33,963

 

$

34,673

 

$

99,845

 

$

90,911

Services

 

 

37,718

 

 

36,314

 

 

105,603

 

 

96,387

Total net sales

 

 

71,681

 

 

70,987

 

 

205,448

 

 

187,298

Cost of sales:

 

 

 

 

 

 

 

 

 

 

 

 

Products (exclusive of depreciation and amortization shown below)

 

 

22,182

 

 

23,796

 

 

65,769

 

 

59,076

Services (exclusive of depreciation and amortization shown below)

 

 

21,329

 

 

21,214

 

 

62,142

 

 

60,991

Depreciation and amortization

 

 

2,751

 

 

2,669

 

 

8,216

 

 

9,620

Total cost of sales

 

 

46,262

 

 

47,679

 

 

136,127

 

 

129,687

Gross profit

 

 

25,419

 

 

23,308

 

 

69,321

 

 

57,611

Operating expenses, net:

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

15,936

 

 

17,033

 

 

49,146

 

 

48,119

Depreciation and amortization

 

 

1,513

 

 

1,588

 

 

4,539

 

 

4,513

Litigation settlement gain

 

 

 —

 

 

 —

 

 

(6,000)

 

 

 —

Total operating expenses, net:

 

 

17,449

 

 

18,621

 

 

47,685

 

 

52,632

Income from operations

 

 

7,970

 

 

4,687

 

 

21,636

 

 

4,979

Other expense, net:

 

 

 

 

 

 

 

 

 

 

 

 

Interest, net

 

 

(6,085)

 

 

(6,151)

 

 

(18,847)

 

 

(17,243)

Foreign currency (loss) gain

 

 

(40)

 

 

16

 

 

(1,320)

 

 

(248)

Other income, net

 

 

14

 

 

 8

 

 

25

 

 

15

Total other expense, net

 

 

(6,111)

 

 

(6,127)

 

 

(20,142)

 

 

(17,476)

Income (loss) from continuing operations before income taxes

 

 

1,859

 

 

(1,440)

 

 

1,494

 

 

(12,497)

Income tax (expense) benefit

 

 

(2,515)

 

 

355

 

 

(3,695)

 

 

4,933

Net loss from continuing operations

 

 

(656)

 

 

(1,085)

 

 

(2,201)

 

 

(7,564)

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

 

 

(28)

 

 

(5,030)

 

 

(16)

 

 

(22,551)

Net loss

 

$

(684)

 

$

(6,115)

 

$

(2,217)

 

$

(30,115)

Basic and diluted loss per share:

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted - Continuing operations

 

$

(0.06)

 

$

(0.10)

 

$

(0.20)

 

$

(0.68)

Basic and diluted  - Discontinued operation

 

 

(0.00)

 

 

(0.45)

 

 

(0.00)

 

 

(2.02)

Net loss per share

 

$

(0.06)

 

$

(0.55)

 

$

(0.20)

 

$

(2.70)

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common share outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

 

11,223,715

 

 

11,159,984

 

 

11,187,550

 

 

11,145,946

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(684)

 

$

(6,115)

 

$

(2,217)

 

$

(30,115)

Currency translation adjustment

 

 

 —

 

 

98

 

 

31

 

 

(87)

Other comprehensive loss from discontinued operations

 

 

 —

 

 

3,983

 

 

 —

 

 

3,983

Reclassification adjustment to foreign currency loss

 

 

 —

 

 

 —

 

 

1,329

 

 

 —

Total comprehensive loss

 

$

(684)

 

$

(2,034)

 

$

(857)

 

$

(26,219)

See accompanying notes to condensed consolidated financial statements

 

4

CPI Card Group Inc. and Subsidiaries

Condensed Consolidated Statements of Stockholders’ Deficit

(Dollars in Thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

other

 

 

 

 

Common Stock

 

Capital

 

Accumulated

 

comprehensive

 

 

 

    

Shares

 

Amount

 

deficiency

 

earnings (loss)

 

loss

 

Total

December 31, 2018

 

11,160,377

 

$

11

 

$

(112,223)

 

$

(36,004)

 

$

(1,360)

 

$

(149,576)

Shares issued under stock-based compensation plans

 

63,814

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Stock-based compensation

 

 —

 

 

 —

 

 

293

 

 

 —

 

 

 —

 

 

293

Components of comprehensive (loss) income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 —

 

 

 —

 

 

 —

 

 

(2,217)

 

 

 —

 

 

(2,217)

Currency translation adjustment

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

31

 

 

31

Reclassification adjustment to foreign currency loss

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

1,329

 

 

1,329

September 30, 2019

 

11,224,191

 

$

11

 

$

(111,930)

 

$

(38,221)

 

$

 —

 

$

(150,140)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

other

 

 

 

 

Common Stock

 

Capital

 

Accumulated

 

comprehensive

 

 

 

    

Shares

 

Amount

 

deficiency

 

earnings (loss)

 

loss

 

Total

June 30, 2019

 

11,223,528

 

$

11

 

$

(111,939)

 

$

(37,537)

 

$

 —

 

$

(149,465)

Shares issued under stock-based compensation plans

 

663

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Stock-based compensation

 

 —

 

 

 —

 

 

 9

 

 

 —

 

 

 —

 

 

 9

Components of comprehensive (loss) income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 —

 

 

 —

 

 

 —

 

 

(684)

 

 

 —

 

 

(684)

Reclassification adjustment to foreign currency loss

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

September 30, 2019

 

11,224,191

 

$

11

 

$

(111,930)

 

$

(38,221)

 

$

 —

 

$

(150,140)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

other

 

 

 

 

Common Stock

 

Capital

 

Accumulated

 

comprehensive

 

 

 

 

Shares

 

Amount

 

deficiency

 

earnings (loss)

 

loss

 

Total

December 31, 2017

 

11,134,714

 

$

11

 

$

(113,081)

 

$

(1,366)

 

$

(5,138)

 

$

(119,574)

Adoption of ASC 606

 

 —

 

 

 —

 

 

 —

 

 

2,795

 

 

 —

 

 

2,795

Shares issued under stock-based compensation plans

 

25,663

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Stock-based compensation

 

 —

 

 

 —

 

 

659

 

 

 —

 

 

 —

 

 

659

Components of comprehensive (loss) income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 —

 

 

 —

 

 

 —

 

 

(30,115)

 

 

 —

 

 

(30,115)

Currency translation adjustment

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

3,896

 

 

3,896

September 30, 2018

 

11,160,377

 

$

11

 

$

(112,422)

 

$

(28,686)

 

$

(1,242)

 

$

(142,339)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

other

 

 

 

 

Common Stock

 

Capital

 

Accumulated

 

comprehensive

 

 

 

    

Shares

 

Amount

 

deficiency

 

earnings (loss)

 

loss

 

Total

June 30, 2018

 

11,159,714

 

$

11

 

$

(112,377)

 

$

(22,571)

 

$

(5,323)

 

$

(140,260)

Shares issued under stock-based compensation plans

 

663

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Stock-based compensation

 

 —

 

 

 —

 

 

(45)

 

 

 —

 

 

 —

 

 

(45)

Components of comprehensive (loss) income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 —

 

 

 —

 

 

 —

 

 

(6,115)

 

 

 —

 

 

(6,115)

Currency translation adjustment

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

4,081

 

 

4,081

September 30, 2018

 

11,160,377

 

$

11

 

$

(112,422)

 

$

(28,686)

 

$

(1,242)

 

$

(142,339)

 

See accompanying notes to condensed consolidated financial statements

 

5

CPI Card Group Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Amounts in Thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 

 

    

2019

    

2018

Operating activities

 

 

 

 

 

 

Net loss

 

$

(2,217)

 

$

(30,115)

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

 

 

 

 

 

 

Loss from discontinued operation

 

 

16

 

 

22,551

Depreciation and amortization expense

 

 

12,755

 

 

14,133

Stock-based compensation expense

 

 

316

 

 

741

Amortization of debt issuance costs and debt discount

 

 

1,469

 

 

1,461

Deferred income taxes

 

 

2,608

 

 

(6,169)

Reclassification adjustment to foreign currency loss

 

 

1,329

 

 

 —

Other, net

 

 

 6

 

 

165

Changes in operating assets and liabilities:

 

 

 

 

 

 

Accounts receivable

 

 

(2,605)

 

 

(13,016)

Inventories

 

 

(12,279)

 

 

(2,628)

Prepaid expenses and other assets

 

 

1,659

 

 

711

Income taxes

 

 

331

 

 

2,207

Accounts payable

 

 

(358)

 

 

2,108

Accrued expenses

 

 

(5,574)

 

 

4,725

Deferred revenue and customer deposits

 

 

(472)

 

 

230

Other liabilities

 

 

17

 

 

1,052

Cash used in operating activities - continuing operations

 

 

(2,999)

 

 

(1,844)

Cash used in operating activities - discontinued operation

 

 

(16)

 

 

(2,914)

Investing activities

 

 

 

 

 

 

Acquisitions of plant, equipment and leasehold improvements

 

 

(3,298)

 

 

(5,028)

Cash received for sale of Canadian subsidiary

 

 

1,451

 

 

 —

Cash used in investing activities - continuing operations

 

 

(1,847)

 

 

(5,028)

Cash used in investing activities - discontinued operation

 

 

 —

 

 

(220)

Financing activities

 

 

 

 

 

 

Proceeds from revolving credit facility

 

 

11,500

 

 

 —

Payments on revolving credit facility

 

 

(11,500)

 

 

 —

Payments on financing leases

 

 

(1,175)

 

 

(388)

Cash used in financing activities

 

 

(1,175)

 

 

(388)

Effect of exchange rates on cash

 

 

36

 

 

 7

Net decrease in cash and cash equivalents

 

 

(6,001)

 

 

(10,387)

Cash and cash equivalents, beginning of period

 

 

20,291

 

 

23,205

Cash and cash equivalents, end of period

 

$

14,290

 

$

12,818

Supplemental disclosures of cash flow information

 

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

 

     Interest

 

$

17,315

 

$

14,703

     Income taxes, net payments (refunds)

 

$

675

 

$

(1,299)

Right-to-use assets obtained in exchange for lease obligations:

 

 

 

 

 

 

  Operating leases

 

$

8,533

 

$

 —

  Financing leases

 

$

5,196

 

$

821

Accounts payable and accrued expenses for acquisitions of plant, equipment and leasehold improvements

 

$

159

 

$

171

 

See accompanying notes to condensed consolidated financial statements

 

6

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 and Discover) in the United States. To a lesser extent, the Company is also engaged in the design, production, data personalization, packaging and fulfillment of retail gift and loyalty cards.  

