CMPO - CompoSecure, Inc.

Operator: Thank you for standing by, and welcome to CompoSecure's Second Quarter 2023 Earnings Call. [Operator Instructions] I would now like to hand the call over to Sean Mansouri, Investor Relations. Please go ahead.
Sean Mansouri: Good afternoon, and thank you for joining us to review CompoSecure's second quarter 2023 financial results. With me on the call is Jon Wilk, CompoSecure's CEO; and Tim Fitzsimmons, CFO. They will begin with prepared remarks, and then we will open the call for Q&A. During the call, we will make statements related to our business that may be considered forward-looking, including statements concerning our plans to execute on our growth strategy and our ability to maintain existing and acquire new customers, as well as other statements regarding our plans and prospects. Forward-looking statements may often be identified with words such as we expect, we anticipate or upcoming. These statements reflect our views only as of today and should not be considered our views as of any subsequent date. We undertake no obligation to update or revise these forward-looking statements. Forward-looking statements are not promises or guarantees of future performance and are subject to a variety of risks and uncertainties that could cause the actual results to differ materially from our expectations. For a discussion of material risks and other important factors that could affect our actual results, please refer to the information in our Annual Report on Form 10-K and other reports filed with the SEC, which are available on the Investor Relations section of our website at composecure.com and on the SEC's website at sec.gov. Please note that the discussion on today's call includes certain non-GAAP financial measures, including adjusted EBITDA, adjusted net income and adjusted EPS. The company believes these non-GAAP financial measures provide useful information to management and investors regarding certain financial and business trends impacting the company's financial condition and results of operations. These non-GAAP financial measures should not be considered as an alternative to net income or any other performance measures derived in accordance with U.S. GAAP and may be different from similarly titled non-GAAP measures used by other companies. A reconciliation of GAAP to non-GAAP measures is available in our press release and earnings presentation available on the Investor Relations section of our website. Thank you. And with that, let me turn the call over to Jon to discuss our second quarter results.
Jonathan Wilk: Thank you, Sean. Good afternoon, everyone, and thank you for joining us for our second quarter conference call. As you hopefully read from our 8-K filed this afternoon, I am excited to announce a 5-year contract extension with one of our largest customers through December 2028 as their exclusive provider of metal cards. This comes on the heels of the extension with American Express we announced last quarter. Which means we have now secured long-term renewals with our 2 largest customers. Throughout our 20-year history, our company has been driven by delivering unmatched value and business impact for our clients, as well as innovation, all while establishing long-term partnerships across the market, and I'm proud that we continue to demonstrate that unique value proposition. Now to summarize the quarter on Page 3. Our second quarter results once again reflected the performance and consistency of our business as net sales for the quarter increased 1% to $98.5 million, driven by strong domestic growth of 11% which was offset by lower international sales, which Tim will cover in a bit more detail. On a year-to-date basis, net sales are up 7% to $194 million. Looking at card issuer trends, our customers continue to report strong growth and have a positive outlook while maintaining their investment in customer acquisition and rewards despite the macroeconomic uncertainty. During the quarter, we continue to position our payment card and Arculus product offerings for growth, including expanding our sales team, continuing trade show and partnership opportunities and executing our B2B marketing strategy. And finally, we are reaffirming our guidance for 2023 which calls for net sales to range between $400 million to $425 million, with adjusted EBITDA ranging between $145 million and $155 million. I'd like to take a minute and cover some of the other highlights for the quarter. Turning to Slide 4. In addition to the contract extension which I previously talked about, we've launched several new metal card programs with top issuers this quarter. To highlight a few, with Citizens Bank, we're helping to deliver an innovative metal card design that integrates a touch card feature from Mastercard to help partially sighted or blind people easily distinguish their payment cards from one another. We also launched with Barclays in the U.K., which is one of the biggest 4 banks in that market, overall, one of the largest markets in Europe. In addition, we launched with Mars, a fintech based in Turkey, which is now offering a premium metal Mastercard. From a marketing perspective, we had a strong presence at events and trade shows and we'll continue to ramp that activity as we go through the year, both domestically and internationally. These efforts have helped increase our pipeline for both payment card and Arculus opportunities. I'm also excited to see industry recognition for our company, our product offerings and our leadership team, that we highlighted on Page 4 as well. Moving on to Slide 5, which provides insight from issuers and payment networks. As you can see from these callouts, Amex continues to expect double-digit revenue growth and even greater EPS growth. Capital One emphasized continued marketing spend on their domestic card business, and Visa believes that growth in payment volumes around the world will remain stable. These comments show confidence in the market for payment cards and we believe we're well-positioned to benefit as a market leader in metal cards. Turning to the growing opportunity for secure authentication on Slide 6. Our lives have become highly digital and reliance on passwords is becoming more worrisome. I've spoken to this on previous calls and this issue -- this is an issue that consumers are beginning to recognize as well. On the left-hand side, you'll see that many consumers are looking to transition from passwords with 68% willing to use non-password log-in methods. And on the right side, a recent study shows that consumers want better methods that provide more visible security. That really connects well to our Arculus offerings on Slide 7 and what we can provide for our B2B customers by combining Arculus Authentication and/or Cold Storage with a payment card. I am pleased with our progress against the Arculus road map. We continue to add to our sales team and bolster our Arculus B2B marketing efforts, and we've added new B2B customers this quarter, including Plug Wallet, an online crypto wallet, and Radix DeFi, a decentralized network. I'll now hand it over to Tim to review our financials before returning for closing remarks.
