CPI Card 10Q 2022 Q3 Quarterly report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

☒

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities and Exchange Act of 1934

For the Quarterly Period Ended September 30, 2022.

☐

Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Transition Period from to

Commission File Number: 001-37584

CPI Card Group Inc.

(Exact name of the registrant as specified in its charter)



Delaware		26-0344657
(State or other jurisdiction of incorporation or organization)		(I.R.S. employer identification no.)

10368 W. Centennial Road
Littleton, CO		80127
(Address of principal executive offices)		(Zip Code)

(720) 681-6304

(Registrant’s telephone number, including area code)

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


Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $0.001 par value	PMTS	Nasdaq Global Market

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer	☐	Accelerated filer	☒

Non-accelerated filer	☐	Smaller reporting company	☒

		Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐ No ☒

Number of shares of Common Stock, $0.001 par value, outstanding as of October 27, 2022: 11,385,619

Table of Contents

Table of Contents


		Page
Part I — Financial Information

Item 1 — Financial Statements (Unaudited)		3

Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations		22

Item 3 — Quantitative and Qualitative Disclosures About Market Risk		35

Item 4 — Controls and Procedures		35

Part II — Other Information

Item 1 — Legal Proceedings		37

Item 1A — Risk Factors		37

Item 6 — Exhibits		38

Signatures		39

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PART I - Financial Information

Item 1. Financial Statements

CPI Card Group Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(in thousands, except share and per share amounts)

(Unaudited)


	September 30,		December 31,
	2022		2021
Assets
Current assets:
Cash and cash equivalents	$	21,507	$	20,683
Accounts receivable, net of allowances of $169 and $86, respectively		75,749		60,953
Inventories		72,219		58,009
Prepaid expenses and other current assets		5,080		5,522
Income taxes receivable		2,112		534
Total current assets		176,667		145,701
Plant, equipment, leasehold improvements and operating lease right-of-use assets, net		57,268		47,251
Intangible assets, net		18,954		21,854
Goodwill		47,150		47,150
Other assets		5,008		6,184
Total assets	$	305,047	$	268,140
Liabilities and stockholders’ deficit
Current liabilities:
Accounts payable	$	25,703	$	26,443
Accrued expenses		34,384		37,150
Deferred revenue and customer deposits		3,915		1,182
Total current liabilities		64,002		64,775
Long-term debt		310,091		303,626
Deferred income taxes		6,445		5,253
Other long-term liabilities		18,769		15,506
Total liabilities		399,307		389,160
Commitments and contingencies (Note 14)
Series A Preferred Stock; $0.001 par value—100,000 shares authorized; 0 shares issued and outstanding at September 30, 2022 and December 31, 2021		—		—
Stockholders’ deficit:
Common stock; $0.001 par value—100,000,000 shares authorized; 11,287,909 and 11,255,466 shares issued and outstanding at September 30, 2022 and December 31, 2021, respectively		11		11
Capital deficiency		(108,085)		(110,782)
Accumulated earnings (loss)		13,814		(10,249)
Total stockholders’ deficit		(94,260)		(121,020)
Total liabilities and stockholders’ deficit	$	305,047	$	268,140

See accompanying notes to condensed consolidated financial statements

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CPI Card Group Inc. and Subsidiaries

Condensed Consolidated Statements of Operations and Comprehensive Income

(in thousands, except share and per share amounts)

(Unaudited)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Net sales:
Products	$	71,606	$	52,276	$	208,867	$	146,445
Services		52,971		47,326		140,442		135,468
Total net sales		124,577		99,602		349,309		281,913
Cost of sales:
Products (exclusive of depreciation and amortization shown below)		42,702		31,493		128,851		86,708
Services (exclusive of depreciation and amortization shown below)		31,190		28,368		85,625		77,975
Depreciation and amortization		2,245		2,056		6,564		6,736
Total cost of sales		76,137		61,917		221,040		171,419
Gross profit		48,440		37,685		128,269		110,494
Operating expenses:
Selling, general and administrative (exclusive of depreciation and amortization shown below)		23,403		19,469		67,335		55,363
Depreciation and amortization		1,592		1,514		4,454		4,873
Total operating expenses		24,995		20,983		71,789		60,236
Income from operations		23,445		16,702		56,480		50,258
Other expense, net:
Interest, net		(7,323)		(7,183)		(22,334)		(23,196)
Other (expense) income, net		(63)		(6)		(79)		23
Loss on debt extinguishment		—		—		(395)		(5,048)
Total other expense, net		(7,386)		(7,189)		(22,808)		(28,221)
Income before income taxes		16,059		9,513		33,672		22,037
Income tax expense		(4,149)		(2,887)		(9,609)		(6,769)
Net income	$	11,910	$	6,626	$	24,063	$	15,268