 

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.

 

In the fourth quarter of 2018, the Company entered into a definitive agreement to sell the Company’s Canadian subsidiary to Allcard Limited, a provider of card solutions to the gift and loyalty sectors. The sale agreement did not include the portions of the business relating to Financial Payment Cards, as that business migrated to the Company’s operations in the U.S. or to other service providers in 2019. The transaction closed on April 1, 2019, and the Company received cash proceeds of $1,451.  After the payment of liabilities and transaction costs, including employee termination costs, the sale did not have a significant impact on cash, and no significant loss on sale.  In connection with the disposition of the foreign entity, the Company released the related cumulative translation adjustment from “Accumulated Other Comprehensive Loss” on the Balance Sheet into income from continuing operations during the nine months ended September 30, 2019. This adjustment was $1,329 and is included in “Foreign Currency Loss” on the Statement of Operations.  The Canadian subsidiary was not a significant operating segment and was part of the Other reportable segment.

 

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 $266 for the three months ended September 30, 2018 and $2,398 for the nine months ended September 30, 2018.  The Company recorded severance charges of $0 and $552, and recorded lease termination charges of $0 and $432 in the three and nine months ended September 30, 2018, respectively. The charges were recorded in the U.S. Debit and Credit segment and were included in “Cost of Sales” and “Selling, General, and Administrative Expenses” on the 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, 2018 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, 2018.

 

 On August 3, 2018, the Company completed the sale of its 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 Colchester, Liverpool and Derby locations. The Company reported the U.K. Limited reporting segment as discontinued operations and restated the comparative financial information for all periods presented in conformity with GAAP. Unless otherwise indicated,

7

information in these notes to the unaudited condensed consolidated financial statements relate to continuing operations. See Note 3 “Discontinued Operation” for further information.

 

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 useful lives of property and equipment, the valuation of goodwill and intangible assets, valuation allowances for inventories and accounts receivable, deferred tax assets, uncertain tax positions, discount rates used to determine right-to-use assets and lease liabilities, and revenue recognized for period-end work in process. Actual results could differ from those estimates.

 

Adoption of New Accounting Standards

 

In February 2016, the Financial Accounting Standards Board (the “FASB”) issued ASC Topic 842, Leases (“ASC 842”), 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. ASC 842 is effective for annual and interim periods beginning after December 15, 2018 (the Company’s fiscal year 2019) with early adoption permitted.  The guidance required 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. In July 2018, the FASB issued additional accounting standard updates clarifying certain provisions, as well as providing for a second transition method allowing entities to initially apply the standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings. 

The Company adopted the new guidance on the effective date of January 1, 2019 and used the adoption date as the date of initial application as allowed under ASC 842. Consequently, historical financial information has not been updated and the disclosures required under the new standard have not be provided for dates and periods before January 1, 2019.

The new standard provides a number of optional practical expedients in transition. The Company elected the ‘package of practical expedients’, which permits the Company not to reassess under the new standard its prior conclusions about lease identification, lease classification, and initial direct costs. The Company did not elect the use-of-hindsight transition practical expedient.

The new standard also provides practical expedients for the Company’s ongoing accounting. The Company elected the short-term lease recognition exemption for all leases that qualify, meaning the Company will not recognize right-of-use assets or lease liabilities for existing and new lease agreements as applicable. The Company also elected the practical expedient to not separate lease and non-lease components for all of its leases.

Right-to-use (“ROU’) represent the right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of the leases do not provide an implicit rate, the Company used its incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. If applicable, the Company used the implicit rate when readily determinable. The operating lease ROU asset also includes any lease payments made and excludes lease incentives.

A lease is deemed to exist when the Company has the right to control the use of identified property, plant or equipment, as conveyed through a contract, for a certain period of time and consideration paid. The right to control is deemed to occur when the Company has the right to obtain substantially all of the economic benefits of the identified assets and the right to direct the use of such assets.

 

As a result of the adoption of ASC 842 the Company recorded $8,025 of operating ROU assets, and corresponding operating lease liabilities of $8,813 on January 1, 2019, relating to existing real estate operating leases.

 

8

The components of operating and finance lease costs for the three and nine months ended September 30, 2019 were as follows:

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

    

September 30, 2019

   

 

September 30, 2019

Total operating lease costs

 

$

659

 

$

1,967

 

 

 

 

 

 

 

Finance lease cost:

 

 

 

 

 

 

  Amortization of right-to-use assets

 

$

273

 

$

574

  Interest on lease liabilities

 

 

98

 

 

160

  Total financing lease costs

 

$

371

 

$

734

 

The following table reflects balances for operating leases and financing leases:

 

 

 

 

 

 

 

 

 

    

September 30, 2019

Operating leases

 

 

 

Operating lease right-to-use assets, net of amortization

 

$

6,796

 

 

 

 

Operating lease liability (current)

 

$

2,218

Long-term operating liability

 

 

5,657

  Total operating lease liabilities

 

$

7,875

 

 

 

 

Financing leases

 

 

 

Property, equipment and leasehold improvements

 

$

7,014

Accumulated depreciation

 

 

(782)

  Total financing leases in property, equipment and leasehold improvements, net

 

$

6,232

 

 

 

 

Financing lease liability (current)

 

$

2,207

Long-term financing liability

 

 

3,427

  Total financing lease liabilities

 

$

5,634

 

 

 

 

Finance and operating lease right-to-use assets are recorded in “Plant, equipment and leasehold improvements, net”. Financing and operating lease liabilities are recorded in “Accrued expenses” and “Other long-term liabilities”.

Components of lease expense were as follows:

 

 

 

 

 

 

 

 

September 30, 2019

Weighted Average Remaining Lease Term

 

 

 

  Operating Leases

 

 

3.61

  Financing Leases

 

 

2.80

 

 

 

 

Weighted Average Discount Rate

 

 

 

  Operating Leases

 

 

8.95%

  Financing Leases

 

 

9.22%

 

 

 

 

 

9

Future cash payments with respect to lease obligations as of September 30, 2019 were as follows:

 

 

 

 

 

 

 

 

 

 

 

Operating

 

 

Financing

 

 

 

Lease

 

 

Leases

Year Ending

 

 

 

 

 

 

2019

 

$

696

 

$

740

2020

 

 

2,854

 

 

2,332

2021

 

 

2,646

 

 

1,716

2022

 

 

1,371

 

 

1,238

2023

 

 

1,097

 

 

178

Thereafter

 

 

602

 

 

 -

  Total lease payments

 

 

9,266

 

 

6,204

Less imputed interest

 

 

(1,391)

 

 

(570)

  Total 

 

$

7,875

 

$

5,634

 

 

 

 

 

 

 

 

Future cash payments with respect to lease obligations as of December 31, 2018 were as follows:

 

 

 

 

 

 

 

 

 

    

Operating

    

Capital

 

 

Leases

 

Leases

2019

 

$

2,927

 

$

521

2020

 

 

2,771

 

 

474

2021

 

 

2,512

 

 

243

2022

 

 

1,243

 

 

256

2023

 

 

971

 

 

71

Thereafter

 

 

652

 

 

 —

Total

 

$

11,076

 

$

1,565

 

Cash paid on operating leases was $514 and $1,448  during the three and nine months ended September 30, 2019, respectively.

 

As of January 1, 2018, the Company adopted Accounting Standards Update Codification ASC 606, Revenue from Contracts with Customers, 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. ASC 606 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 applied ASC 606 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. See Note 2 “Net Sales” for revenue recognition timing and methodology under ASC 606. 

 

Recently Issued Accounting Standards

 

In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"). This ASU changes the model for the recognition of credit losses from an incurred loss model, which recognized credit losses only if it was probable that a loss had been incurred, to an expected loss model, which requires the Company to estimate the total credit losses expected on the portfolio of financial instruments. This standard is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company does not anticipate the adoption of this standard will have a material impact on the Company’s consolidated financial position, results of operations, and cash flows.

 

10

 

2. Net Sales

 

The Company disaggregates its net sales by major source as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 2019

 

 

Products

 

Services

 

Total

U.S. Debit and Credit

 

$

34,218

 

$

17,284

 

$

51,502

U.S. Prepaid Debit

 

 

 —

 

 

20,452

 

 

20,452

Intersegment eliminations

 

 

(255)

 

 

(18)

 

 

(273)

Total

 

$

33,963

 

$

37,718

 

$

71,681

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2019

 

 

Products

 

Services

 

Total

U.S. Debit and Credit

 

$

100,338

 

$

51,179

 

$

151,517

U.S. Prepaid Debit

 

 

 —

 

 

53,162

 

 

53,162

Other

 

 

397

 

 

1,282

 

 

1,679

Intersegment eliminations

 

 

(890)

 

 

(20)

 

 

(910)

Total

 

$

99,845

 

$

105,603

 

$

205,448

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 2018

 

 

Products

 

Services

 

Total

U.S. Debit and Credit

 

$

34,176

 

$

13,826

 

$

48,002

U.S. Prepaid Debit

 

 

 —

 

 

21,190

 

 

21,190

Other

 

 

549

 

 

1,371

 

 

1,920

Intersegment eliminations

 

 

(52)

 

 

(73)

 

 

(125)

Total

 

$

34,673

 

$

36,314

 

$

70,987

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2018

 

 

Products

 

Services

 

Total

U.S. Debit and Credit

 

$

88,340

 

$

40,652

 

$

128,992

U.S. Prepaid Debit

 

 

 —

 

 

52,128

 

 

52,128

Other

 

 

3,549

 

 

4,050

 

 

7,599

Intersegment eliminations

 

 

(978)

 

 

(443)

 

 

(1,421)

Total

 

$

90,911

 

$

96,387

 

$

187,298

 

Products Net Sales

“Products” net sales are 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, 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 the design and production of Financial Payment Cards, including contact-EMV®, Dual-Interface EMV®, metal, contactless and magnetic stripe cards, private label credit cards and retail gift cards. Card@Once® printers and consumables are also included in “Products” net sales, and their associated revenues are recognized at the time of shipping.

