CPI Card Group Inc. (PMTS) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion in conjunction with the consolidated financial statements and the notes to those statements included elsewhere in this Annual Report on Form 10-K. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, some of which are not within our control. See "Risk Factors" and “Cautionary Statement Regarding Forward-Looking Statements.”
Company Overview
We are a payments technology company and leading provider of comprehensive Financial Payment Card solutions in the United States. We define “Financial Payment Cards” as credit, debit and Prepaid Debit Cards (as defined below) issued on the networks of the “Payment Card Brands” (Visa, Mastercard®, American Express® and Discover®). We define “Prepaid Debit Cards” as debit cards issued on the networks of the Payment Card Brands, but not linked to a traditional bank account. We also offer an instant card issuance solution, which provides customers the ability to issue a personalized debit or credit card within the bank branch to individual cardholders. We have established a leading position in the Financial Payment Card solutions market through more than 20 years of experience.
We serve a diverse set of several thousand customers which includes direct customers and indirect customer relationships whereby CPI provides Financial Payment Card solutions to a customer through a Group Service Provider (as defined below). Our customers include some of the largest issuers of debit and credit cards in the United States, the
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largest Prepaid Debit Card program managers in the United States, numerous financial technology companies (“fintechs”), as well as independent community banks, credit unions and Group Service Providers. We define “Group Service Providers” as reseller or card processor organizations that assist small card issuers, such as credit unions, with managing their credit and debit card programs, including managing the Financial Payment Card issuance process, core banking operations and other financial services.
We serve our customers through a network of high-security production and card services facilities in the United States, each of which is audited for compliance with the standards of the Payment Card Industry Security Standards Council (the “PCI Security Standards Council”) by one or more of the Payment Card Brands. Many of our customers require us to comply with PCI Security Standards Council requirements that relate to the provision of our products and services. Our network of high-security production facilities allows us to optimize our solutions offerings and to serve the needs of our diverse customer base.
Driven by a combination of our strong relationships, quality, technology, and innovation, we believe we have strong positions in the following markets:
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | the U.S. prepaid debit market, including the largest U.S. Prepaid Debit Card program managers; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | the U.S. small to mid-sized financial institutions market, which includes independent community banks and credit unions; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | the U.S. large issuer market, serving some of the largest U.S. debit and credit card issuers; and |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | the U.S. fintech market, where we produce and personalize Financial Payment Cards for financial technology companies. |
Trends and Key Factors Affecting our Financial Performance
We believe the following key factors may have a meaningful impact on our business performance and may negatively influence our financial and operating results:
We believe some customers have reduced demand for our products and services and we may experience reduced demand from customers in the future due to the following:
●Some large banks point toward the possibility that the U.S. economy may experience an economic slowdown in the near future, which we believe has caused, and may continue to cause, some of our customers, particularly in the banking and financial services industry, to have concerns about the broader economic environment and therefore reduce overall spending, delay spending into future periods, or request pricing concessions, including on card programs or other products and services we offer.
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Some of our customers have anticipated supply-chain-related delays and have correspondingly increased their own inventory of the Company’s products on hand during 2022. As supply-chain lead times have improved and given the economic concerns noted above, we believe some customers have become and continue to remain more focused on reducing their inventory levels. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Certain banks have experienced negative liquidity events, including takeover by industry regulators and deposit outflows, which have had the effect of deteriorating share prices and limiting access to capital, leading to cautionary signals and uncertainty in the financial services industry. Following these events, we experienced reduced demand in the Debit and Credit segment. |
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Segment Overview
Our business consists of the following reportable segments:
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Debit and Credit; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Prepaid Debit; and |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Other. |
Debit and Credit Segment
Our Debit and Credit segment primarily produces Financial Payment Cards and provides integrated card services, including digital services, for card-issuing financial institutions and fintechs primarily in the United States. Products produced by this segment primarily include EMV® and non-EMV Financial Payment Cards, including contact and contactless (dual-interface) cards and plastic and encased metal cards, and Second Wave payment cards featuring a core made with ROBP, and other private label credit cards that are not issued on the networks of the Payment Cards Brands. We also sell Card@Once® printers and related supplies as part of our proprietary and patented instant card issuance system. Services provided include a variety of integrated card services, including card personalization and fulfillment services. We also provide print-on-demand services, where we produce images, personalized payment cards and related collateral on a one-by-one, on-demand basis for our customers, as well as our Card@Once software-as-a-service (SaaS) solution. The Debit and Credit segment operations are each audited for compliance by one or more of the Payment Card Brands. Many of our customers require us to comply with the standards of the PCI Security Standards Council.
