Welcome to the CPI Card Group's First Quarter 2023 Earnings Call. My name is Bailey and I will be your operator today. [Operator Instructions]. Now, I will turn the call over to Mike Salop, CPI's Head of Investor Relations.

Thanks, operator. And good morning, everyone. Welcome to the CPI Card Group first quarter 2023 earnings webcast and conference call. Today's date is May 9, 2023. And on the call today from CPI Card Group are Scott Scheirman, President and Chief Executive Officer; and Amintore Schenkel, Chief Financial Officer. Before we begin, I'd like to remind everyone that this call may contain forward-looking statements as they are defined under the Private Securities Litigation Reform Act of 1995. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. For a discussion of such risks and uncertainties, please see CPI Card Group's most recent filings with the SEC. All forward-looking statements made today reflect our current expectations only, and we undertake no obligation to update any statements to reflect the events that occur after this call. Also, during the course of today's call, the company will be discussing one or more non-GAAP financial measures, including, but not limited to, EBITDA, adjusted EBITDA, adjusted EBITDA margin, net leverage ratio and free cash flow. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures are included in the press release and slide presentation we issued this morning. Copies of today's press release as well as the presentation that accompanies this conference call are accessible on CPI's Investor Relations website, investors.cpicardgroup.com. In addition, CPI's Form 10-Q for the quarter ended March 31, 2023 will be available on CPI's Investor Relations website. And now, I'd like to turn the call over to President and Chief Executive Officer, Scott Schierman.

Thanks, Mike. And good morning, everyone. During today's call, I will discuss CPI's first quarter performance, reiterate our outlook for the full year and review our long term strategy. Amintore will review the financial results in more detail and then we'll open up the call for questions. We will start on slide 4. Overall, I'm very pleased with the first quarter performance. We increased sales by 8% despite comparisons with a very strong first quarter in 2022, which benefited from large eco-focused card orders and significant instant issuance printer upgrade sales. Growth in this year's first quarter was led by ongoing strength in sales of contactless cards and we also delivered good growth from other areas across our debit and credit portfolio. We grew adjusted EBITDA 11% to $25 million and increased the adjusted EBITDA margin 50 basis points to 20.7%, driven by operating leverage. We increased net income by 81% to nearly $11 million, aided by sales growth, operating leverage, a lower tax rate and lower interest expense, as we've utilized cash flow to reduce our average borrowings. We also improved our overall financial position in the quarter, generating nearly $4 million of positive free cash flow, retiring an additional $8 million of our senior notes and reducing our net leverage ratio up to 2.9 times at quarter-end. As we mentioned in March, this year, we're focused on continuing to execute our strategies, grow the business, win share in the marketplace, increase cash flow and reduce leverage. We believe the first quarter demonstrated good progress against each of these goals. As we look to the rest of the year, our sales efforts will remain focused on gaining market share with our differentiated portfolio of innovative products and services and end-to-end solutions and leading quality and customer service. Turning to…

Thank you, Scott. And good morning everyone. I will begin my overview on slide 8. First quarter net sales increased 8% to $120.9 million compared to the prior year quarter, led by the Debit and Credit segment which increased 11%. As Scott mentioned, Debit and Credit sales growth was driven by strong sales of contactless cards and personalization services also contributed solid sales growth, as did Card@Once instant issuance solutions. Prepaid Debit segment net sales decreased 2% compared with the prior year, and we continue to expect full year prepaid sales to be similar to 2022 levels. Overall, pricing contributed a little less than half of the sales growth in the quarter, primarily due to pricing actions implemented over the course of 2022. First quarter gross profit of $43.1 million increased 10% from the prior year, while gross profit margin increased from 35.3% to 35.7%, driven by operating leverage from sales growth, including benefits from price increases, partially offset by the impacts of inflation on materials costs and expenses incurred related to a production staffing model change in our Prepaid segment. SG&A expenses increased by approximately $1 million in the quarter compared to the prior year, primarily due to increased headcount and related compensation expenses to support our growth and strategic execution, partially offset by a reduction in professional services expenses, primarily related to third-party SOX costs incurred in the prior year. Our tax rate was 20.7% in the quarter, which compared to 38.3% in the prior year quarter due to higher interest expense deductibility and a favorable adjustment to reflect a change in state tax law. We would project a normalized rate excluding any adjustment items of between 25% and 30%, but including the Q1 adjustment benefit, we currently expect the overall 2023 rate to be at the lower…