 

The Company includes gross shipping and handling revenue and cost in net sales and cost of sales, respectively.

 

Services Net Sales

 

Revenue is recognized for “Services” as the services are performed. Items included in “Services” net sales 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. The Company also generates “Service” revenue click-fees from the Company’s patented card design software, known as MYCA, which provides customers and cardholders the ability to design cards on the internet

11

and customize cards with individualized digital images. “Services” revenue is also generated from personalizing retail gift cards historically in Canada prior to disposition. As applicable, 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, enforceable rights and obligations for goods and services occur only when a customer places a purchase order or statement of work to obtain goods or services under an MSA. 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

 

On August 3, 2018, the Company completed the sale of its United Kingdom facilities that comprised the U.K. Limited reporting segment. The Company reported the sale of the U.K. Limited reporting segment as discontinued operations and restated the comparative financial information for all periods presented in conformity with GAAP.  The Company did not retain significant continuing involvement with the discontinued operation subsequent to the disposal.

 

The major line items constituting the loss from the discontinued operation for the three and nine months ended September 30, 2018 are presented in the table below.  The amounts relating to the discontinued operation for the three and nine months ended September 30, 2019 were not significant.    

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

September 30, 2018

 

 

September 30, 2018

Total net sales

 

$

1,943

 

 

$

10,741

Total cost of sales

 

 

1,721

 

 

 

10,221

Selling, general and administrative

 

 

1,238

 

 

 

4,303

Impairments

 

 

 -

 

 

 

7,615

Other expense

 

 

4,009

 

 

 

4,038

Pretax (loss) from discontinued operation

 

 

(5,025)

 

 

 

(15,436)

Pretax loss on sale of discontinued operation

 

 

(5)

 

 

 

(7,248)

Total pretax loss on discontinued operation

 

 

(5,030)

 

 

 

(22,684)

Income tax benefit

 

 

 -

 

 

 

133

Net (loss) from discontinued operation

 

$

(5,030)

 

 

$

(22,551)

 

 

4. Accounts Receivable

 

Accounts receivable consisted of the following:

 

 

 

 

 

 

 

 

 

    

September 30, 2019

    

December 31, 2018

 

 

 

 

 

 

    

Trade accounts receivable

 

$

39,927

 

$

36,428

Unbilled accounts receivable

 

 

5,249

 

 

7,577

 

 

 

45,176

 

 

44,005

Less allowance for doubtful accounts

 

 

(370)

 

 

(211)

Accounts receivable, net

 

$

44,806

 

$

43,794

 

 

12

5.  Inventories

 

Inventories are summarized below:

 

 

 

 

 

 

 

 

 

    

September 30, 2019

    

December 31, 2018

 

 

 

 

 

 

 

Raw materials

 

$

17,963

 

$

8,235

Finished goods

 

 

5,309

 

 

2,991

Inventory reserve

 

 

(1,167)

 

 

(1,399)

 

 

$

22,105

 

$

9,827

 

 

6. Plant, Equipment and Leasehold Improvements

 

Plant, equipment and leasehold improvements consisted of the following:

 

 

 

 

 

 

 

 

 

    

September 30, 2019

    

December 31, 2018

 

 

 

 

 

 

 

Machinery and equipment

 

$

53,647

 

$

62,067

Machinery and equipment under financing leases

 

 

7,014

 

 

1,812

Furniture, fixtures and computer equipment

 

 

4,456

 

 

7,730

Leasehold improvements

 

 

14,892

 

 

19,651

Construction in progress

 

 

1,188

 

 

1,596

 

 

 

81,197

 

 

92,856

Less accumulated depreciation

 

 

(44,338)

 

 

(53,746)

Operating lease right-of-use assets, net of accumulated amortization

 

 

6,796

 

 

 —

 

 

$

43,655

 

$

39,110

 

 

 

 

 

 

 

 

Depreciation expense of plant, equipment and leasehold improvements, including depreciation of assets under financing leases, was $3,105  and $3,093 for the three months ended September 30, 2019 and 2018, respectively, and $9,268 and $10,641 for the nine months ended September 30, 2019, and 2018, respectively.

 

Operating lease right-of-use assets, net of amortization, are further described in Note 1, Business Overview and Summary of Significant Accounting  Policies.

 

7. Goodwill and Other Intangible Assets

 

The Company reports all of its goodwill in its U.S. Debit and Credit segment at September 30, 2019 and December 31, 2018.

 

Intangible assets consist of customer relationships, technology and software, non-compete agreements and trademarks. Intangible amortization expense was $1,159 and $1,164 for the three months ended September 30, 2019 and 2018, respectively, and $3,487 and $3,492 for the nine months ended September 30, 2019 and 2018, respectively. 

 

13

At September 30, 2019 and December 31, 2018, intangible assets, excluding goodwill, were comprised of the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

 

December 31, 2018

 

 

Average Life

 

 

 

 

Accumulated

 

Net Book

 

 

 

 

Accumulated

 

Net Book

 

 

(Years)

 

Cost

 

Amortization

 

Value

 

Cost

 

Amortization

 

Value

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer relationships

    

12

to

20

    

$

55,454

    

$

(28,045)

    

$

27,409

    

$

55,454

    

 

(25,587)

    

$

29,867

Technology and software

 

 7

to

10

 

 

7,101

 

 

(4,720)

 

 

2,381

 

 

7,101

 

 

(4,024)

 

 

3,077

Trademarks

 

7.5

to

10

 

 

3,330

 

 

(1,169)

 

 

2,161

 

 

3,330

 

 

(877)

 

 

2,453

Non-compete agreements

 

 5

to

 8

 

 

491

 

 

(491)

 

 

 —

 

 

491

 

 

(451)

 

 

40

Intangible assets subject to amortization

 

 

 

 

 

$

66,376

 

$

(34,425)

 

$

31,951

 

$

66,376

 

$

(30,939)

 

$

35,437

 

The estimated future aggregate amortization expense for the identified amortizable intangibles noted above as of September 30, 2019 was as follows:

 

 

 

 

 

2019

 

$

1,150

2020

    

 

4,595

2021

 

 

4,352

2022

 

 

3,867

2023

 

 

3,867

Thereafter

 

 

14,120

 

 

$

31,951

 

 

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.

 

14

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Carrying

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Value as of 

 

Fair Value as of 

 

Fair Value Measurement at September 30, 2019

 

 

September 30, 

 

September 30, 

 

 (Using Fair Value Hierarchy)

 

 

2019

 

2019

 

Level 1

 

Level 2

 

Level 3

Liabilities:

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

First Lien Term Loan

 

$

312,500

 

$

246,875

 

$

 —

 

$

246,875

 

$

 —

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Carrying

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 Value as of

 

Fair Value as of

 

Fair Value Measurement at December 31, 2018

 

 

December 31, 

 

December 31, 

 

 (Using Fair Value Hierarchy)

 

 

2018

 

2018

 

Level 1

 

Level 2

 

Level 3

Liabilities:

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

First Lien Term Loan

 

$

312,500

 

$

203,125

 

$

—

 

$

203,125

 

$

—

 

The aggregate fair value of the Company’s First Lien Term Loan, as defined in Note 10 “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.

 

 

9. Accrued Liabilities

 

Accrued liabilities consisted of the following:

 

 

 

 

 

 

 

 

 

    

September 30, 2019

    

December 31, 2018

 

 

 

 

 

 

    

Accrued payroll and related employee expenses

 

$

4,233

 

$

4,040

Accrued employee performance bonus

 

 

3,574

 

 

7,137

Accrued Interest

 

 

4,834

 

 

5,058

Operating and financing lease liability (current portion)

 

 

4,425

 

 

521

Other

 

 

4,505

 

 

7,097

Total accrued expenses

 

$

21,571

 

$

23,853

 

 

10. Long-Term Debt and Credit Facility

 

At September 30, 2019 and December 31, 2018, long-term debt and credit facilities consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

 

    

Interest

    

 

September 30, 

    

December 31, 

 

 

Rate (1)

 

 

2019

 

2018

First Lien Term Loan (1)

 

6.71

%  

 

$

312,500

 

$

312,500

Unamortized discount

 

 

 

 

 

(1,940)

 

 

(2,448)

Unamortized deferred financing costs

 

 

 

 

 

(3,273)

 

 

(4,234)

Total Long-term debt

 

 

 

 

$

307,287

 

$

305,818

(1)  Interest Rate at September 30, 2019. Interest rate at December 31, 2018 was 7.02%.

 

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.

 

15

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, 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 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 September 30, 2019, 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. The Company was not required to make any prepayments of the First Lien Term Loan with respect to our 2018 annual financial statements.

 

At September 30, 2019, 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 interest rate on the Revolving Credit Facility is the Federal base rate plus 3.5%. 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 September 30, 2019 and December 31, 2018, 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.

 

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.

 

11. Income Taxes – Continuing Operations

 

During the three months ended September 30, 2019, the Company recognized an income tax expense of $2,515 on a pre-tax income of $1,859,  compared to an income tax benefit of $355  on a pre-tax loss of $1,440 for the prior year period. During the nine months ended September 30, 2019, the Company recognized an income tax expense of $3,695 on pre-tax income of $1,494, representing an effective income tax rate of 247.3%.  For the nine months ended September 30, 2018, the Company recognized an income tax benefit of $4,933 on a pre-tax loss of $12,497, representing an effective income tax rate of 39.5%.