Prepaid Debit Segment
Our Prepaid Debit segment primarily provides integrated prepaid card services to Prepaid Debit Card providers in the United States, including tamper-evident security packaging. This segment also produces Financial Payment Cards issued on the networks of the Payment Card Brands that are included in the tamper-evident security packages. The Prepaid Debit segment operation is audited for compliance by one or more of the Payment Card Brands. Many of our customers require us to comply with the standards of the PCI Security Standards Council.
Other
Our Other segment includes corporate general and administrative expenses.
Key Components of Results of Operations
Set forth below is a brief description of key line items of our consolidated statements of operations and comprehensive income.
Net Sales
Net sales reflect our revenue generated from the sale of products and services. Product net sales include the design and production of Financial Payment Cards, including contact and contactless cards, which includes our eco-focused cards. Contactless EMV cards have additional technology to process contactless transactions and generally have a higher selling price than contact-only EMV cards. We also generate product revenue from the sale of our Card@Once instant issuance system and consumables, private label credit cards and retail gift cards. Services net sales include revenue from the personalization and fulfillment of Financial Payment Cards, including print-on-demand services, tamper-evident security packaging, fulfillment services and SaaS personalization of instant issuance Financial Payment cards. See Part II, Item 8, Financial Statements and Supplementary Data, Note 2 “Summary of Significant Accounting Policies” and Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, “Critical Accounting Policies and Estimates—Revenue Recognition” in this Annual Report on Form 10-K for further information and timing of revenue recognition for net sales. We include gross shipping and handling revenue in net sales.
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Cost of Sales
Cost of sales includes the direct and indirect costs of the products we sell and the services that we provide. Product costs include the cost of raw materials, including microchips for all EMV cards and antennas for contactless EMV cards, labor costs, equipment and facilities costs, operation overhead, depreciation and amortization, leases and rental charges and transport costs. Product costs also include Card@Once instant issuance printer and consumable product costs. Services costs include the cost of labor, raw materials in the case of tamper-evident security packaging, equipment and facilities costs, operation overhead, depreciation and amortization, leases and rental charges and transport costs. Cost of sales can be impacted by many factors, including volume, operational efficiencies, procurement costs, promotional activity, and employee relations. We include the costs of shipping and handling related to customer sales in cost of sales.
Gross Profit and Gross Margin
Gross profit consists of our net sales less our cost of sales. Gross margin is gross profit as a percentage of net sales.
Operating Expenses
Operating expenses are primarily comprised of selling, general and administrative expenses (“SG&A”) which generally consist of expenses for executive, finance, sales, marketing, legal and compliance, information technology, procurement, customer service, human resources, research and development and administrative personnel, including payroll, benefits and stock-based compensation expense, bad debt expense and outside legal and other advisory fees, including consulting, accounting, and software related fees. Operating expense also includes depreciation and amortization expense and may include impairment charges on tangible and intangible assets, when necessary.
Income from Operations and Operating Margin
Income from operations consists of our gross profit less our net operating expenses. Operating margin is income from operations as a percentage of net sales.
Other Expense, net
Other expense, net consists primarily of interest expense and other non-operating items.
Income Tax Expense
Income tax expense consists of our federal and state income taxes at statutory rates, including the impact of other items such as valuation allowances, tax credits, permanent items, and foreign taxes.
Net Income
Net income consists of our income from operations, less other expense, net, and income taxes.
