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

Thanks, operator, and good morning, everyone. Welcome to the CPI Card Group fourth quarter 2023 earnings webcast and conference call. Today's date is March 7, 2024. And on the call today from CPI Card Group are John Lowe, President and Chief Executive Officer; and Jeff Hochstadt, Chief Financial Officer. Before we begin, I'd like to remind everyone that this call may contain forward-looking statements as they are defined in 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, investor.cpicardgroup.com. In addition, CPI's Form 10-K for the year ended December 31, 2023, will be available on CPI's Investor Relations website. On today's call, our growth rates refer to comparisons with the prior year period, unless otherwise noted. And now I'd like to turn the call over to President and Chief Executive Officer, John Lowe.

Thanks, Mike, and good morning, everyone. For today's call, I will give an overview and discuss our strategic priorities. Jeff will go into more detail on our 2023 results and 2024 financial outlook, and then we will open the call for questions. Let's start on Slide 4. As most of you are aware, I was named President and CEO of CPI Card Group in January, taking over from Scott Scheirman, who announced his plans to retire mid last year. I would like to take a moment to thank Scott. Under his leadership, our team delivered a remarkable turnaround over the last six years and established a strong foundation that we can build from as we begin the next phase of the company's growth. CPI has a strong culture and values that have helped to establish us as a trusted leader in the U.S. payment space, and we have a great leadership team in place today. This team combines both experienced CPI leaders that have helped drive our success over the last several years as well as some relatively newer hires to bring in additional outside expertise. Among the experienced leaders we have promoted Peggy O'Leary to Senior Vice President, Prepaid Solutions and Chief Development and Digital Officer. Peggy has been leading our prepaid business since 2022, and has been instrumental in driving our growth strategy in various areas of the business since joining CPI in 2015. Peggy will be supported in business development by Rob Dixon who is our Vice President of Business Development and Digital Solutions. Rob has been leading our product, growth and innovation strategy for instant issuance, personalization and digital solutions. And he and his team have been integral in expanding our product and solution sets, including our digital connections and solutions. Last year, we also brought…

Thanks, John, and good morning, everyone. I will begin my overview on Slide 8. The fourth quarter environment was generally what we expected as customers remain cautious with spending and continue to work down their inventory levels. The sales decline had a negative effect on margins as we lost operating leverage, although we continue to manage discretionary spending tightly. Overall, fourth quarter net sales declined 19%. Net income decreased 78%, and adjusted EBITDA declined 27% compared to the prior year period. For the full year, net sales decreased 7%, net income declined 34% and adjusted EBITDA fell 8% as reductions in operating expenses helped to offset the impacts of the sales and gross margin decline. Net income for both the quarter and the year was negatively impacted by accruals for the previously announced Executive Retention Award as well as higher tax rates. Despite the reduction in net income, we were able to significantly increase our free cash flow for the year, more than doubling last year's level due to improvements in working capital and tight management of capital spending. We were also able to maintain a relatively consistent net leverage ratio ending the year at 3.1x. Turning to the detailed fourth quarter results on Slide 9. The 19% sales decline was comprised of a 22% decrease in our debit and credit segment and a 5% decline in prepaid. Within debit and credit, the primary driver of this decline was reduced card sales. We saw this decline across contactless, contact and non-EMV cards. Sales of eco-focused cards declined compared to some very large orders in the prior year period but did increase relative to the third quarter as we filled some good-sized orders in the fourth quarter. Card@Once's instant issuance sales increased in the fourth quarter compared to prior year, driven…

Thanks Jeff. To summarize, 2023 was a challenging year for the market, and we believe the first half of 2024 will continue to be affected by cautious customer spending, but we expect growth to gradually return over the course of the year. We are focused on continuing to win business and gain share with our existing portfolio, while also expanding our addressable market over the long term through the introduction of adjacent product and service solutions. We generated strong free cash flow in 2023 despite the decline in net income, and our outlook projects to return to slight sales growth in 2024, with declines in the first half of the year, offset by growth in the second half. Our leadership team is very excited about the future and proud of the strong team of employees we have in place, and I want to take a moment to thank all of our employees for their continued dedication and commitment to serving our customers well. Thank you for joining our call today, and we will now open the call for any questions.

[Operator Instructions] We'll go first to Jaeson Schmidt at Lake Street Capital Markets.

Hi, guys. Thanks for taking my questions. Just curious if you're seeing any cancellations or some of these headwinds are just due to push outs and delays in new programs?