 

For the nine months ended September 30, 2019 and 2018, the effective tax rate differs from the U.S. federal statutory income tax rate as follows:

 

 

 

 

 

 

 

 

September 30,

 

 

 

2019

    

2018

    

Tax at federal statutory rate

 

21.0

%

21.0

%

State Taxes, net

 

38.0

 

0.5

 

Valuation allowance

 

174.1

 

(2.5)

 

Tax benefit U.K. discontinued operation

 

 —

 

27.7

 

Other

 

14.2

 

(7.2)

 

Effective income tax rate

 

247.3

%

39.5

%

16

 

The effective tax rate differs from the federal U.S. statutory rate primarily due to the impact of tax expense recorded related to a partial valuation allowance of $2,600 on certain U.S. deferred tax assets at an effective income tax rate impact of 174.1% for the nine months ended September 30, 2019.  The partial valuation allowance is due to the limitation on the deductibility of business interest expense which is a provision of U.S. government tax reform legislation enacted in December 2017.  For the nine months ended September 30, 2018, the primary reason that the effective tax rate differs from the federal U.S. statutory rate is due to a tax benefit recorded in connection with the U.K. Limited discontinued operation. The Company’s income tax receivable on the condensed consolidated balance sheet as of September 30, 2019, is primarily comprised of a  $5,005 U.S. federal income tax receivable relating to a prior tax year. 

 

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

 

Nine Months Ended

 

 

 

September 30, 

 

September 30, 

 

 

    

2019

    

2018

 

2019

 

2018

 

Numerator:

 

 

 

 

 

 

    

 

    

    

 

    

 

Net loss from continuing operations

 

$

(656)

 

$

(1,085)

 

$

(2,201)

 

$

(7,564)

 

Net loss from discontinued operation

 

 

(28)

 

 

(5,030)

 

 

(16)

 

 

(22,551)

 

Net loss

 

$

(684)

 

$

(6,115)

 

$

(2,217)

 

$

(30,115)

 

Denominator: 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and Diluted weighted-average common shares outstanding

 

 

11,223,715

 

 

11,159,984

 

 

11,187,550

 

 

11,145,946

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted-Continuing operations

 

$

(0.06)

 

$

(0.10)

 

$

(0.20)

 

$

(0.68)

 

Basic and diluted-Discontinued operation

 

 

(0.00)

 

 

(0.45)

 

 

(0.00)

 

 

(2.02)

 

Basic and diluted net loss per share

 

$

(0.06)

 

$

(0.55)

 

$

(0.20)

 

$

(2.70)

 

 

The Company reported a net loss for the three and nine months ended September 30, 2019 and 2018. Accordingly, the potentially dilutive effect of 840,819 and 666,101 stock options and 9,256 and 68,811 restricted stock units were excluded from the computation of diluted earnings per share as of September 30, 2019 and 2018, respectively, as their inclusion would be anti-dilutive.

 

13. Commitments and Contingencies; Litigation Settlement 

 

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.

 

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 CPI’s October 2015 initial public offering (“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

17

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 In Re CPI Card Group Inc. Securities Litigation, Case No. 1:16-CV-04531 (S.D.N.Y.) (the “Class Action”), which was dismissed in its entirety, with prejudice, on February 25, 2019.  Under its terms, the stay of the Derivative Suit was lifted 30 days after the entry of final judgment in the Class Action which was entered on February 25, 2019.  The Derivative Suit litigation is ongoing.

Given the current stage of this matter, the range of any potential loss is not probable or estimable and no liability has been recorded as of September 30, 2019 and December 31, 2018.

Litigation Settlement

CPI Card Group Inc. v. Multi Packaging Solutions, Inc., et al. Second Case

During the summer of 2017, the Company and its subsidiary, CPI Card Group – Minnesota, Inc. (together, the “Company Plaintiffs”), commenced a lawsuit in the United States District Court for the District of Minnesota against a former employee, Multi Packaging Solutions, Inc. (“MPS”), and two MPS employees as individuals (collectively, the Defendants).  On June 12, 2019, the Company Plaintiffs and the Defendants reached a settlement pursuant to which the case was resolved and dismissed by mutual agreement on terms that provided for, among other things, a cash payment to the Company.  The Company received a $6,000 cash settlement payment during the second quarter of 2019, and recorded the gain within income from operations, in the Other segment.  The case was dismissed in its entirety, with prejudice, by court order on July 12, 2019.  For further information see Part II-Item 1. Legal Proceedings.

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.

 

14. Stock-Based Compensation

 

CPI Card Group Inc. Omnibus Incentive Plan

 

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 September 30, 2019, there were 228,555 shares available for grant under the Omnibus Plan. 

During the nine months ended September 30, 2019, the Company did not grant any awards of non-qualified stock options.

18

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, 2018

 

910,627

 

$

14.99

 

 

Granted

 

 —

 

 

 —

 

 

Forfeited

 

(69,808)

 

 

12.45

 

 

Outstanding as of September 30, 2019

 

840,819

 

$

15.20

 

7.62

Options vested and exercisable as of September 30, 2019

 

517,794

 

 

16.57

 

7.52

Options vested and expected to vest

 

840,819

 

 

15.20

 

7.62

 

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, 2018

 

605,352

 

$

3.14

Granted

 

 -

 

 

 -

Forfeited

 

(51,567)

 

 

3.25

Vested

 

(230,760)

 

 

2.28

Non-vested as of September 30, 2019

 

323,025

 

$

3.74

 

Unvested options as of September 30, 2019, will vest as follows:

 

 

 

 

2019

 

45,345

2020

 

225,980

2021

 

51,700

Total unvested options as of September 30, 2019

 

323,025

 

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

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 

 

 

2019

 

2018

Weighted-average grant-date fair value of options granted

 

$

n/a

 

$

1.20

 

The following table summarizes the changes in the number of outstanding restricted stock units:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-

 

 

 

 

 

 

 

 

Average

 

 

 

 

 

Weighted-

 

Remaining

 

 

    

 

    

Average

 

Amortization

 

 

 

 

 

Grant-Date

 

Period

 

 

 

Units

 

Fair Value

 

(in Years)

 

Outstanding as of December 31, 2018

 

68,649

 

$

6.25

 

 

 

Granted

 

 —

 

 

 

 

 

 

Vested

 

(57,563)

 

 

3.15

 

 

 

Forfeited

 

(1,830)

 

 

21.75

 

 

 

Outstanding as of September 30, 2019

 

9,256

 

$

22.44

 

0.60

 

 

During the nine months ended September 30, 2019, the Company did not grant any awards of restricted stock units.

 

 

19

Unvested restricted stock units as of September 30, 2019, will vest as follows:

 

 

 

 

2019

 

 —

2020

 

9,013

2021

 

243

Total unvested restricted stock units as of September 30, 2019

 

9,256

 

The following table summarizes the changes in the number of outstanding cash performance units:

 

 

 

 

 

    

Units

Outstanding as of December 31, 2018

 

425,012

Granted

 

 

Vested

 

(212,505)

Forfeited

 

(40,181)

Outstanding as of September 30, 2019

 

172,326

 

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 of March 22, 2017, compared to the Company’s stock price on the date of grant. During the nine months of 2019, the second tranche of the cash performance units vested. Accordingly, the Company made a cash payment of $106 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 re-measured to fair value at the end of each reporting period. As of September 30, 2019, the Company recognized a liability of $73 in “Accrued expenses” in the Condensed Consolidated Balance Sheet for unsettled cash performance units.

Compensation expense for the Omnibus Plan for the three months ended September 30, 2019 and 2018 was $9 and $(42), as a result of forfeitures, respectively. Compensation expense for the nine months ended September 30, 2019 and 2018 was $317 and $741, respectively. As of September 30, 2019, the total unrecognized compensation expense related to unvested options, restricted stock units and cash performance unit awards under the Omnibus Plan was $217, which the Company expects to recognize over an estimated weighted-average period of 0.93 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.

 

During the nine months ended September 30, 2019, the remaining 6,600 outstanding shares were exercised.  As such, there were no outstanding shares remaining as of September 30, 2019.

 

Compensation expense and unrecorded compensation expense related to options previously granted under the Option Plan, for the three and nine months ended September 30, 2019 and 2018, were de minimis.  

 

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

20

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.

 

On August 3, 2018, the Company completed the sale of the U.K. Limited segment. See Note 3 “Discontinued Operation” for further information. The Company has restated all historical periods presented within these financial statements and has not included U.K. Limited as a reportable segment. 

 

As of September 30, 2019, 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 historically derived its revenue from the production of financial payment cards and retail gift cards in Canada. The Company’s Canadian subsidiary was sold on April 1, 2019. The sale agreement did not include the portions of the business relating to Financial Payment Cards, as those business customers of the Canadian subsidiary migrated to the Company’s operations in the U.S. or to other service providers in 2019.