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Results of Operations
Year Ended December 31, 2023 Compared With Year Ended December 31, 2022
The following table presents the components of our consolidated statements of operations for each of the periods presented:
| | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | Year Ended December 31, | | |||||||||
| | | 2023 | | 2022 | | $ Change | | % Change | | |||
| | | (dollars in thousands) | ||||||||||
| Net sales: (1) | | | | | | | | | | | | |
| Products | $ | 249,354 | $ | 281,190 | $ | (31,836) | (11.3) | % | ||||
| Services | | | 195,193 | | 194,555 | | | 638 | 0.3 | % | ||
| Total net sales | | | 444,547 | | | 475,745 | | | (31,198) | (6.6) | % | |
| Cost of sales (1) | | | 289,058 | | 299,978 | | | (10,920) | (3.6) | % | ||
| Gross profit | | | 155,489 | | | 175,767 | | | (20,278) | (11.5) | % | |
| Operating expenses | | | 93,899 | | 96,637 | | | (2,738) | (2.8) | % | ||
| Income from operations | | | 61,590 | | | 79,130 | | | (17,540) | (22.2) | % | |
| Other expense, net: | | | | | | | | | | | | |
| Interest, net | | | (26,913) | | (29,616) | | | 2,703 | (9.1) | % | ||
| Other expense, net | | | (215) | | (367) | | | 152 | * | | ||
| Income before taxes | | | 34,462 | | | 49,147 | | | (14,685) | (29.9) | % | |
| Income tax expense | | | (10,477) | | (12,607) | | | 2,130 | (16.9) | % | ||
| Net income | | $ | 23,985 | | $ | 36,540 | | $ | (12,555) | (34.4) | % | |
| | | | | | | | | | | | | |
| Gross profit margin | | | 35.0% | | | 36.9% | | | | | | |
* Calculation not meaningful
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| (1) | For the years ended December 31, 2023 and 2022, net sales and cost of sales each include $0.7 million and $1.0 million of intersegment eliminations, respectively. |
The following discussion of our consolidated results of operations and segment results refers to the year ended December 31, 2023, compared to the corresponding period in the prior year. The results of operations should be read in conjunction with the discussion of our segment results of operations, which provide more detailed discussions concerning certain components of the Consolidated Statements of Income.
Net Sales:
Net sales decreased for the year ended December 31, 2023, primarily due to decreased Products net sales in our Debit and Credit segment, driven by lower volumes, partially offset by increased Card@Once services. Net sales also benefited from price increases, which were primarily implemented in 2022.
Gross Profit and Gross Profit Margin:
Gross profit and gross profit margin decreased for the year ended December 31, 2023, primarily due to lower net sales and higher materials costs.
Operating Expenses:
Operating expenses decreased for the year ended December 31, 2023, primarily due to decreases in professional services in our Other segment and operating expenses in our Prepaid Debit segment, partially offset by an increase in compensation expenses. Compensation expenses increased due to the impacts of compensation related to an executive retention agreement and increased employee headcount and salary increases, partially offset by lower employee short-term incentive compensation.
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Interest, net:
Interest expense decreased for the year ended December 31, 2023, primarily due to lower outstanding principal balances on our borrowings. For the year ended December 31, 2022, interest expense included a $0.6 million premium paid relating to the $20.0 million early redemption of the 8.625% Senior Secured Notes due 2026 (the “Senior Notes”).
Other Expense, net:
Other expense, net was relatively consistent for the years ended December 31, 2023, and 2022.
Income Tax Expense:
Our effective tax rate on pre-tax income was 30.4% and 25.7% for the years ended December 31, 2023, and 2022, respectively. The increase in the effective tax rate for the year ended December 31, 2023, was primarily due to tax deductibility limitations on executive compensation and a decrease in unrecognized tax benefits liabilities during the year ended December 31, 2022 due to the lapse of the statute of limitations.