Basic and diluted earnings per share:
Basic earnings per share	$	1.06	$	0.59	$	2.14	$	1.36
Diluted earnings per share	$	1.01	$	0.56	$	2.05	$	1.30

Basic weighted-average shares outstanding		11,265,767		11,238,678		11,259,655		11,234,054
Diluted weighted-average shares outstanding		11,788,921		11,799,321		11,730,668		11,755,381

Comprehensive income:
Net income	$	11,910	$	6,626	$	24,063	$	15,268
Total comprehensive income	$	11,910	$	6,626	$	24,063	$	15,268

See accompanying notes to condensed consolidated financial statements

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CPI Card Group Inc. and Subsidiaries

Condensed Consolidated Statements of Stockholders’ Deficit

(in thousands, except per share amounts)

(Unaudited)


	Common Stock			Capital		Accumulated
	Shares	Amount		deficiency		earnings (loss)		Total
June 30, 2022	11,262,688	$	11	$	(108,880)	$	1,904	$	(106,965)
Stock-based compensation	—		—		966		—		966
Shares issued under stock-based compensation plans	25,221		—		(171)		—		(171)
Components of comprehensive income:
Net income	—		—		—		11,910		11,910
September 30, 2022	11,287,909	$	11	$	(108,085)	$	13,814	$	(94,260)


	Common Stock			Capital		Accumulated
	Shares	Amount		deficiency		earnings (loss)		Total
December 31, 2021	11,255,466	$	11	$	(110,782)	$	(10,249)	$	(121,020)
Stock-based compensation	—		—		2,928		—		2,928
Shares issued under stock-based compensation plans	32,443		—		(231)		—		(231)
Components of comprehensive income:
Net income	—		—		—		24,063		24,063
September 30, 2022	11,287,909	$	11	$	(108,085)	$	13,814	$	(94,260)


	Common Stock			Capital		Accumulated
	Shares	Amount		deficiency		earnings (loss)		Total
June 30, 2021	11,237,056	$	11	$	(111,726)	$	(17,548)	$	(129,263)
Stock-based compensation	—		—		116		—		116
Shares issued under stock-based compensation plans	1,938		—		(12)		—		(12)
Components of comprehensive income:
Net income	—		—		—		6,626		6,626
September 30, 2021	11,238,994	$	11	$	(111,622)	$	(10,922)	$	(122,533)


	Common Stock			Capital		Accumulated
	Shares	Amount		deficiency		earnings (loss)		Total
December 31, 2020	11,230,482	$	11	$	(111,858)	$	(26,190)	$	(138,037)
Stock-based compensation	—		—		214		—		214
Shares issued under stock-based compensation plans	8,512		—		22		—		22
Components of comprehensive income:
Net income	—		—		—		15,268		15,268
September 30, 2021	11,238,994	$	11	$	(111,622)	$	(10,922)	$	(122,533)

See accompanying notes to condensed consolidated financial statements

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CPI Card Group Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)