Performance Measures of Reportable Segments

 

Revenue and EBITDA of the Company’s reportable segments for the three and nine months ended September 30, 2019, and 2018, were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Sales

 

 

Three Months Ended September 30, 

 

Nine Months Ended September 30, 

 

 

2019

 

2018

 

2019

 

2018

U.S. Debit and Credit

    

$

51,502

    

$

48,002

    

$

151,517

    

$

128,992

U.S. Prepaid Debit

 

 

20,452

 

 

21,190

 

 

53,162

 

 

52,128

Other

 

 

 —

 

 

1,920

 

 

1,679

 

 

7,599

Intersegment eliminations

 

 

(273)

 

 

(125)

 

 

(910)

 

 

(1,421)

Total

 

$

71,681

 

$

70,987

 

$

205,448

 

$

187,298

 

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

EBITDA

 

 

Three Months Ended September 30, 

 

Nine Months Ended September 30, 

 

 

2019

 

2018

 

2019

 

2018

U.S. Debit and Credit

    

$

11,417

    

$

9,136

    

$

32,387

    

$

24,788

U.S. Prepaid Debit

 

 

8,342

 

 

8,831

 

 

20,001

 

 

18,337

Other

 

 

(7,551)

 

 

(8,999)

 

 

(19,292)

 

 

(24,246)

Total

 

$

12,208

 

$

8,968

 

$

33,096

 

$

18,879

 

The following table provides a reconciliation of total segment EBITDA from continuing operations to net loss from continuing operations for the three and nine months ended September 30, 2019, and 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

September 30, 

 

September 30, 

 

    

2019

    

2018

    

2019

    

2018

Total segment EBITDA from continuing operations

 

$

12,208

 

$

8,968

 

$

33,096

 

$

18,879

Interest, net

 

 

(6,085)

 

 

(6,151)

 

 

(18,847)

 

 

(17,243)

Income tax (expense) benefit

 

 

(2,515)

 

 

355

 

 

(3,695)

 

 

4,933

Depreciation and amortization

 

 

(4,264)

 

 

(4,257)

 

 

(12,755)

 

 

(14,133)

Net loss from continuing operations

 

$

(656)

 

$

(1,085)

 

$

(2,201)

 

$

(7,564)

 

21

Balance Sheet Data of Reportable Segments

 

Total assets of the Company’s reportable segments at September 30, 2019, and December 31, 2018, were as follows:

 

 

 

 

 

 

 

 

 

    

September 30, 2019

    

December 31, 2018

 

 

 

 

 

 

 

U.S. Debit and Credit

 

$

174,139

 

$

169,567

U.S. Prepaid Debit

 

 

30,432

 

 

25,117

Other

 

 

9,178

 

 

12,520

Total assets

 

$

213,749

 

$

207,204

 

Net Sales by Products and Services

 

Net sales from products and services sold by the Company for the three and nine months ended September 30, 2019 and 2018 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended 

 

Nine Months Ended

 

 

September 30, 

 

September 30, 

 

    

2019

    

2018

    

2019

    

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

Products net sales (a)

 

$

33,963

 

$

34,673

 

$

99,845

 

$

90,911

Services net sales (b)

 

 

37,718

 

 

36,314

 

 

105,603

 

 

96,387

Total net sales

 

$

71,681

 

$

70,987

 

$

205,448

 

$

187,298

(a)   “Products” net sales include the design and production of Financial Payment Cards in contact-EMV, Dual-Interface EMV, metal, contactless and magnetic stripe card formats. The Company also generates “Products” revenue from the sale of Card@Once printers and consumables, 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 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. “Services” revenue is also generated from personalizing retail gift cards, historically generated in Canada prior to the disposition.

 

Net Sales to Geographic Locations, Property, Equipment and Leasehold Improvements and Long-Lived Assets

 

Subsequent to the sale of the Company’s U.K. Limited segment and reclassification to discontinued operations, and the sale of the Company’s Canada operations on April 1, 2019, the Company’s Net Sales, Property, Equipment and Leasehold Improvements, and Long-Lived assets relating to geographic locations outside of the United States is insignificant.

 

22

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

 

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, 2018 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: 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 and the resulting restraints on our ability to pursue our business strategies; our limited ability to raise capital in the future; system security risks, data protection breaches and cyber-attacks and possible exposure to litigation and/or regulatory penalties under applicable data privacy and other laws for failure to prevent such incidents; interruptions in our operations, including our information technology systems, or in the operations of the third parties that operate the data centers or computing infrastructure on which we rely; our failure to maintain our listing on the NASDAQ Capital Market; our inability to adequately protect our trade secrets and intellectual property rights from misappropriation or infringement, claims that our technology is infringing on the intellectual property of others, and risks related to open source software; defects in our software; problems in production quality and process; our failure to retain our existing customers or identify and attract new customers; a loss of market share or a decline in profitability resulting from competition; our inability to recruit, retain and develop qualified personnel, including key personnel; 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; the effect of legal and regulatory proceedings; 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; quarterly variation in our operating results; our inability to realize the full value of our long-lived assets; our failure to operate our business in accordance with the PCI Security Standards Council (“PCI”) security standards or other industry standards such as Payment Card Brand certification standards; costs relating to the obligatory collection of sales tax and claims for uncollected sales tax in states that impose sales tax collection requirements on out-of-state retailers; disruption or delays in our manufacturing operations or supply chain; a decline in U.S. and global market and economic conditions and resulting decreases in consumer and business spending; costs relating to product defects and any related product liability and/or warranty claims; maintenance and further imposition of tariffs and/or trade restrictions on goods imported into the United States; our dependence on licensing arrangements; non-compliance with, and changes in, laws in the United States and in foreign jurisdictions in which we operate and sell our products; risks associated with the controlling stockholders’ ownership of our stock; and other risks that are described in Part I, Item 1A – Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2018 filed with the SEC on March 6, 2019 and our other reports filed from time to time with the Securities and Exchange Commission (the “SEC”).  

 

We caution and advise readers not to place undue reliance on forward-looking statements, which speak only as of the date hereof. These statements are based on assumptions that may not be realized and involve risks and uncertainties that could cause actual results to differ materially from the expectations and beliefs contained herein. We

23

undertake no obligation to publicly update or revise any forward-looking statements after the date they are made, whether as a result of new information, future events or otherwise.

 

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 and Discover in the United States). To a lesser extent, the Company is also engaged in the design, production, data personalization, packaging and fulfillment of retail gift and loyalty cards. 

 

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.

 

In the fourth quarter of 2018, we entered into a definitive agreement to sell our Canadian subsidiary to Allcard Limited, a provider of card solutions to the gift and loyalty sectors. The sale agreement did not include the portions of the business relating to Financial Payment Cards, as that business migrated to our operations in the U.S. or to other service providers in 2019. The transaction closed on April 1, 2019, and we received cash proceeds of $1.5 million.  After the payment of liabilities and transaction costs, including employee termination costs, the sale did not have a significant impact on cash, and no significant loss on sale.  In connection with the disposition of the foreign entity, we released the related cumulative translation adjustment from “Accumulated Other Comprehensive Loss” on the Balance Sheet into income from continuing operations during the nine months ended September 30, 2019. This adjustment was $1.3 million and is included in “Foreign Currency Loss” on the Statement of Operations.  The Canadian subsidiary was not a significant operating segment and was part of the Other reportable segment.

 

On August 3, 2018, we completed the sale of the U.K. Limited segment. The historical financial position, results of operations and cash flows for the U.K. Limited segment 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 from the discontinued operation for the three and nine months ended September 30, 2018 are presented in the table below.  The amounts relating to the discontinued operation for the three and nine months ended September 30, 2019 were not significant.

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

September 30, 2018

 

 

September 30, 2018

Total net sales

 

$

1,943

 

 

$

10,741

Total cost of sales

 

 

1,721

 

 

 

10,221

Selling, general and administrative

 

 

1,238

 

 

 

4,303

Impairments

 

 

 -

 

 

 

7,615

Other expense

 

 

4,009

 

 

 

4,038

Pretax (loss) from discontinued operation

 

 

(5,025)

 

 

 

(15,436)

Pretax loss on sale of discontinued operation

 

 

(5)

 

 

 

(7,248)

Total pretax loss on discontinued operation

 

 

(5,030)

 

 

 

(22,684)

Income tax benefit

 

 

 -

 

 

 

133

Net (loss) from discontinued operation

 

$

(5,030)

 

 

$

(22,551)

 

U.K. Limited incurred losses from operations during the three and nine months ended September 30, 2018 due to the softness in the U.K. 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 sale of the discontinued operation.

 

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 $0.3 million for the three months ended September 30, 2018, and $2.4 million for the nine months

24

ended September 30, 2018.  We recorded a lease termination charge of $0 and $0.4 million and recorded severance charges of $0 and $0.6 million in the three and nine months ended September 30, 2018, respectively. 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

 

Nine Months Ended

 

 

September 30, 

 

September 30, 

 

    

2019

    

2018

    

2019

    

2018

 

 

(dollars in thousands)

Net sales:

 

 

 

 

 

 

 

 

 

 

 

 

Products

 

$

33,963

 

$

34,673

    

$

99,845

 

$

90,911

Services

 

 

37,718

 

 

36,314

 

 

105,603

 

 

96,387

Total net sales

 

 

71,681

 

 

70,987

 

 

205,448

 

 

187,298

Cost of sales

 

 

46,262

 

 

47,679

 

 

136,127

 

 

129,687

Gross profit

 

 

25,419

 

 

23,308

 

 

69,321

 

 

57,611

Selling, general and administrative (including depreciation and amortization)

 

 

17,449

 

 

18,621

 

 

53,685

 

 

52,632

Litigation settlement gain

 

 

 —

 

 

 —

 

 

(6,000)

 

 

 —

Income from operations

 

 

7,970

 

 

4,687

 

 

21,636

 

 

4,979

Other expense, net:

 

 

 

 

 

 

 

 

 

 

 

 

Interest, net

 

 

(6,085)

 

 

(6,151)

 

 

(18,847)

 

 

(17,243)

Foreign exchange (loss) gain

 

 

(40)

 

 

16

 

 

(1,320)

 

 

(248)

Other income, net

 

 

14

 

 

 8

 

 

25

 

 

15

Income (loss) from continuing operations before taxes

 

 

1,859

 

 

(1,440)

 

 —

1,494

 

 

(12,497)

Income tax (expense) benefit

 

 

(2,515)

 

 

355

 

 

(3,695)

 

 

4,933

Net loss from continuing operations

 

$

(656)

 

$

(1,085)

 

$

(2,201)

 

$

(7,564)

 

Refer to Part II, Item 1, Legal Proceedings, for further information regarding the cash litigation settlement gain.