Segment Discussion
Debit and Credit:
| | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | Year Ended December 31, | ||||||||||
| | | 2023 | 2022 | | $ Change | | % Change | | ||||
| | | (dollars in thousands) | | |||||||||
| Net sales | | $ | 361,057 | | $ | 390,559 | | $ | (29,502) | | (7.6) | % |
| Gross profit | | $ | 126,776 | | $ | 144,214 | | $ | (17,438) | | (12.1) | % |
| Income from operations | | $ | 94,906 | | $ | 110,045 | | $ | (15,139) | | (13.8) | % |
| | | | | | | | | | | | | |
| Gross profit margin | | | 35.1% | | | 36.9% | | | | | | |
Net Sales:
Net sales for Debit and Credit decreased for the year ended December 31, 2023, primarily due to a decrease in Products net sales, driven by volume declines in eco-focused cards compared to 2022, which benefited from the acquisition of a new portfolio by an existing customer, and EMV cards, partially offset by increased sales of other contactless cards. This decrease was partially offset by an increase in Services net sales due to higher Card@Once services, driven by a higher printer installation base. Net sales also benefited from price increases, which were primarily implemented in 2022.
Gross Profit and Gross Profit Margin:
Gross profit and gross profit margin for Debit and Credit decreased for the year ended December 31, 2023, primarily due to lower net sales and higher materials costs.
Income from Operations:
The changes in income from operations for Debit and Credit for the year ended December 31, 2023 were primarily due to the factors discussed in “Gross Profit and Gross Profit Margin” above and decreases in operating expenses related to compensation related expenses and professional services.
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Prepaid Debit:
| | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | Year Ended December 31, | ||||||||||
| | | 2023 | 2022 | | $ Change | | % Change | | ||||
| | | (dollars in thousands) | | |||||||||
| Net sales | | $ | 84,237 | | $ | 86,136 | | $ | (1,899) | | (2.2) | % |
| Gross profit | | $ | 28,713 | | $ | 31,553 | | $ | (2,840) | | (9.0) | % |
| Income from operations | | $ | 24,927 | | $ | 25,577 | | $ | (650) | | (2.5) | % |
| | | | | | | | | | | | | |
| Gross profit margin | | | 34.1% | | | 36.6% | | | | | | |
Net Sales:
Net sales for Prepaid Debit decreased for the year ended December 31, 2023, primarily due to decreased volumes from existing customers, partially offset by sales to new customers.
Gross Profit and Gross Profit Margin:
Gross profit and gross profit margin for Prepaid Debit decreased for the year ended December 31, 2023, primarily due to lower net sales, as well as increased labor costs and other expenses related to implementation of a change in our production staffing model where we completed the transition of temporary worker positions to permanent employee positions.
Income from Operations:
Income from operations for Prepaid Debit decreased for the year ended December 31, 2023, primarily due to the factors discussed in “Gross Profit and Gross Profit Margin” above, partially offset by lower operating expenses.
Other:
As the Other segment is comprised entirely of corporate expenses, income from operations for Other consists of operating expenses shown below.
| | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | Year Ended December 31, | ||||||||||
| | | 2023 | 2022 | | $ Change | | % Change | | ||||
| | | (dollars in thousands) | | |||||||||
| Operating expenses | | $ | 58,243 | | $ | 56,492 | | $ | 1,751 | | 3.1 | % |
Operating Expenses:
Other operating expenses increased for the year ended December 31, 2023, primarily due to increased compensation expenses as a result of $7.0 million of compensation related to an executive retention agreement and increased employee headcount and salary increases, partially offset by decreases in employee short-term incentive compensation and professional services.
Liquidity and Capital Resources
At December 31, 2023, we had $12.4 million of cash and cash equivalents. Our primary source of liquidity has been cash generated from our operating activities, which has been driven from net income and fluctuations in working capital. Our working capital fluctuates primarily due to the timing of tax payments, timing of receipts from customers, inventory levels, payments of employee incentive programs and interest payments on our Senior Notes, with the interest payments being due in the first and third quarters of the year.