Thanks, Amintore. Before opening the call for questions, I would like to welcome Jeff Hochstadt to the CPI team. We announced today that Jeff will become our new Chief Financial Officer effective May 13, replacing Amintore, who had previously declared his plans to resign in 2023 due to family related personal reasons. Jeff is a proven strategic leader who brings a vast background of diverse business and financial experience to CPI. He most recently had his own company providing strategic and financial consulting services, which followed his career at Western Union from 2006 through 2021, including roles as Chief Strategy Officer and Senior Vice President and Head of Global Financial Planning. Jeff has also held various financial and strategic positions with First Data, Morgan Stanley, IBM and Pricewaterhouse, among others. Amintore will stay with CPI full time through the end of the second quarter and then will continue as an advisor for a period of time. I want to again thank Amintore for his many contributions to CPI and his commitment to ensure a smooth transition. To summarize today's call, we had a strong performance in the first quarter, increasing sales, adjusted EBITDA margins and free cash flow and driving further improvements in our net leverage ratio. Although we have seen some new risks arise from the banking industry turmoil of recent weeks, we're taking responsive actions and have affirmed our full year outlook. Overall, we remain focused on continuing to execute our strategies, grow the business, win share in the marketplace, increase cash flow and reduce net leverage in 2023. Thank you for joining our call today. And we will now open up the call for any questions.

[Operator Instructions]. And your first question will come from Jaeson Schmidt.

Congrats on a really nice start to the year. Scott, just want to dig into your caution around Q2. Is the softening demand more related to push-outs or are you seeing cancellations as well?

What I would describe it is, as we move through the month of April, just saw softening in customer demand or customer orders coming in. Some customers that might be not placing an order, some customers that might be pushing the order to, say, the third quarter or fourth quarter. So, it really seems to have tied back to the Silicon Valley Bank and subsequent, I'm going to use the word banking turmoil, Jaeson, where customers feel uncertain about the future. We believe they're probably tightening or spending just to see how things will unroll over the weeks, maybe the months to come from that standpoint. But, again, I have a lot of confidence in the long term business. There's a lot of secular trends in place for sure. Cards continue to grow, card payments are growing at the expense of cash. As we shared in the script, Visa, MasterCard cards in circulation have grown at 11% CAGR over the last three years ending December 31, 2022. I believe contactless cards are still a really good opportunity for us. We think at the end of 2022, the market was 50% to 60% converted to contactless. We think that'll be over 80% by 2025. And then I'd also just emphasize our eco cards, right? The broadly – banks, end user consumers, the issuers, the networks, everybody's trying to be more sustainable. And we are definitely a market leader with eco-focused cards, issuing over 95 million. So I think there are some near term challenges, but long term, I'm very positive on the business and believe there's continued opportunity to gain share and grow over the long term.

I think you've probably answered sort of what my next question was going to be on. The confidence that Q2 is simply this air pocket and you would have resumed to a more normalized environment, is this really just due to kind of customers noting that these launches have simply been delayed into the second half?

I would say there's some of that, right? There's things that are happening in the market where I would say the regulators and the government are continuing to try and do things to provide more confidence to end user consumers with banks. They've done, in my view, some of the right things to get these banks recapitalized or take them over. So, hopefully, this banking turmoil will subside in the coming weeks or months, if you will. But again, as we called out in the earnings release or the script comments, we assume that the turmoil in the banking industry affects the second quarter, but does not worsen. And we believe we'll return to a more normalized environment over the course of the year, but we'll have to play it out from that standpoint, but so far in the month of April, customer demand has been soft.

The last one for me and I'll jump back into queue. Just curious if you could expand on some of these new initiatives that you've implemented to drive sales?