 

Segment Discussion

 

Three Months Ended September 30, 2019 Compared With Three Months Ended September 30, 2018

 

Net Sales

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended  September 30, 

 

 

 

 

 

 

 

 

2019

    

2018

    

$ Change

    

% Change

 

 

 

(dollars in thousands)

 

Net sales by segment:

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Debit and Credit

 

$

51,502

 

$

48,002

 

$

3,500

 

7.3

%

U.S. Prepaid Debit

 

 

20,452

 

 

21,190

 

 

(738)

 

(3.5)

%

Other

 

 

 —

 

 

1,920

 

 

(1,920)

 

(100.0)

%

Eliminations

 

 

(273)

 

 

(125)

 

 

(148)

 

*

%

Total

 

$

71,681

 

$

70,987

 

$

694

 

1.0

%

* Not meaningful

 

Net sales for the three months ended September 30, 2019, increased $0.7 million, or 1.0%, to $71.7 million compared to $71.0 million for the three months ended September 30, 2018. 

 

U.S. Debit and Credit:

 

Net sales for U.S. Debit and Credit for the three months ended September 30, 2019, increased $3.5 million, or 7.3%, to $51.5 million compared to $48.0 million for the three months ended September 30, 2018. The net sales increase

25

was primarily due to higher volumes of card personalization and fulfillment, dual-interface EMV® card sales, and higher Card@Once® sales.  Dual-interface EMV cards have additional technology to process contactless transactions and generally have a higher selling price than other contact-only EMV® cards, which benefitted the current year period sales increase as compared to the prior year period. 

 

U.S. Prepaid Debit:

 

Net sales for U.S. Prepaid Debit for the three months ended September 30, 2019, decreased $0.7 million, or 3.5%, to $20.5 million, compared to $21.2 million for the three months ended September 30, 2018. The decrease was the result of less sales volumes from our existing customer base.

 

Other:

 

In the three months ended September 30, 2018, Other net sales were $1.9 million.  During the three months ended September 30, 2019, there were no sales in the Other segment.  In April 2019, we sold the Canadian subsidiary and no longer have any operations contributing to Other net sales. 

 

Gross Profit and Gross Profit Margin

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended  September 30, 

 

 

 

 

 

 

 

 

 

 

 

 

% of 2019

 

 

 

 

% of 2018

 

 

 

 

 

  

 

 

    

2019

    

Net Sales

    

2018

    

Net Sales

    

$ Change

    

% Change

 

 

 

 

(dollars in thousands)

 

 

Gross profit by segment:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Debit and Credit

 

$

16,503

 

32.0

%  

$

13,551

 

28.2

%  

$

2,952

 

21.8

%  

 

U.S. Prepaid Debit

 

 

8,916

 

43.6

%  

 

9,439

 

44.5

%  

 

(523)

 

(5.5)

%  

 

Other

 

 

 —

 

*

%  

 

318

 

16.6

%  

 

(318)

 

*

%  

 

Total

 

$

25,419

 

35.5

%  

$

23,308

 

32.8

%  

$

2,111

 

9.1

%  

 

* Not meaningful;

 

Gross profit for the three months ended September 30, 2019, increased $2.1 million, or 9.1%, to $25.4 million compared to $23.3 million for the three months ended September 30, 2018. Gross profit margin for the three months ended September 30, 2019 increased to 35.5% compared to 32.8% for the three months ended September 30, 2018.

 

U.S. Debit and Credit:

 

Gross profit for U.S. Debit and Credit for the three months ended September 30, 2019, increased $3.0 million, or 21.8%, to $16.5 million compared to $13.6 million during the three months ended September 30, 2018. The increase in gross profit and gross profit margin for U.S. Debit and Credit segment was driven primarily by higher card personalization and fulfillment sales and efficiencies gained from the consolidation of our personalization operations in the prior year. Higher priced dual-interface EMV cards sales, and higher Card@Once sales also contributed to the increase in gross margin. Partially offsetting these increases was higher card manufacturing material costs driven primarily by a mix of certain products. Gross profit margin increased to 32.0% during the three months ended September 30, 2019, compared to 28.2% in the prior year period.  

   

U.S. Prepaid Debit:

 

Gross profit for U.S. Prepaid Debit during the three months ended September 30, 2019, decreased 5.5% to $8.9 million compared to $9.4 million for the three months ended September 30, 2018. Gross profit margin for U.S. Prepaid Debit for the three months ended September 30, 2019, decreased to 43.6% compared to 44.5% for the three months ended September 30, 2018. The decrease in gross profit and margin was attributed to lower sales resulting in lower cost absorption.

 

Other:

 

In the three months ended September 30, 2018, Other gross profit was $0.3 million. In April 2019, we sold our Canadian subsidiary and no longer have any operations contributing to Other net sales or gross profit.

 

26

Operating Expenses, net

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended  September 30, 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

% of 2019

 

 

 

 

% of 2018

 

 

 

 

 

 

 

 

    

2019

    

Net Sales

    

2018

    

Net Sales

    

$ Change

    

% Change

 

 

 

 

(dollars in thousands)

 

 

Operating expenses, net,  by segment:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Debit and Credit

 

$

7,649

 

14.9

%

$

7,060

 

14.7

%

$

589

 

8.3

%

 

U.S. Prepaid Debit

 

 

1,100

 

5.4

%

 

1,050

 

5.0

%

 

50

 

4.8

%

 

Other

 

 

8,700

 

*

%

 

10,511

 

*

%

 

(1,811)

 

(17.2)

%

 

Total

 

$

17,449

 

24.3

%

$

18,621

 

26.2

%

$

(1,172)

 

(6.3)

%

 

* Not meaningful;

 

Operating expenses, net, for the three months ended September 30, 2019, decreased $1.2 million, or 6.3%, to $17.4 million compared to $18.6 million for the three months ended September 30, 2018.

 

U.S. Debit and Credit:

 

U.S. Debit and Credit operating expenses increased $0.6 million to $7.6 million in the three months ended September 30, 2019 compared to $7.1 million in the three months ended September 30, 2018, due to increased selling and compensation costs.    

 

U.S. Prepaid Debit:

 

U.S. Prepaid Debit operating expenses were flat for the three months ended September 30, 2019 when compared to the three months ended September 30, 2018.  The total operating expenses were $1.1 million in both of the three months ended September 30, 2019, and September 30, 2018. 

 

Other:

 

Other operating expenses during the three months ended September 30, 2019 decreased $1.8 million compared to the three months ended September 30, 2018, primarily from decreased legal fees, and a reduction in costs due to the sale of our Canadian subsidiary.

 

Income from Operations and Operating Margin

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended  September 30, 

 

 

 

 

 

 

 

 

 

 

 

 

% of 2019

 

 

 

 

% of 2018

 

 

 

 

 

 

 

 

    

2019

    

Net Sales

    

2018

    

Net Sales

    

$ Change

    

% Change

  

 

 

 

(dollars in thousands)

 

 

Income (loss) from operations by segment:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Debit and Credit

 

$

8,858

 

17.2

%

$

6,491

 

13.5

%

$

2,367

 

36.5

%

 

U.S. Prepaid Debit

 

 

7,815

 

38.2

%

 

8,389

 

39.6

%

 

(574)

 

(6.8)

%

 

Other

 

 

(8,703)

 

*

%

 

(10,193)

 

*

%

 

1,490

 

14.6

%

 

Total

 

$

7,970

 

11.1

%

$

4,687

 

6.6

%

$

3,283

 

70.0

%

 

* Not meaningful

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from operations for the three months ended September 30, 2019 was $8.0 million compared to income from operations of $4.7 million for the three months ended September 30, 2018. The Company’s operating income margin for the three months ended September 30, 2019 increased to 11.1% compared to 6.6% for the three months ended September 30, 2018. 

 

U.S. Debit and Credit:

 

Income from operations for U.S. Debit and Credit for the three months ended September 30, 2019 increased $2.4 million, to $8.9 million compared to $6.5 million for the three months ended September 30, 2018 due primarily to higher card personalization and fulfillment sales and efficiencies gained from the consolidation of our personalization

27

operations in the prior year, higher dual-interface EMV cards sales, and Card@Once sales. The impact of these improvements to income from operations were partially offset by higher operating expenses and higher card manufacturing material costs driven by a mix of certain products. Operating margins for the three months ended September 30, 2019 increased to 17.2% compared to 13.5% for the three months ended September 30, 2018. 

 

U.S. Prepaid Debit:

 

Income from operations for U.S. Prepaid Debit for the three months ended September 30, 2019 decreased to $7.8 million compared to $8.4 million for the three months ended September 30, 2018 primarily due to lower sales volumes. U.S. Prepaid Debit operating income margin for the three months ended September 30, 2019 decreased to 38.2% from 39.6% for the same period in 2018, primarily as a result of lower cost absorption from lower sales.

 

Other:

 

The loss from operations in Other was $8.7 million for the three months ended September 30, 2019 compared to a loss from operations of $10.2 million for the same time period in 2018. The improvement is loss from operations was primarily due to the reduction in operating expenses as described above and the effects from the sale of our Canadian subsidiary by eliminating prior year Canadian losses. 

 

Interest, net:  

 

Interest expense for the three months ended September 30, 2019 decreased to $6.1 million compared to $6.2 million for the three months ended September 30, 2018. Our average interest rate decreased on the First Lien Term Loan for the three months ended September 30, 2019 compared to the same period in 2018. 

 

Income tax benefit (expense): 

 

During the three months ended September 30, 2019, we recorded an income tax expense of $2.5  million on pre-tax income of $1.9 million, representing an effective income tax rate of 135.3%.  During the three months ended September 30, 2018, we recorded an income tax benefit of $0.4 million on pre-tax loss of $1.4 million, representing an effective tax rate of 24.7%. For the quarter ended September 30, 2019, the effective tax rate differs from the federal U.S. statutory rate of 21.0% primarily due to the impact of the partial valuation allowance, which is due to the limitation on the deductibility of business interest expense,  a provision of U.S. government tax reform legislation.     

 

Net loss from continuing operations:

 

During the three months ended September 30, 2019, net loss from continuing operations was $0.7 million, compared to a $1.1 million net loss during the three months ended September 30, 2018. The change was primarily due to higher net sales and gross profit, lower operating expenses, and offset by higher income tax expense in the third quarter of 2019.