Our ability to make investments in and grow our business, service our debt and improve our debt leverage ratios, while maintaining strong liquidity, depends on 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,
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combined with our current cash levels, and our senior secured revolving credit facility (the “ABL Revolver”) with available borrowing capacity of $74.7 million as of December 31, 2023, will be adequate to fund debt service requirements and provide cash, as required, to support our ongoing operations, capital expenditures, lease obligations, share repurchases and working capital needs. Our future cash flows could be impacted by a variety of factors, some of which are beyond our control. These factors include, but are not limited to, changes in economic conditions, especially those impacting our customers, and the pricing, terms and availability of goods and services that we purchase, and financings that we enter into.
Cash Flow from Operating Activities
Cash provided by operating activities increased for the year ended December 31, 2023 to $34.0 million from $31.3 million for the year ended December 31, 2022, primarily due to collections on outstanding receivables from the prior year end and a decrease in inventory purchases in 2023. These positive cash flow impacts were partially offset by lower net income and higher employee performance incentive compensation payments in 2023 related to 2022 performance. Cash flow from operating activities is expected to be negatively impacted in the first quarter of 2024 due to a $5.0 million payment pursuant to an agreement entered into on June 2, 2023 with the Company’s prior Chief Executive Officer, who departed in the first quarter of 2024. Additionally, we anticipate inventory levels to increase in 2024 as a result of the capacity reservation agreement we entered into with one of our suppliers in 2022, which will be in effect through 2025.
Financing
As of December 31, 2023, we had the following outstanding borrowings:
| | | | | | | |
|---|---|---|---|---|---|---|
| | | December 31, | ||||
| | 2023 | 2022 | ||||
| | | (dollars in thousands) | ||||
| Senior Notes | | $ | 267,897 | | $ | 285,000 |
| ABL Revolver | | | — | | | 5,000 |
| Unamortized deferred financing costs | | | (2,900) | | | (4,478) |
| Total long-term debt | | $ | 264,997 | | $ | 285,522 |
Senior Notes
On March 15, 2021, we completed an offering of $310.0 million aggregate principal amount of Senior Notes and related guarantees at an issue price of 100%. The Senior Notes bear interest at a rate of 8.625% per annum and mature on March 15, 2026. Interest is payable on the Senior Notes on March 15 and September 15 of each year.
As permitted by the indenture governing the Senior Notes, we may also from time to time repurchase some or all of the Senior Notes in open market transactions, in privately negotiated transactions or otherwise. During the year ended December 31, 2023, we repurchased $17.1 million of our Senior Notes in open market transactions. We may redeem some or all of the Senior Notes in 2024, subject to market and other conditions. Pursuant to the terms of the indenture, redemptions would be priced at 104.313% of the principal amount of any notes to be redeemed through March 15, 2024, 102.156% from March 16, 2024 through March 15, 2025, and reducing to 100% thereafter, in each case plus accrued and unpaid interest. The timing and amount of any such redemptions or repurchases will depend upon market conditions, contractual commitments, our capital needs and other factors.
ABL Revolver
On March 15, 2021, we entered into a Credit Agreement with Wells Fargo Bank, National Association providing for an ABL Revolver. On March 3, 2022, we entered into Amendment No. 1 to the Credit Agreement, which amended the ABL Revolver. The amendment, among other things, increased the available borrowing capacity to $75.0 million, increased the uncommitted accordion feature to $25.0 million and revised the interest rate provisions to replace the prior LIBOR benchmark with updated benchmark provisions using the secured overnight financing rate (“SOFR”) as administered by the Federal Reserve Bank of New York. On October 11, 2022, we entered into Amendment No. 2 to the Credit Agreement, which amended the ABL Revolver to adjust certain monthly document delivery terms and to clarify
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the treatment of certain inventory. We primarily utilize our ABL Revolver to provide general liquidity and to support shorter term financing requirements.
Borrowings under the amended ABL Revolver bear interest at a rate per annum equal to the applicable term SOFR adjusted for a credit spread, plus an applicable interest rate margin. We may select a one, three or six-month term SOFR, which is adjusted for a credit spread of 0.10% to 0.30% depending on the term selected. The applicable interest rate margin ranges from 1.25% to 1.75% depending on the average excess availability of the facility for the most recently completed quarter. The unused portion of the ABL Revolver commitment accrues a monthly unused line fee, between 0.375% to 0.50% per annum, multiplied by the aggregate amount of Revolver commitments less the average Revolver usage during the immediately preceding month.