Timothy Fitzsimmons: Thanks, Jon, and good evening, everyone. I'll provide a more detailed overview of our Q2 2023 financial performance, and then turn it back to Jon before we open up the call for questions. Unless stated otherwise, all comparisons and various commentaries are on a year-over-year basis. As Jon mentioned, net sales increased 1% to $98.5 million compared to $97.2 million. The increase was primarily driven by continued domestic growth in the company's metal card payment business, which was up 11%, partially offset by lower international sales, which is a more variable market due to customer mix and a smaller sales base. International sales remained in line with the company's targeted revenue mix of approximately 20%. Gross margin for the quarter was 55% compared to 61% in the prior year. The decrease was primarily due to higher material and labor costs resulting from inflationary pressures and less favorable product mix compared to 2023. It's important to note that gross margin continues to be in line with our previously stated mid-50% margin target. Net income from the quarter was $32.7 million compared to $60.7 million in the prior year. $25.4 million of the difference was driven by non-cash items. Q2 of 2023 had $9.2 million added to net income for non-cash items, while Q2 of 2022 had $34.6 million. These non-cash adjustments are a result of changes in the valuations of the warrants, the earn-out consideration and derivative liabilities, which is primarily driven by the company's stock price improvement year-over-year. Adjusted EBITDA in Q2 was $36.9 million compared to $39.7 million in the prior year, with an adjusted EBITDA margin of 37% compared to 41% in the second quarter of '22. The decrease in adjusted EBITDA margin was driven by product mix and the impact of the inflationary pressures, that I've already spoken to, as well as continued investment in our sales and support teams. Adjusted EBITDA includes the net impact of $4.2 million of our continued investment in Arculus. As we have stated in the past, this is right in line with managing our investments to be at or below our overall net investment in '22 and our ongoing effort to deliver long-term value for our shareholders. On Slide 10, year-to-date 2023 results. On this slide, you can see our year-to-date performance. Net sales were up 7% to $194 million, driven by our strong sales execution and continued demand for metal payment cards. Our year-to-date gross margin of 55% is in line with our mid-50% target despite the higher labor and material costs I've just mentioned. Net income for the first half was $43.4 million compared to $87.6 million in the prior year. $41.3 million of the difference was driven by non-cash items. Full year 2023 had $4.3 million added to net income for non-cash items, while the full year of '22 had $37 million. Adjusted EBITDA for the first half was $72 million compared to $73 million in the prior year. EBITDA margin for the first half was 37% compared to 40% in the prior year. This was impacted by the gross margin decrease and continued investment in sales and support teams. This includes our year-to-date net investment in Arculus of $8.7 million. On Slide 11, looking closer with the split between domestic and international, you can see that our domestic sales continued to improve, increasing 11% to the second quarter of $78 million, again, due to the strength of our sales execution and favorable industry trends. International net sales for the second quarter of 2023 were $21 million, remaining in line with our long-term target of roughly 20% of total net sales. Moving on to the balance sheet, which you'll find in the appendix. We had cash and cash equivalents of $23 million and total debt of $358 million, which includes $228 million of term loan and $130 million of exchangeable notes. This results in a total net debt of $335 million. As always, we want to provide both our overall debt leverage and our bank agreement secured debt leverage ratio as our bank agreement is calculated with slight differences. At June 30, our overall leverage ratio was 2.5x based on a net debt of $335 million and trailing 12-month adjusted EBITDA of $136 million. This compares to 3x at June 30, 2022 with the improvement driven by paying down debt and increased trailing 12-month adjusted EBITDA. At June 30, 2023, we had a bank agreement secured debt leverage ratio of 1.6x based on a total secured debt of $228 million and trailing 12-month bank adjusted EBITDA of $143 million. This compares to 2.2x at June 30, 2022. We've generated year-to-date operating cash flow of $53 million. I want to turn now to earnings per share. As a reminder, our method under GAAP for calculating basic and diluted EPS allows us to allocate changes and adjustments of mark-to-market instruments among the public company and operating subsidiaries to better reflect the actual economic impact of the conversion of such instruments on our net income on a per share basis. GAAP EPS for the 3 months ended June 30, 2023 was $0.31 per basic share and $0.29 per diluted share. This compares to $0.56 and $0.52 per basic and diluted share, respectively, in the year ago period. The decrease was primarily driven by changes to the fair value of the warrants, earn-out consideration and derivative liabilities, primarily driven by our stock price improvement. You can read through the footnotes on the slide that take