	Nine Months Ended September 30,
	2022		2021
Operating activities
Net income	$	24,063	$	15,268
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation and amortization expense		11,018		11,609
Stock-based compensation expense		2,928		214
Amortization of debt issuance costs and debt discount		1,449		1,880
Loss on debt extinguishment		395		5,048
Deferred income taxes		1,192		(752)
Other, net		437		210
Changes in operating assets and liabilities:
Accounts receivable		(14,862)		(10,846)
Inventories		(13,916)		(21,831)
Prepaid expenses and other assets		1,501		(3,340)
Income taxes, net		(1,577)		10,603
Accounts payable		(440)		83
Accrued expenses and other liabilities		(3,208)		7,212
Deferred revenue and customer deposits		2,733		(843)
Cash provided by operating activities		11,713		14,515
Investing activities
Capital expenditures for plant, equipment and leasehold improvements		(14,440)		(4,827)
Other		95		156
Cash used in investing activities		(14,345)		(4,671)
Financing activities
Principal payments on First Lien Term Loan		—		(312,500)
Principal payments on Senior Credit Facility		—		(30,000)
Principal payments on Senior Notes		(20,000)		—
Principal payments on ABL Revolver		(10,000)		(15,000)
Proceeds from Senior Notes		—		310,000
Proceeds from ABL Revolver, net of discount		35,000		14,750
Debt issuance costs		(262)		(9,452)
Payments on debt extinguishment and other		(831)		(2,663)
Proceeds from finance lease financing		2,074		—
Payments on finance lease obligations		(2,457)		(1,725)
Cash provided by (used in) financing activities		3,524		(46,590)
Effect of exchange rates on cash		(68)		(4)
Net decrease in cash and cash equivalents		824		(36,750)
Cash and cash equivalents, beginning of period		20,683		57,603
Cash and cash equivalents, end of period	$	21,507	$	20,853
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest	$	27,026	$	22,107
Income taxes paid	$	10,859	$	4,708
Income taxes (refunded)	$	(449)	$	(9,846)
Right-of-use assets obtained in exchange for lease obligations:
Operating leases	$	816	$	3,666
Financing leases	$	7,783	$	484
Accounts payable and accrued expenses for capital expenditures for plant, equipment and leasehold improvements	$	1,781	$	1,005

See accompanying notes to condensed consolidated financial statements

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CPI Card Group Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except share and per share amounts or as otherwise indicated)

(Unaudited)

1. Business Overview and Summary of Significant Accounting Policies

Business Overview

CPI Card Group Inc. (which, together with its subsidiary companies, is referred to herein as “CPI” or the “Company”) is a payment technology company and leading provider of comprehensive Financial Payment Card solutions in the United States. CPI is engaged in the design, production, data personalization, packaging and fulfillment of Financial Payment Cards, which the Company defines as credit, debit and Prepaid Debit Cards (defined below) issued on the networks of the Payment Card Brands (Visa, Mastercard^®, American Express^® and Discover^®). CPI defines “Prepaid Debit Cards” as debit cards issued on the networks of the Payment Card Brands, but not linked to a traditional bank account. CPI also offers an instant card issuance solution, which provides bank customers the ability to issue a personalized debit or credit card within the bank branch to individual cardholders.

CPI serves its 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 by one or more of the Payment Card Brands. CPI’s leading network of high-security production facilities allows the Company to optimize its solutions offerings and serve its customers.

COVID-19 Update

The COVID-19 pandemic and associated counteracting measures implemented by governments and businesses around the world have impacted, and continue to impact, economies and societies globally, including the locations where CPI, its customers and suppliers conduct business. The Company believes the global impacts from COVID-19, along with other macro-economic factors, have contributed to, among other things certain adverse effects on its supply chain, production lead times, labor availability, employee absenteeism and costs. Though the Company has implemented measures to attempt to mitigate the impacts of the challenges described above, the Company believes that such impacts, and the associated costs, may continue throughout 2022 and beyond. The long-term implications of COVID-19 on the Company’s results of operations and overall financial performance remain uncertain, though the health and safety of CPI employees remains paramount.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was signed into law. The CARES Act, among other things, included provisions relating to refundable payroll tax credits, deferment of employer social security payments, changes in net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitation and technical corrections to tax depreciation methods for qualified improvement property. The Company deferred employer social security payments in 2020 in accordance with the CARES Act, and the first installment repayment was made in the fourth quarter of 2021. The second installment payment is permitted to be paid no later than the fourth quarter of 2022 and had not been paid as of September 30, 2022.

Basis of Presentation

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to Form 10-Q and Article 8 of Regulation S-X. In the opinion of management, these financial statements reflect all adjustments (consisting of normal recurring adjustments) considered necessary for the fair statement of the results of the interim periods presented. The condensed consolidated balance sheet as of December 31, 2021 is derived from the audited financial statements as of that date. The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.