You'll probably appreciate, Jaeson, for competitive reasons, I don't want to get into a lot of detail here. But over the last week to 10 days, the teams have been meeting and they've come up with a number of ideas that I believe will be helpful to drive the top line, incent some demand in the marketplace. Also, we are just closely like, probably many companies are right now, just closely, managing our expenses and making some decisions on some expenses that maybe can be pushed off to later in the year or in to 2024. So it's a combination of those. But again, for competitive reasons, I don't want to get into a lot of detail on how we're driving demand.

Your next question comes from Leanne Hayden.

This is Ed Najarian and Leanne Hayden at EF Hutton. So two quick questions. First on the senior secured notes. Could you give us some context about just on a couple of things. Number one, how quickly you are kind of contemplating paying that down over the next year or two. And I guess, secondarily on that, what kind of purchase costs you're seeing on the senior secured notes relative to par. It looks like the ABL revolver is sort of replacing some of that debt to some extent. Are you getting some rate arbitrage there relative to the 8.6% on the secured notes?

First, I would say we've been committed to deleveraging the balance sheet, both through growing our profitability and using our cash flow to reduce our debt outstanding. As we think about 2023, without getting into real specifics, so far, we've bought back $15 million of our debt. I'm going to call it, it's been a tad bit below $1 or below par, so we think it's a good value and a good thing for the shareholders to do that. Where we think the leverage will end up in 2023, as we've guided, is somewhere between 2.5 and 3 times. We closed Q1 at 2.9x. So broadly, I would say we continue to be committed to deleverage the balance sheet. Amintore, do you want to speak about the rate between the senior notes and the revolver?

There's a little bit of a differential and I'll let you guys do the math by looking at our disclosures in terms of the rate that we've got on the ABL versus the senior notes. But there is a positive rate differential between the two if we borrow on the ABL versus having those balances still remain outstanding on the senior notes. And as it relates to the repurchases, we have been able to do those repurchases below par. And clearly, as we look forward at what we will do going forward here in the future, we've indicated that we do on our leverage ratio to be between 2.5 and 3 by the time we hit to the end of the year. And clearly, we'll look at what makes sense in terms of either repurchasing notes or utilizing cash for other activities out there. But we continue to have one of our key mantras, as it relates to our capital structure strategy, deleveraging our balance sheet.

You're at 2.9 on the leverage ratio now. I guess maybe I'm trying a little bit putting words in your mouth. Would it be reasonable to think we could get to the lower end of that 2.5 to 3 range by the end of the year?

I will try to give you an it-depends answer. We gave a range, just so that we've got flexibility, if you will. Again, we're committed to deleveraging the balance sheet. But as we think about the uses of our cash or capital and we want to make sure we've got ample liquidity, but also invest in the business, whether that's through CapEx or working capital. There's things that will help us grow the business long term. We're actively looking at how do we deploy that cash, so it has the best return to our shareholders at the end of the day. So that's why there's a bit of a range there, just so that as we move through the year, if there's opportunities, we can take a hard look at those and make the best decisions for our shareholders.

Just one more quick question. I don't know if you're maybe willing to go here or not, but in terms of a bit of weakness, I guess, in the second quarter relative to the whole broader situation with regional banks, any ability to put any context or parameters around that from a revenue or a sales standpoint or just to give us any kind of range of how to think about that magnitude?

Yeah, you're right. I don't want to go there. But what I would tell you is that we've reaffirmed the full-year outlook. Q1 results are actually down, but our color really has been around that we just expect second quarter results to not be as strong as first quarter just due to softening demand. And part of that just depends upon how we progress through the second quarter, the timing of orders and so forth. Again, I want to get our investors – our potential investors to really focus on the long-term opportunities here. There's a lot of great secular trends that we spoke about with contactless cards, eco cards. Clearly, cards will continue to grow in our opinion. In our instant issuance, Card@Once business, SaaS-based business, we've got, by far, the best solution in the marketplace. So over the long term, I believe there's a lot of opportunities for us to grow and continue to gain market share – possibly gain market share just as we have historically.

And with no further questions, that concludes today's CPI Card Group's first quarter earnings call. Thank you for joining.