Amounts borrowed and outstanding under the ABL Revolver are required to be repaid in full, together with any accrued and unpaid interest, on the earliest to occur of March 15, 2026 and the date that is 90 days prior to the maturity of the Senior Notes (and may be subject to earlier mandatory prepayment upon certain events).
Credit Ratings and Debt Covenants
The credit ratings on our debt are an important consideration in our overall business, managing our financing costs and facilitating access to additional capital on favorable terms. Factors that we believe are important in assessing our credit ratings include earnings, cash flow generation, leverage, available liquidity and the overall business.
We have obligations to make an offer to repay the Senior Notes, requiring prepayment in advance of the maturity date, upon the occurrence of certain events including a change of control, certain asset sales and based on an annual excess cash flow calculation. The annual excess cash flow calculation is determined based on an adjusted net income calculation pursuant to the terms of the indenture, and varies based on our annual net leverage ratio. We are required to offer to pay 50% of excess cash flow if the net leverage ratio exceeds 4.5 to 1; 25% if the net leverage ratio is between 4 to 1 and 4.5 to 1, and 0% if the net leverage ratio is less than or equal to 4 to 1. Any required prepayments are to be made within 125 days after the issuance of our annual financial statements. No such payment was required to be made in either 2024 or 2023 based on our operating results for the years ended December 31, 2023 and 2022, respectively.
The Senior Notes and the ABL Revolver contain covenants limiting our ability, and the ability of CPI CG Inc. and our restricted subsidiaries to, among other things, incur or guarantee additional debt or issue disqualified stock or certain preferred stock; create or incur liens; pay dividends, redeem stock or make other distributions; make certain investments; create restrictions on the ability of CPI CG Inc. and our restricted subsidiaries to pay dividends to us or make other intercompany transfers; transfer or sell assets; merge or consolidate; and enter into certain transactions with affiliates, subject to a number of important exceptions and qualifications as set forth in the respective agreements.
The ABL Revolver includes limitations on our ability to borrow in certain situations, including limitations based on the calculation of a borrowing capacity and further limitations that are triggered if the amount available to borrow under the ABL Revolver is less than $7.5 million. The borrowing capacity represents the net availability under the ABL Revolver and is calculated as the lesser of a) the total of certain eligible assets, including cash, accounts receivable and inventories, further reduced by stated contribution percentages and adjustments or b) the $75.0 million of available borrowing capacity under the ABL Revolver (“Borrowing Base”). The Borrowing Base is further reduced by credit line reserves, letters of credit, as well as the loan ledger balance outstanding on the ABL Revolver. Additionally, commencing with the month immediately following a date on which borrowing capacity is below $7.5 million and until such time that borrowing capacity equals or exceeds $7.5 million for 30 consecutive days, we must maintain a fixed charge coverage ratio (as defined in the Credit Agreement for the ABL Revolver) greater than 1.00, calculated for the trailing 12 months in order to borrow under the ABL Revolver.
Cash Priorities
Capital Expenditures
We primarily use cash in investing activities for capital expenditures. During the year ended December 31, 2023, capital expenditures, including investments to support the business, such as machinery and information technology equipment, totaled $6.4 million. We acquired $11.3 million of additional machinery and equipment utilizing financing lease arrangements in 2023, which has been reflected as a non-cash investing activity in the statement of cash flows.
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During 2023, we commenced work on relocating and modernizing our production facility in Indiana. We anticipate this project will extend into 2025. Total capital expenditures, net for this project are anticipated to increase cash used in investing activities and assets acquired under lease arrangements in both 2024 and 2025.
Share Repurchase Authorization and Activity
On November 2, 2023, our board of directors approved a share repurchase plan authorizing us to repurchase up to $20.0 million of our common stock, par value $0.001 per share. This authorization expires on December 31, 2024.