 

 

Nine Months Ended September 30, 2019 Compared With Nine Months Ended September 30, 2018

 

Net Sales

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 

 

 

 

 

 

 

 

    

2019

    

2018

    

$ Change

    

% Change

 

 

 

(dollars in thousands)

 

 

Net sales by segment:

 

 

 

 

 

 

 

 

 

 

 

    

U.S. Debit and Credit

 

$

151,517

 

$

128,992

 

$

22,525

 

17.5

%

U.S. Prepaid Debit

 

 

53,162

 

 

52,128

 

 

1,034

 

2.0

%

Other

 

 

1,679

 

 

7,599

 

 

(5,920)

 

(77.9)

%

Eliminations

 

 

(910)

 

 

(1,421)

 

 

511

 

*

%

Total

 

$

205,448

 

$

187,298

 

$

18,150

 

9.7

%

 

28

Net sales for the nine months ended September 30, 2019 increased $18.2 million, or 9.7%, to $205.4 million compared to $187.3 million for the nine months ended September 30, 2018.

 

U.S. Debit and Credit:

 

Net sales for U.S. Debit and Credit for the nine months ended September 30, 2019, increased $22.5 million, or 17.5%, to $151.5 million compared to $129.0 million for the nine months ended September 30, 2018. The net sales increase was primarily due to higher volumes of dual-interface EMV cards, card personalization and fulfillment, as well as higher Card@Once sales. Dual-interface EMV cards have additional technology to process contactless transactions and generally have a higher selling prices.    

 

U.S. Prepaid Debit:

 

Net sales for U.S. Prepaid Debit for the nine months ended September 30, 2019, increased $1.0 million, or 2.0%, to $53.2 million, compared to $52.1 million for the nine months ended September 30, 2018. The increase was the result of additional sales volumes from our existing customer base.

 

Other:

 

Other net sales were $1.7 million for the nine months ended September 30, 2019, compared to $7.6 million for the nine months ended September 30, 2018. The decrease was a result of lower sales volumes during the first quarter of 2019, and the disposition of our Canada subsidiary on April 1, 2019. 

 

Gross Profit and Gross Profit Margin

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended  September 30, 

 

 

 

 

 

 

 

 

 

 

 

% of 2019

 

 

 

 

% of 2018

 

 

 

 

 

 

 

 

2019

 

Net Sales

      

2018

    

Net Sales

      

$ Change

    

% Change

  

 

 

(dollars in thousands)

 

Gross profit by segment:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Debit and Credit

 

$

47,647

 

31.4

%  

$

35,891

 

27.8

%  

$

11,756

 

32.8

%  

U.S. Prepaid Debit

 

 

21,771

 

41.0

%  

 

20,111

 

38.6

%  

 

1,660

 

8.3

%  

Other

 

 

(97)

 

(5.8)

%  

 

1,609

 

21.2

%  

 

(1,706)

 

*

%  

Total

 

$

69,321

 

33.7

%  

$

57,611

 

30.8

%  

$

11,710

 

20.3

%  

 

Gross profit for the nine months ended September 30, 2019, increased $11.7 million, or 20.3%, to $69.3 million compared to $57.6 million for the nine months ended September 30, 2018. Gross profit margin for the nine months ended September 30, 2019 increased to 33.7 % compared to 30.8% for the nine months ended September 30, 2018.

 

U.S. Debit and Credit:

 

Gross profit for U.S. Debit and Credit for the nine months ended September 30, 2019, increased $11.8 million, or 32.8%, to $47.6 million compared to $35.9 million during the nine months ended September 30, 2018. The increase in gross profit and gross profit margin for U.S. Debit and Credit was driven primarily by increased sales volumes and favorable overhead cost absorption. In addition, higher card personalization and fulfillment sales and efficiencies gained from the consolidation of our personalization operations in the prior year improved gross profit and gross profit margin in 2019. Partially offsetting the gross profit margin increase compared to the prior year-to-date period were higher card manufacturing material costs driven primarily by a mix of certain products. Gross profit margin increased to 31.4% during the nine months ended September 30, 2019, compared to 27.8% in the prior year period.  

   

U.S. Prepaid Debit:

 

Gross profit for U.S. Prepaid Debit during the nine months ended September 30, 2019 increased 8.3% to $21.8 million compared to $20.1 million for the nine months ended September 30, 2018. Gross profit margin for U.S. Prepaid Debit for the nine months ended September 30, 2019 increased to 41.0% compared to 38.6% for the nine months ended September 30, 2018. The increase in gross profit and gross margin was attributed to higher sales volumes from our existing customer base and favorable product mix.

29

 

Other:

 

Other gross loss was $0.1 million for the nine months ended September 30, 2019 compared to gross profit of $1.6 million for the nine months ended September 30, 2018.  The decrease was a result of lower sales volumes during the first quarter of 2019, and the disposition of our Canada subsidiary on April 1, 2019. 

 

Operating Expenses, net

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended  September 30, 

 

 

 

 

 

 

 

 

 

 

2019

 

 

 

2018

 

    

 

$ Change

    

% Change

 

 

 

(dollars in thousands)

 

Operating expenses, net,  by segment:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Debit and Credit

 

$

23,027

 

15.2

%

$

20,241

 

15.7

%

$

2,786

 

13.8

%

U.S. Prepaid Debit

 

 

3,266

 

6.1

%

 

3,179

 

6.1

%

 

87

 

2.7

%

Other

 

 

27,392

 

*

%

 

29,212

 

*

%

 

(1,820)

 

(6.2)

%

Other-litigation settlement

 

 

(6,000)

 

*

%

 

 —

 

*

%

 

(6,000)

 

*

%

Total

 

$

47,685

 

23.2

%

$

52,632

 

28.1

%

$

(4,947)

 

(9.4)

%

 

Operating expenses, net, for the nine months ended September 30, 2019 decreased $5.0 million, or 9.4%, to $47.7 million compared to $52.6 million for the nine months ended September 30, 2018.  The cash litigation settlement gain received in the second quarter contributed $6.0 million to the decline in operating expenses, net, for the nine months ended September 30, 2019, compared to the prior year period, and was partially offset by an increase in operating expenses of $1.1 million. 

 

U.S. Debit and Credit:

 

U.S. Debit and Credit operating expenses increased $2.8 million to $23.0 million in the nine months ended September 30, 2019 compared to $20.2 million in the nine months ended September 30, 2018, due to increased selling and compensation costs. This increase was partially offset by the impact of charges relating to the consolidation of our personalization operations incurred in 2018.

 

U.S. Prepaid Debit:

 

U.S. Prepaid Debit operating expenses were essentially flat for the nine months ended September 30, 2019 when compared to the nine months ended September 30, 2018.

 

Other:

 

Other operating expenses decreased $1.8 million, or 6.2%, to $27.4 million compared to $29.2 million for the nine months ended September 30, 2018.  Other operating expenses declined due to lower legal fees and savings from the sale of our Canadian subsidiary for the nine months ended September 30, 2019. During the second quarter of 2019, we received $6.0 million cash related to a litigation settlement as described previously, which was recorded as a reduction to net operating expenses in the Other segment.

 

Income from Operations and Operating Margin

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended  September 30, 

 

 

 

 

 

 

 

 

 

 

 

% of 2019

 

 

 

 

% of 2018

 

 

 

 

 

 

 

 

2019

 

Net Sales

       

2018

    

Net Sales

       

$ Change

    

% Change

  

 

 

(dollars in thousands)

 

Income (loss) from operations by segment:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Debit and Credit

 

$

24,619

 

16.2

%

$

15,650

 

12.1

%

$

8,969

 

57.3

%

U.S. Prepaid Debit

 

 

18,505

 

34.8

%

 

16,932

 

32.5

%

 

1,573

 

9.3

%

Other

 

 

(21,488)

 

*

%

 

(27,603)

 

*

%

 

6,115

 

22.2

%

Total

 

$

21,636

 

10.5

%

$

4,979

 

2.7

%

$

16,657

 

334.5

%

30

 

Income from operations for the nine months ended September 30, 2019 was $21.6 million compared to income from operations of $5.0 million for the nine months ended September 30, 2019. The Company’s operating profit margin for the nine months ended September 30, 2019, increased to 10.5% compared to an operating profit margin of 2.7% for the nine months ended September 30, 2018.  In the second quarter of 2019, we received $6.0 million cash for a litigation settlement which was recorded through income from operations within the Other segment.  

 

U.S. Debit and Credit:

 

Income from operations for U.S. Debit and Credit for the nine months ended September 30, 2019 increased $9.0 million, to $24.6 million compared to $15.7 million for the nine months ended September 30, 2018. The increase in income from operations was driven by increased sales volumes, favorable overhead cost absorption, higher card personalization and fulfillment sales, and efficiencies gained from the consolidation of our personalization operations. The impact of these improvements to income from operations were partially offset by higher card manufacturing material costs driven primarily by a mix of certain products, and higher operating expenses. Operating margins for the nine months ended September 30, 2019, increased to 16.2% compared to 12.1% for the nine months ended September 30, 2018. 

 

U.S. Prepaid Debit:

 

Income from operations for U.S. Prepaid Debit for the nine months ended September 30, 2019, increased to $18.5 million compared to $16.9 million for the nine months ended September 30, 2018. The increase in income from operations was attributed to higher sales volumes from our existing customer base and favorable cost absorption due to higher sales. U.S. Prepaid Debit operating income margin for the nine months ended September 30, 2019 increased to 34.8% from 32.5% for the same period in 2018.

 

Other:

 

The loss from operations in Other was $21.5 million for the nine months ended September 30, 2019, compared to a loss from operations of $27.6 million for the same time period in 2018. The 2019 loss benefited primarily from the $6.0 million cash litigation settlement gain in the second quarter of 2019.

 

Interest, net:  

 

Interest expense for the nine months ended September 30, 2019, increased $1.6 million to $18.8 million compared to $17.2 million for the nine months ended September 30, 2018. The additional interest expense resulted primarily from a higher average interest rate on the First Lien Term Loan for the nine months ended September 30, 2019 compared to the same period in 2018. 