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Use of Estimates

Management uses estimates and assumptions relating to the reporting of assets and liabilities at the date of the financial statements, the reported revenues and expenses recognized during the reporting period, and certain financial statement disclosures in the preparation of the condensed consolidated financial statements. Significant items subject to such estimates and assumptions include the carrying amount of property and equipment, goodwill and intangible assets, leases, liability for sales tax, valuation allowances for inventories and deferred taxes, revenue recognized for work performed but not completed and uncertain tax positions. Actual results could differ from those estimates.

Recent Accounting Standards

Recently Issued Accounting Standards

In June 2016, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2016-13, Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"). This ASU changes the model for the recognition of credit losses from an incurred loss model, which recognized credit losses only if it was probable that a loss had been incurred, to an expected loss model, which requires the Company to estimate the total credit losses expected on the portfolio of financial instruments. The effective date of ASU 2016-13 was amended by ASU 2019-10, Credit Losses Effective Dates. Since CPI is a smaller reporting company, adoption of this accounting standard is effective for the Company for fiscal years beginning after December 15, 2022, and interim periods therein, with early adoption permitted. The Company has elected not to early adopt this accounting standard. The Company is evaluating the impact of adoption of this standard and does not anticipate the application of ASU 2016-13 will have a material impact on the Company’s consolidated financial position or results of operations.

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2. Net Sales

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


	Three Months Ended September 30, 2022
	Products		Services		Total
Debit and Credit	$	71,857	$	27,655	$	99,512
Prepaid Debit		-		25,335		25,335
Intersegment eliminations		(251)		(19)		(270)
Total	$	71,606	$	52,971	$	124,577

	Nine Months Ended September 30, 2022
	Products		Services		Total
Debit and Credit	$	209,236	$	76,472	$	285,708
Prepaid Debit		—		64,010		64,010
Intersegment eliminations		(369)		(40)		(409)
Total	$	208,867	$	140,442	$	349,309

	Three Months Ended September 30, 2021
	Products		Services		Total
Debit and Credit	$	52,292	$	23,829	$	76,121
Prepaid Debit		—		23,498		23,498
Intersegment eliminations		(16)		(1)		(17)
Total	$	52,276	$	47,326	$	99,602

	Nine Months Ended September 30, 2021
	Products		Services		Total
Debit and Credit	$	146,651	$	72,147	$	218,798
Prepaid Debit		—		63,339		63,339
Intersegment eliminations		(206)		(18)		(224)
Total	$	146,445	$	135,468	$	281,913

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, the Company estimates revenue by taking actual costs incurred and applying historical margins for similar types of contracts. Items included in “Products” net sales are produced Financial Payment Cards, including contact-EMV^®, contactless dual-interface EMV, contactless and magnetic stripe cards, CPI’s eco-focused solutions, including Second Wave^® and Earthwise^TM cards made with upcycled plastic, metal cards, private label credit cards and retail gift cards. Card@Once^® printers and consumables are also included in “Products” net sales, and their associated revenues are recognized at the time of shipping. The Company includes gross shipping and handling revenue in net sales, and shipping and handling costs in cost of sales.

EMV^® is a registered trademark in the U.S. and other countries and an unregistered trademark elsewhere. The EMV trademark is owned by EMVCo, LLC.

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 software as a service personalization of instant issuance debit cards. As applicable, for work performed but not completed and unbilled, the Company estimates revenue by taking actual costs incurred and applying historical margins for similar types of contracts.

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Customer Contracts

The Company often enters into Master Services Agreements (“MSAs”) with its customers. Generally, enforceable rights and obligations for goods and services occur only when a customer places a purchase order or statement of work to obtain goods or services under an MSA. The contract term as defined by 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 short term in nature.

3. Accounts Receivable

Accounts receivable consisted of the following:


		September 30,		December 31,
		2022		2021
Trade accounts receivable	$	62,561	$	50,042
Unbilled accounts receivable		13,357		10,997
		75,918		61,039
Less allowance for doubtful accounts		(169)		(86)
	$	75,749	$	60,953

4. Inventories

Inventories consisted of the following:


		September 30,		December 31,
		2022		2021
Raw materials	$	64,924	$	54,254
Finished goods		10,024		6,778
Inventory reserve		(2,729)		(3,023)
	$	72,219	$	58,009