During the year ended December 31, 2023, we repurchased 13,180 shares, on a trade date basis, of our common stock at an average price of $18.93 per share excluding commissions, or $0.3 million in aggregate. In accordance with the Stock Repurchase Agreement entered into on December 6, 2023, we are obligated to purchase 39,540 shares from Parallel49, at an average price of $18.55 per share, payment for which, along with any obligations incurred connected to shares repurchased in the first quarter of 2024, is due in the second quarter of 2024.
We had $19.0 million remaining in our share repurchase authorization as of December 31, 2023. We may purchase shares through open market purchases or through privately negotiated transactions, the extent and timing of which will depend upon a variety of factors, including market conditions, regulatory requirements and other corporate considerations, as determined by us.
Material Cash Requirements
Our material cash requirements include interest payments on our long-term debt, operating and finance lease payments, and purchase obligations to support our operations.
Debt Service Requirements
As of December 31, 2023, the total projected principal and interest payments on our borrowings were $326.4 million, primarily related to the Senior Notes, of which $23.5 million of interest is expected to be paid in the next 12 months. The remaining interest payments are expected to be paid over the remaining term of the Senior Notes, which mature in 2026, and the principal is due upon maturity. We have estimated our future interest payments assuming no additional borrowings under the ABL Revolver, no early redemptions of principal on the Senior Notes, and no debt issuances or renewals upon the maturity dates of our notes. However, we may borrow additional amounts under the ABL Revolver, redeem principal on the Senior Notes early or refinance all or a portion of our borrowings in future periods.
Leases
We lease real property for production and services, in addition to equipment. Refer to Part II, Item 8, Financial Statements and Supplementary Data, Note 9, “Financing and Operating Leases” for details on our leasing arrangements, including future maturities of our operating lease liabilities, as of December 31, 2023.
In February 2024, we entered into a build-to-suit lease agreement to relocate and modernize our operations at our Fort Wayne, Indiana production facility, which is set to commence the later of: the landlord’s delivery of exclusive possession of the premises; and March 1, 2025. Under this lease agreement, we will pay an annual base rent of $0.9 million subject to an annual rent increase of 2.0%. The lease is for ten years and includes two consecutive options to extend the term of the lease by five years for each such option.
Purchase Obligations
A purchase obligation is an agreement to purchase goods or services that is enforceable, legally binding, and specifies all significant terms. As of December 31, 2023, we had approximately $138.0 million of outstanding purchase obligations, of which approximately $89.4 million is expected to be paid in the next 12 months.
Included in the above amounts, during 2022, we entered into a capacity reservation agreement with one of our chip suppliers to reserve production supply capacity due to the current global supply shortage environment. Under the
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agreement, we agreed to pay certain fees in exchange for the supplier’s commitment to reserve capacity to produce a set quantity of chips from 2023 through 2025, subject to certain conditions, and we have committed to purchase those chips. The total value of the minimum non-cancellable commitment is $194.9 million over the term of the agreement. As of December 31, 2023, the remaining commitment was $125.3 million, of which $77.0 million is expected to be paid in the next 12 months. In the event that the supplier is unable to deliver the specified quantity of chips, it will be subject to liquidated damages of 10% of the price of any non-delivered products.
Cyclical and Seasonal Nature of Business
Financial Payment Cards are generally influenced by broader cyclical changes in the economy, with economic downturns potentially resulting in decreases in the demand for our products and services and economic upturns potentially resulting in increases in demand. In particular, prolonged economic downturns typically have resulted in significant reductions in the demand for general purpose credit cards due to tightening credit conditions. Our net sales are also influenced by changes in customer behavior such as altering inventory management practices, Financial Payment Card renewal cycles and demand for new products, such as contactless cards. Additionally, we historically have generated higher net sales in the third and fourth quarters of the year, as our sales of Prepaid Debit Card solutions are more heavily weighted toward the second half of the year when consumers tend to purchase more of these products and services in anticipation of the holiday season in the United States and timing related to the production of health insurance and health savings account cards.