you through the complexities of the allocation of net income due to the Up-C structure and the shares that are included in the basic and diluted calculations. Now let's look at the 6-month EPS. Turning to Slide 13. You could see how we are tracking with GAAP EPS for the year, which now puts us at $0.45 per basic share and $0.41 per diluted share. This compares to $0.80 and $0.75 per basic and diluted share, respectively, in the year ago period. Again, this was impacted by the same factors I outlined on the previous slides as non-cash adjustments can have either a positive or a negative impact on net income. On Slide 14, we're also providing non-GAAP adjusted net income and adjusted EPS, which excludes the impact of non-cash fair value adjustments on the warrants earn-out and stock-based comp. We believe that this provides a clearer picture of the economics of the company's operating results. With that background, our non-GAAP EPS for the second quarter 2023 was $0.29 per basic share and $0.25 per diluted share. This compares to $0.33 per basic share and $0.29 per diluted share in the year ago period. The decrease in adjusted EPS was driven primarily by the previously outlined product mix, inflationary pressures and continued investment in our sales and support teams. In the appendix, you'll find a reconciliation between the GAAP and non-GAAP net income used in these calculations. Turning to Slide 15. Adjusted EPS for the [Technical Difficulty] put us at [ $0.50 ] per basic share and $0.48 per diluted share. This compares to $0.60 and $0.52 per basic and diluted share, respectively, in the year ago period, again, impacted by the same factors I have outlined on the previous slides. I'll now turn it back to Jon to discuss our guidance and give closing remarks.
Jonathan Wilk: Thanks, Tim. Now turning to Slide 16. As I mentioned earlier, we remain on track for 2023, and we are reaffirming our previously issued guidance. We anticipate net sales to range from between $400 million to $425 million with gross margin in the [ mid-50s ] range and expected adjusted EBITDA to finish between $145 million and $155 million. To close on Slide 17, I want to highlight a few things that we've covered today. One, we've reaffirmed our guidance and have now re-signed long-term contracts with our 2 largest customers. Our customers continue to maintain a positive outlook for the premium payment [Technical Difficulty] opportunity around Arculus Authentication and Cold Storage. We are bolstering our position to take advantage of growth opportunities by adding salespeople and focusing on our B2B marketing efforts. We remain thoughtful about our investments to better capture long-term value for our shareholders, and that continues to pay off simultaneously, supporting margin and driving growth opportunities. With that, I'd like to open [Technical Difficulty].
Operator: [Operator Instructions] Our first question comes from the line of Reggie Smith of JPMorgan.
Reginald Smith: My first, you cited, I guess, macro uncertainty in the press release. So I was curious if you felt or saw any macro weakness, and how that manifests in the business?
Jonathan Wilk: We're seeing at this point data that still remains, I'd say, positive. There's just [ the ] [ watch ] item out there for us and for our issuer partners that we continue to monitor closely. But so far, those signs have been solid.
Reginald Smith: And if I could follow up with one more. Obviously, you reiterated your guidance, which is great. And not to nitpick here, but just curious, I guess, when you think about what's implied for the back half and kind of the range of outcomes for the back half by maintaining guidance in the same range, I guess, it somewhat implies that there is a wider band of potential outcome for the last 2 quarters. I'm not sure if that was -- if that's even accurate, or the message you're trying to convey, but curious how you think about that. So essentially, you've got a $25 million range over the last 2 quarters of the year, where before you had a similar range over 3 quarters of performance, if you follow my question?
Jonathan Wilk: Yes. I think you may be reading too much into it from that perspective. We typically have not updated guidance quarter-to-quarter. We feel good about the ranges that we've given. What it does imply, Reggie, is that the back half would be stronger from a revenue standpoint to come into that range. And if you look at where we are year-to-date on EBITDA, we're right about halfway to the bottom end of that range as well. So, I mean, those are the implications I wouldn't read more into it than that, other than we feel very comfortable with the ranges we've given.
Reginald Smith: And if I can get one more in quickly. So obviously, '22 was an amazing year for you guys that -- it's a very difficult comp. If you were to kind of control for that, how are you thinking about kind of the growth of the business kind of long-term?
Jonathan Wilk: So we haven't given updated long-term guidance, Reggie. We'll issue updated guidance as we move through the back half of this year. And what we said in the past is we do believe this business on average can grow in the mid-teens. But more specifically, the implications around gross margins, being able to continue to operate [ mid-50s ], EBITDA in the core business north of [ 40% ] with investment perhaps [ mid-30s ]. So that's how we think about it.