 

Income tax benefit (expense):

 

During the nine months ended September 30, 2019, we recorded income tax expense of $3.7 million on pre-tax income of $1.5 million, representing an effective income tax rate of 247.3%.  During the nine months ended September 30, 2018, we recorded an income tax benefit of $4.9 million on pre-tax loss of $12.5 million, representing an effective tax rate of 39.5%. The effective tax rate differs from the federal U.S. statutory rate in 2019 primarily due to the impact of tax expense recorded related to a partial valuation allowance of $2.6 million on certain U.S. deferred tax assets at an effective income tax rate impact of 174.1% for the nine months ended September 30, 2019.  The partial valuation allowance is due to the limitation on the deductibility of business interest expense which is a provision of U.S. government tax reform legislation enacted in December 2017.  In the prior year period, the effective tax rate differs from the federal U.S. statutory rate primarily due to a tax benefit recorded in connection with the U.K. Limited discontinued operation.    

 

Net loss from continuing operations:

 

During the nine months ended September 30, 2019, net loss from continuing operations was $2.2 million, compared to a $7.6 million loss during the nine months ended September 30, 2018. The change was primarily due to the $6.0 million cash litigation settlement gain, higher net sales and gross profit, offset partially by higher interest expense and income taxes in the 2019 period.

31

 

Liquidity and Capital Resources

 

At September 30, 2019, we had $14.3 million of cash and cash equivalents. Of this amount, $0.2 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, 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.

 

The Company is party to a First Lien Credit Facility, dated as of August 17, 2015, that includes both a Term Loan facility and a $40.0 million Revolving Credit Facility, of which $20.0 million was available for borrowing as of September 30, 2019.  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.  As of September 30, 2019, our net leverage ratio was 9.0 times Adjusted EBITDA. The First Lien Term Loan and Revolving Credit Facility mature on August 17, 2022 and August 17, 2020, respectively. We may also be required to make prepayments 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 prepayments to be made after the issuance of our annual financial statements. We were not required to make any prepayments of the First Lien Term Loans with respect to our 2018 annual financial statements.

 

At September 30, 2019, $312.5 million of First Lien Term Loan was outstanding and no loans were outstanding under the Revolving Credit Facility. 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 September 30, 2019, the interest rate on our First Lien Term Loan was 6.71%. The interest rate on the Revolving Credit Facility is the Federal base rate plus 3.5%.

 

 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 September 30, 2019, we were in compliance with all covenants under the First Lien Credit Facility.

 

Operating Activities – Continuing Operations

 

Cash used in operating activities – continuing operations for the nine months ended September 30, 2019, was $3.0 million compared to a usage of $1.8 million during the nine months ended September 30, 2018. The year over year fluctuation was due primarily to an improvement in net loss from continuing operations of $5.4 million, including the $6.0 million cash received from the litigation settlement, offset by working capital cash flow changes primarily in accounts receivable, inventory, and accrued expenses when compared to the prior year.  For the nine months ended September 30, 2019, we had a cash usage of $12.3 million related to our investment in inventory to support the growth of the business.  We also had a cash usage in accrued expenses related primarily to employee performance incentive compensation earned in 2018 and paid in the first quarter of 2019.  Cash interest paid during the nine months ended September 30, 2019, was $17.3 million, which was higher than the prior year period by $2.6 million.  Cash inflows from tax refunds of $1.3 million were received during the nine months ended September 30, 2018. 

 

Investing Activities – Continuing Operations

 

Cash used in investing activities – continuing operations for the nine months ended September 30, 2019 was $1.8 million, compared to a usage of $5.0 million during the nine months ended September 30, 2018. Cash used in investing activities – continuing operations was related to capital expenditures, including investments to support the growth of the business in 2019, such as machinery and information technology equipment.  Partially offsetting the capital expenditure outflows, we received cash of $1.5 million for the sale of our Canadian subsidiary in the second quarter of 2019.  As presented in our supplemental disclosures of non-cash information on the statement of cash flows,  

32

finance leases were executed for the acquisition of right-to-use machinery and equipment assets totaling $5.2 million, and $0.8 million during the nine months ended September 30, 2019, and 2018, respectively.

 

Financing Activities

 

During the nine months ended September 30, 2019 and 2018, cash used in financing activities was $1.2 million and $0.4 million, respectively, and related to principal payments on finance lease obligations.  For working capital purposes, we borrowed and repaid $11.5 million on the Revolving Credit Facility during the nine months ended September 30, 2019, all occurring within the first and second quarter of 2019.  We had no borrowings or payments on the Revolving Credit Facility during the three months ended September 30, 2019, and no balance outstanding as of September 30, 2019. 

 

Contractual Obligations

 

During the nine months ended September 30, 2019, 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, 2018.

 

Off-Balance Sheet Arrangements

 

We had no material off-balance sheet arrangements at September 30, 2019.

 

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, 2018, for which there were no material changes as of September 30, 2019, included:

 

·

Impairment Assessments of Goodwill and Long-Lived Assets,

·

Inventory Valuation,

·

Revenue recognition

·

Stock-Based Compensation and

·

Income Taxes. 

 

Since  the date of our annual report we adopted ASC 842 Leases, and record lease liabilities and assets as the present value of future minimum lease payments using a discount rate that is either implicit in the lease or our incremental borrowing rate. We estimate our incremental borrowing rate by using market data from companies similar to us, having publically traded debt instruments and similar credit ratings. Our estimated incremental borrowing rate utilizes judgements, including selection of comparable companies, our credit risk, sensitivity analysis and valuation estimates for inclusion in the calculated rate.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Not required due to smaller reporting company status. 

 

Item 4. Controls and Procedures

 

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

33

evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2019.

 

Changes in Internal Control over Financial Reporting

 

There have not been any changes in the Company’s internal control over financial reporting that occurred during the third quarter of 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company implemented changes to internal controls due to the adoption of Accounting Standard Update No. 2016-02, Leases (Accounting Standard Codification Topic 842) effective January 1, 2019. These changes include processes to evaluate and account for contracts under the new accounting standard. There were no significant changes to the Company’s internal control over financial reporting due to the adoption of the new standard.

 

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 resource constraints, which require management 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.  

 

PART II – Other Information

Item 1. Legal Proceedings  

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 CPI’s October 2015 initial public offering (“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 In Re CPI Card Group Inc. Securities Litigation, Case No. 1:16-CV-04531 (S.D.N.Y.) (the “Class Action”), which was dismissed in its entirety, with prejudice, on February 25, 2019.  Under its terms, the stay of the Derivative Suit was lifted 30 days after the entry of final judgment in the Class Action which was entered on February 25, 2019.  The Derivative Suit litigation is ongoing.

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 ultra-secure gift card packages sold to at least one customer infringe a Company patent on ultra-secure gift card packages. MPS answered the complaint and counterclaimed for invalidity and non-infringement. The Company’s

34

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. 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”) to review the patent at issue in the patent infringement suit. The PTAB instituted the IPR on January 9, 2018. The PTAB entered its final written decision on January 4, 2019, determining that all of the claims in the patent are unpatentable. The Company filed an appeal of this decision to the federal circuit court on March 1, 2019.  The patent infringement suit is administratively dismissed pending the final determination of the patent validity.

Second case.    During the summer of 2017, the Company and its subsidiary, CPI Card Group – Minnesota, Inc. (together, the “Company Plaintiffs”), commenced a lawsuit in the United States District Court for the District of Minnesota against a former employee, Multi Packaging Solutions, Inc. (“MPS”), and two MPS employees as individuals (collectively, the Defendants).  MPS is a competitor of the Company Plaintiffs and the former employee was a sales executive who left the Company Plaintiffs in 2017 to join MPS.  In the lawsuit, the Company Plaintiffs alleged, among other things, that the Defendants misappropriated the Company Plaintiffs’ trade secrets and confidential information and that the former employee violated his employment agreements with the Company Plaintiffs.  After some early discovery, the Company Plaintiffs moved for a preliminary injunction, which the Court granted in December, 2017. The Company Plaintiffs received a second preliminary injunction in August 2018.  On June 12, 2019, the Company Plaintiffs and the Defendants reached a settlement pursuant to which the case was resolved and dismissed by mutual agreement on terms that provided for, among other things, a cash payment to the Company and ongoing protections of the Company Plaintiffs’ trade secrets and confidential information, together with certain restrictions on the former employee and another individual defendant to protect the Company’s customer relationships. The case was dismissed in its entirety, with prejudice, by court order on July 12, 2019.  For further information see Part I-Financial Information, Note 13.

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 Factors

The risk factors disclosed in the section entitled “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2018 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 October 31, 2019, Jason Bohrer stepped down from his position with the Company as Senior Vice President and General Manager, Secure Card, effective October 31, 2019.  Mr. Bohrer will remain an employee and provide transition assistance through December 13, 2019.  Mr. Bohrer is eligible to receive a cash severance and certain other benefits under the Company’s executive severance guidelines, the terms of which are described in the Company’s proxy statement filed on April 12, 2019.

 

35

Item 6. Exhibits

 

 

 

 

 

 

 

Exhibit
Number

    

Exhibit Description

 

 

 

10.1

 

2020 Executive Retention Agreement, dated September 11, 2019 between CPI Card Group Inc. and Scott Scheirman.

10.2

 

Form of 2020 Executive Retention Agreement, dated September 11, 2019 for certain Executive Officers.

10.3

 

Form of 2020 Executive Short-Term Incentive Plan.

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.

 

 

 

36

SIGNATURES

 

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.

 

 

 

 

November 6, 2019

/s/ John Lowe

 

John Lowe

 

Chief Financial Officer

 

(Principal Financial Officer)

 

 

 

37

CPI Card (NASDAQ:PMTS)
Historical Stock Chart
From Mar 2024 to Apr 2024 Click Here for more CPI Card Charts.
CPI Card (NASDAQ:PMTS)
Historical Stock Chart
From Apr 2023 to Apr 2024 Click Here for more CPI Card Charts.