5. Plant, Equipment, Leasehold Improvements and Operating Lease Right-of-Use Assets

Plant, equipment, leasehold improvements and operating lease right-of-use assets consisted of the following:


		September 30,		December 31,
		2022		2021
Machinery and equipment	$	61,302	$	64,051
Machinery and equipment under financing leases		14,375		9,088
Furniture, fixtures and computer equipment		2,774		4,570
Leasehold improvements		14,508		14,142
Construction in progress		5,208		5,268
		98,167		97,119
Less accumulated depreciation and amortization		(52,240)		(61,937)
Operating lease right-of-use assets, net of accumulated amortization		11,341		12,069
	$	57,268	$	47,251

Depreciation expense of plant, equipment and leasehold improvements, including depreciation of assets under financing leases, was $2,870 and $2,482 for the three months ended September 30, 2022 and 2021, respectively, and $8,118 and $8,223 for the nine months ended September 30, 2022 and 2021, respectively.

Operating lease right-of-use assets, net of accumulated amortization, are further described in Note 9, “Financing and Operating Leases.”

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6. Goodwill and Other Intangible Assets

The Company reports all of its goodwill in the Debit and Credit segment at September 30, 2022 and December 31, 2021. Goodwill is tested for impairment at least annually on October 1 or more frequently when an event occurs or circumstances change that indicate the carrying value may not be recoverable. The Company did not identify a triggering event requiring a quantitative test for impairment as of September 30, 2022.

Intangible assets consist of customer relationships, technology, and trademarks. Intangible amortization expense was $967 and $1,088 for the three months ended September 30, 2022 and 2021, respectively, and $2,900 and $3,386 for the nine months ended September 30, 2022 and 2021, respectively.

At September 30, 2022 and December 31, 2021, intangible assets, excluding goodwill, were comprised of the following:


		September 30,						December 31,
		2022						2021
	Weighted Average			Accumulated		Net Book				Accumulated		Net Book
	Life (Years)	Cost		Amortization		Value		Cost		Amortization		Value
Customer relationships	17.2	$	55,454	$	(37,877)	$	17,577	$	55,454	$	(35,419)	$	20,035
Technology	10		7,101		(6,717)		384		7,101		(6,567)		534
Trademarks	8.7		3,330		(2,337)		993		3,330		(2,045)		1,285
Intangible assets subject to amortization		$	65,885	$	(46,931)	$	18,954	$	65,885	$	(44,031)	$	21,854

The estimated future aggregate amortization expense for the identified amortizable intangibles noted above as of September 30, 2022 was as follows:


2022 (excluding the nine months ended September 30, 2022)	$	966
2023		3,867
2024		3,630
2025		3,440
2026		2,471
Thereafter		4,580
	$	18,954

7. Fair Value of Financial Instruments

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). In determining fair value, the Company utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

● Level 1—Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities accessible to the reporting entity at the measurement date.

● Level 2— Observable inputs other than Level 1 prices, such as quoted prices in active markets for similar assets and liabilities, quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term for the assets or liabilities.

● Level 3— Valuations based on unobservable inputs for the asset or liability used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date.

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The Company’s financial assets and liabilities that are not required to be re-measured at fair value in the condensed consolidated balance sheets were as follows:


	Carrying		Estimated
	Value as of		Fair Value as of		Fair Value Measurement at September 30, 2022
	September 30,		September 30,		(Using Fair Value Hierarchy)
	2022		2022		Level 1		Level 2		Level 3
Liabilities:
Senior Notes	$	290,000	$	279,125	$	—	$	279,125	$	—
ABL Revolver	$	25,000	$	25,000	$	—	$	25,000	$	—


	Carrying		Estimated
	Value as of		Fair Value as of		Fair Value Measurement at December 31, 2021
	December 31,		December 31,		(Using Fair Value Hierarchy)
	2021		2021		Level 1		Level 2		Level 3
Liabilities:
Senior Notes	$	310,000	$	327,050	$	—	$	327,050	$	—

The aggregate fair value of the Company’s Senior Notes (as defined in Note 10, “Long-Term Debt”) was based on bank quotes. The fair value measurement associated with the ABL Revolver (as defined in Note 10, “Long-Term Debt”) approximates its carrying value as of September 30, 2022, given the applicable variable interest rates and nature of the security interest in Company assets.