Operator: Our next question comes from the line of John Todaro of Needham & Company.
John Todaro: Congrats on the contract renewal. First one here -- I have 2. But if we could just go back to the sales outlook for a moment and without trying to dig too deep into it. As you mentioned, it does imply kind of an uptick. Are there any second half drivers that we should be thinking about and aware of?
Jonathan Wilk: The drivers for us are fairly consistent, John. I try to hit them almost -- on each call, which is continued growth from our top clients, domestic expansion outside of those top clients, international growth and fintechs really across domestic and international. And we're seeing the opportunities coming in and across all 4 of those areas and feel good about that.
John Todaro: And then just a second question. Inflationary pressures were recorded as some of the gross margin decline. I would imagine from here -- maybe a little additionary inflationary pressures, but would love to hear if there's any color there, and if we should kind of expect that new number for gross margin moving forward, at least for the rest of '23?
Jonathan Wilk: So we -- I've said, I'll continue to say, and Tim reiterated a number of times, we think gross margin should be in the [ mid-50s ]. Sometimes it could be a few points higher, sometimes it could be a few points lower. We think that [ mid-50s ] is the right range for people to be thinking about. And this quarter, we're right on that number. So the time Tim spent was around explaining the difference between second quarter of last year and those were the examples he gave. But net-net, we've been saying for a long time we think that [ mid-50s ] is the right target and we came in exactly on that, and we feel good about that continuing.
Operator: Our next question comes from the line of Harold Goetsch of B. Riley.
Harold Goetsch: My question is, there's been a little bit of scare in the banking sector in the back half of Q1 and Q2. And I'm wondering if -- was there any impact of any inventory drawdown in the channel? Where do you think inventories are in the right shape, both at your company and with your bank partners?
Jonathan Wilk: So, we've certainly been watching and monitoring the activity among things like regional banks. We have not seen an impact on our business from that. We've seen, I'd say, continued strong levels of conversation across that next level of bank in the U.S. and feel good about that. Citizens is a great example of a new launch, which we're very proud of. With reference to inventory levels, we don't have perfect visibility into what clients could be carrying around that. I'd say, generally speaking, we've carried more inventory post COVID. We've wanted higher inventory levels of key raw material items going in. Generally, issuers, I think, are keeping appropriate amounts of safety stock of cards on hand, and I really haven't seen a change there.
Operator: Our next question comes from the line of Chase White of Compass Point Research & Trading.
Chase White: So on your contract expansion, you've got your top 2 clients now extended. Is it safe to assume that the contract extension that you just announced is on similar terms when it comes to escalators and other KPIs? And does that give you any better visibility? Obviously, you kind of touched on this earlier, but any better visibility into early 2024 in terms of the business? And I have a follow-up after that.
Jonathan Wilk: I'm not going to comment on terms and conditions of the renewal, except to say that we have planned for all of the contract renewals we had coming up as part of our normal business cycle. We remain comfortable with our overall guidance in the context of all of our renewals. And we'll give updated guidance as we move toward the end of the year here. But just having our top clients under contract and winning those opportunities, we think, is a very important statement around our business, yes.
Chase White: And a follow-up. Any updates on your exchange partner for Arculus, or when we could hear more about that?
Jonathan Wilk: So we're continuing to advance partnerships, some previously announced, some I announced today. And I continue to feel terrific about the product we built, the platform, the Arculus road map. We maintain, and continue to maintain a positive outlook there. Things always seem to take a little bit longer than you anticipate as you're trying to get some of these programs up and running. And we continue to work through with the exchange partner, that we highlighted earlier this year, around piloting the Arculus authentication technology. So we look forward to more updates as we move through the year as well.
Operator: [Operator Instructions] Our next question comes from the line of Mark Palmer of Berenberg Capital Markets.
Mark Palmer: The company is throwing off a very healthy amount of cash flow on a pretty consistent basis. What are your priorities right now with regard to the use of that cash? And [ you ] see that your overall leverage ratio is at 2.5x. What do you think as being an optimal level of leverage that you want to maintain as you continue to operate the business?
Jonathan Wilk: Yes, we continue to throw off a significant amount of cash. As we've highlighted before, our 2 stated priorities are organic growth and continuing to pay down debt. And as Tim highlighted and you highlighted in your question, we've continued to lower those leverage ratios. So feel good about that. When you look, Tim's reference points were for June of last year, same time. If you go back further to when we went public, it's even further deleveraging from that point. And we got there through a combination of paying down debt and growing EBITDA and we would look to continue to do both of those things. So beyond that, it's Board level conversations around capital allocation that we will continue to have and monitor on an ongoing basis.
Operator: As there appear to be no further questions in queue, this does conclude today's conference call. Thank you for participating. You may now disconnect.