Critical Accounting Policies and Estimates
Our management’s discussion and analysis of financial condition and results of operations is based on our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America. In preparing our financial statements, we make estimates, assumptions and judgments that can have a significant impact on our reported net sales, results of operations and net income, as well as on the value of certain assets and liabilities on our balance sheet during and as of the reporting periods. These estimates, assumptions and judgments are necessary because future events and their effects on our results and the value of our assets cannot be determined with certainty and are made based on our historical experience and on other assumptions that we believe to be reasonable under the circumstances. These estimates may change as new events occur or additional information is obtained, and we may periodically be faced with uncertainties, the outcomes of which are not within our control and may not be known for a prolonged period of time. Because the use of estimates is inherent in the financial reporting process, actual results could differ from those estimates.
Revenue Recognition
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 produced for specific customers and have no alternative use and the Company has an enforceable right to payment for work performed. For work performed but not completed and unbilled, we estimate net sales by taking actual costs incurred and applying historical margins for similar types of contracts. Margins across each business with similar contracts have been relatively consistent and we have not made changes to our methods and assumptions during 2023. Items included in “Products” net sales are produced Financial Payment Cards, including contact-EMV, contactless EMV, Second Wave, 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.
Services Net Sales: Net sales are 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 SaaS personalization of instant issuance debit and credit cards. For work performed but not completed and billed, we estimate revenue by taking actual costs incurred and applying historical margins for similar types of contracts. Margins across each business with similar contracts have been relatively consistent and we have not made changes to our methods and assumptions during 2023.
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. Usually our contractual arrangements include neither exclusivity clauses nor commitments from our customers to order any given quantities of products on a
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medium or long-term basis. The contract term as defined by ASC 606, Revenue from Contracts with Customers, 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 considered short term in nature.
Income Taxes
We are subject to income taxes in the United States and certain foreign jurisdictions. Significant judgment is required in evaluating our tax positions and determining our provision for income taxes. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income.
The Company has deferred tax assets and liabilities and maintains valuation allowances where it is more likely than not that all or a portion of deferred tax assets will not be realized. Significant judgment is required in determining any valuation allowance recorded against deferred tax assets. The determination of the amount of valuation allowance to be provided on recorded deferred tax assets involves consideration of estimates regarding the timing and amount of the reversal of taxable temporary differences and the impact of tax planning strategies. Changes in the relevant facts can significantly impact the judgment or need for valuation allowances. In the event we change our determination as to the amount of deferred tax assets that can be realized, we will adjust our valuation allowance with a corresponding impact to the provision for income taxes in the period in which such determination is made.
During the ordinary course of business, there are transactions and calculations for which the ultimate tax determination is uncertain. The company is required to make estimates regarding future compensation for covered individuals to determine the value of its deferred tax assets related to the future deductibility of executive stock compensation and accrued incentive compensation, which also requires significant judgment. We also establish reserves for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes will be due. The reserves are established when we believe that certain positions are likely to be challenged and may not be fully sustained on review by tax authorities. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or refinement of an estimate. Although we believe our reserves are reasonable, no assurance can be given that the final outcome of these matters will be consistent with what is reflected in our historical income tax provisions and accruals. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will impact the current provision for income taxes. We recognize interest and penalties related to unrecognized tax benefits as a component of income tax expense.
The Company’s valuation allowance recorded as of December 31, 2023, relates primarily to a capital loss realized on the sale of a foreign subsidiary whereby the Company does not anticipate a capital gain in the foreseeable future that would allow for the recognition of the capital loss carryover. In addition, the Company has a partial valuation allowance on certain state interest deduction limitations and net operating losses, which the Company estimates may not be fully utilized. Additionally, other changes to the federal and state tax regulations can lead to variability in allowable deductions, which can impact the Company’s valuation allowance.
Recent Accounting Pronouncements
Refer to Part II, Item 8, Financial Statements and Supplementary Data, Note 2, “Summary of Significant Accounting Policies” for a discussion of recent accounting pronouncements.