The carrying amounts for cash and cash equivalents, accounts receivable and accounts payable each approximate fair value due to their short-term nature.

8. Accrued Expenses

Accrued expenses consisted of the following:


	September 30,		December 31,
	2022		2021
Accrued payroll and related employee expenses	$	8,697	$	7,558
Accrued employee performance bonuses		6,975		6,900
Employer payroll taxes, including social security deferral		2,277		1,910
Accrued rebates		2,040		1,423
Estimated sales tax liability		762		1,019
Accrued interest		1,105		7,955
Current operating and financing lease liabilities		5,445		4,114
Other		7,083		6,271
Total accrued expenses	$	34,384	$	37,150

The estimated sales tax liability is further described in Note 14, “Commitments and Contingencies” and Note 1, “Business Overview and Summary of Significant Accounting Policies.”

9. Financing and Operating Leases

Right-of-use (“ROU”) represents the right to use an underlying asset for the lease term, and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. A lease is deemed to exist when the Company has the right to control the use of identified property, plant or equipment, as conveyed through a contract, for a certain period of time and consideration paid. The right to control is deemed to occur when the Company has the right to obtain substantially all of the economic benefits of the identified assets and the right to direct the use of such assets.

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The components of operating and finance lease costs were as follows:



	Three Months Ended		Three Months Ended
	September 30, 2022		September 30, 2021
Operating lease costs	$	783	$	538
Variable lease costs		184		181
Short-term operating lease costs		—		122
Total expense from operating leases	$	967	$	841

Finance lease costs:
Right-of-use amortization expense	$	449	$	256
Interest on lease liabilities		116		92
Total financing lease costs	$	565	$	348


	Nine Months Ended		Nine Months Ended
	September 30, 2022		September 30, 2021
Operating lease costs	$	2,282	$	1,580
Variable lease costs		470		509
Short-term operating lease costs		—		416
Total expense from operating leases	$	2,752	$	2,505

Finance lease costs:
Right-of-use amortization expense	$	1,233	$	751
Interest on lease liabilities		334		297
Total financing lease costs	$	1,567	$	1,048

The following table reflects balances for operating and financing leases:


		September 30,		December 31,
		2022		2021
Operating leases:
Operating lease right-of-use assets, net of amortization	$	11,341	$	12,069

Current operating lease liabilities	$	2,304	$	1,857
Non-current operating lease liabilities		9,514		10,703
Total operating lease liabilities	$	11,818	$	12,560

Financing leases:
Property, equipment and leasehold improvements	$	14,375	$	9,088
Accumulated depreciation		(2,644)		(2,451)
Total financing leases in property, equipment and leasehold ___improvements, net	$	11,731	$	6,637

Current financing lease liabilities	$	3,141	$	2,257
Non-current financing lease liabilities		7,110		2,668
Total financing lease liabilities	$	10,251	$	4,925

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

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Future cash payment with respect to lease obligations as of September 30, 2022 were as follows:


		Operating		Financing
		Leases		Leases
2022 (excluding the nine months ended September 30, 2022)	$	788	$	1,040
2023		3,164		3,626
2024		2,896		2,828
2025		2,090		2,537
2026		1,958		1,175
Thereafter		3,657		271
Total lease payments		14,553		11,477
Less imputed interest		(2,735)		(1,226)
Total	$	11,818	$	10,251

10. Long-Term Debt

At September 30, 2022 and December 31, 2021, long-term debt consisted of the following:


	Interest		September 30,		December 31,
	Rate ⁽¹⁾		2022		2021
Senior Notes	8.625	%	$	290,000	$	310,000
ABL Revolver	4.701	%		25,000		—
Unamortized deferred financing costs				(4,909)		(6,374)
Total long-term debt				310,091		303,626
Less current maturities				—		—
Long-term debt, net of current maturities			$	310,091	$	303,626

(1) The Senior Notes bear interest at a fixed rate. The interest rate on the ABL Revolver represents the average effective variable interest rate on outstanding borrowings as of September 30, 2022.

On March 15, 2021, the Company completed a private offering by its wholly-owned subsidiary, CPI CG Inc., of $310,000 aggregate principal amount of 8.625% Senior Secured Notes due 2026 (the “Senior Notes”) and related guarantees. 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.