Good morning, Jaeson. Good to talk to you again. No, I wouldn't say anything is related to cancellations. I would say, more related to just cautious spending that remains in the market, continuous inventory rebalancing, if you will. But as we said on the call, we expect the first half to continue to kind of be a little bit choppy, rebalancing to continue, but we expect in the second half to return to growth. But we're not necessarily seeing any cancellations or reductions of orders, if you will. It's more just overall slowness in the market.

Got you. And then you noted expanding into some adjacent areas. Do you expect to see sort of meaningful inroads this year? Or is this year mortgage more about learning about the market and some of the opportunities there?

Yes. Great question. We've been working on adjacencies for a number of years. As an example, I think you probably heard us in prior quarters talk about growth in the health account space that's HSA cards, flexible spending account cards. But the big areas that we're trying to grow into prospectively are push provisioning essentially where we're pushing a digital credential to a customer's wallet. That's an area where we feel like we have differentiation in the market because we're essentially agnostic to a core and processor that the small to medium bank issuers we work with Hughes. So I wouldn't say it would be meaningful this year to the financials. But we definitely feel like over the longer term, it will be meaningful to the business. So kind of kicking it off and growing but not substantial this year.

Okay. That's helpful. And then just the last one for me, and I'll jump back into queue, and serve a good segue to it. It was on that push provisioning. Do you guys expect to receive an incremental fee for this? Or is this just more an added service to increase the value proposition?

Yes. So the economics of it are similar to unit cost for card sales. You're essentially adding on an additional service. So every time someone pushes that digital credential to their wallet, we are earning a fee off of that a processing fee, if you will, similar to what we do within our Card@Once instant issuance solution, so think of our Card@Once instant issuance solution, how we have transaction processing fees that occur every day across our 15,000 branches, push provisioning is a similar kind of economic animal, if you will. So every time someone pushes to their wallet, we get a fee.

Okay, perfect. Appreciate the call, you guys. Thanks a lot.

Thanks Jaeson.

We'll move to our next question from [Andrew Scott] at ROTH MKM.

Hi, good morning, and thank you for taking my questions. First one for me. I was wondering if you could provide a bit more details around the new Indiana facility and if you could help us quantify the potential capacity expansion. It sounds like the building is double the size of the existing facility. And any additional details around the build-out time line may be helpful as well.

Yes. Good morning. Well, I'll give an overview and then hand it off to Jeff. Our Indiana facility, we've been in for a number of years. We love Fort Wayne, Indiana. They do a great job for us. That's a facility where the leases expiring in 2026. It gives us an opportunity to really move that facility, but in doing so, build out what I would call a state-of-the-art facility. That's efficiencies, it's both digital and physical kind of enablement, if you will, to tie everything together in the plant. And ultimately, we'll double our capacity in Indiana. But keep in mind that the expansion that we're doing in Indiana is roughly 10% of our overall footprint. So it's definitely a growth in capacity, but it's not significant to the overall business, but it will be a good growth to support our secured card business over the longer term.

Andrew, this is Jeff. We are really excited about Indiana and the expansion opportunities there. So as we stated, it will probably be about a $20 million investment over the next several years, about $13 million cash flow impact over the next two years. And we'll probably be in that facility at the end of 2025. So a couple of years -- and that's really the time line. We're starting to build it out now, but that's probably when it will be ready.

Great. Thanks for the color. And then second one for me. Can you kind of speak to the long-term potential of eco-friendly cards? You guys have seen really good momentum with the large issuers, but I'm curious as to how discussions with the smaller issuers have gone to date? And kind of just as adoption of the eco-friendly cards increased how this may impact company margins and profitability?

Yes. So ECO is a great space for us. I mean, we started selling Eco into the market in 2019. We did that with one of the largest issuers in the U.S. We are, we believe, a leader in the eco-focus space in the U.S. selling more than 100 million cars. We don't update the stats every single quarter, but into the U.S. over time. If you think of the large issuer base similar to what's happened in the contactless transition, the largest of issuers move quickly. We've seen great success in that space. And now what we're doing, one of our big goals in '24 is to push and penetrate within our small to medium issuer base. And just to keep in mind, if you look at our debit and credit segment broadly, the majority of our revenue actually comes from those small to medium issuers. So we expect the transition to take a number of years and occur over time, similar to the contactless transition. But we do have a significant number of what I would call small to medium issuers who were interested in the product and want to buy the product. We have been selling it on a smaller scale, if you will, but it will be a benefit to our overall -- we believe, our market share, our way to differentiate in the market, but also all of our eco-focused products, for the most part, are contactless and premium products, if you will. So you can also, generally speaking, charge either the same amount for a contactless card or sometimes anymore.

Great. Well, thanks for the call, and I'll pop back into queue.

Okay. Thank you.

And that concludes today's CPI Card Group fourth quarter earnings call. Thank you for joining, and have a good day.