On March 15, 2021, the Company and CPI CG Inc., as borrower, entered into a Credit Agreement with Wells Fargo Bank, National Association, as lender, administrative agent and collateral agent, providing for an asset-based, senior secured revolving credit facility of up to $50,000 (the “ABL Revolver”). The ABL Revolver matures on the earliest to occur of March 15, 2026 and the date that is 90 days prior to the maturity of the Senior Notes. On March 3, 2022, the Company and CPI CG Inc. entered into Amendment No. 1 to the Credit Agreement (the “Amendment”), which amended the ABL Revolver. The Amendment, among other things, increased the available borrowing capacity under the ABL Revolver to $75,000, increased the uncommitted accordion feature to $25,000 from $15,000, and revised the interest rate provisions to replace the prior LIBOR benchmark with updated benchmark provisions using the secured overnight financing rate (“SOFR”) administered by the Federal Reserve Bank of New York. On October 11, 2022, the Company and CPI CG Inc. entered into Amendment No. 2 to the Credit Agreement, which amended the ABL Revolver to adjust certain monthly document delivery terms and to clarify the treatment of certain inventory.

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. The Company 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. For each quarter through March 31, 2023, the applicable interest rate margin ranges from 1.50% to 1.75% depending on the average unused capacity of the facility for the previous quarter. The unused portion of the ABL Revolver commitment accrues a monthly commitment fee, 0.50% per annum through March 31, 2023, based on the average daily borrowing capacity under the ABL Revolver over the previous month. Unused commitment fee expense was $179 and $118 for the nine months ended September 30, 2022 and 2021, respectively. The interest rate margin and unused commitment fee percentage changes, effective April 1, 2023, to between 1.25% and 1.75% (interest rate margin) and 0.375% and 0.50% (unused commitment fee).

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The ABL Revolver includes limitations on the Company’s 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 $7,500. 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 $75,000 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 $7,500 and until such time that borrowing capacity equals or exceeds $7,500 for 30 consecutive days, the Company 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.

On March 15, 2021, the Company used net proceeds from the Senior Notes, together with cash on hand and initial borrowings of $15,000 under the ABL Revolver, to pay in full and terminate a previous Senior Credit Facility and a previous First Lien Term Loan on March 15, 2021, and to pay related fees and expenses. Early termination of the Senior Credit Facility required payment of a “make-whole” premium of $2,635 as an early termination penalty, which was paid on March 15, 2021, and recorded as interest expense on the condensed consolidated statement of comprehensive income for the year ended December 31, 2021.

On March 11, 2022, the Company used the available borrowing capacity under the ABL Revolver to fund the redemption of $20,000 aggregate principal amount of the Senior Notes at a redemption price equal to 103% of the principal amount thereof plus accrued and unpaid interest thereon to the redemption date.

The Senior Notes are guaranteed by the Company and certain of its current and future wholly-owned domestic subsidiaries (other than CPI CG Inc. as the issuer of the Senior Notes) that guarantee the ABL Revolver. The Senior Notes are secured by substantially all of the assets of CPI CG Inc. and the guarantors, subject to customary exceptions. The ABL Revolver is guaranteed by the Company and its subsidiaries (other than CPI CG Inc. as borrower and excluded subsidiaries), and is secured by substantially all of the assets of CPI CG Inc. and the guarantors, subject to customary exceptions.

The Senior Notes and the ABL Revolver contain covenants limiting the ability of the Company, CPI CG Inc. and the Company’s 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 its restricted subsidiaries to pay dividends to the Company 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 Company has 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 pursuant to the terms of that certain Indenture, dated as of March 15, 2021, by and among CPI CG Inc., the Company, the subsidiary guarantors and U.S. Bank National Association, as trustee, with any required prepayments to be made after the issuance of the Company’s annual financial statements. No such payment was required to be made in 2022 based on the Company’s operating results for the year ended December 31, 2021.

Deferred Financing Costs and Discount

Certain costs and discounts incurred with borrowings are reflected as a reduction to the long-term debt balance. These costs are amortized as an adjustment to interest expense over the life of the borrowing using the effective-interest rate method. The remaining unamortized debt issuance costs recorded on the Senior Notes were $4,909 and is reported as a reduction to the long-term debt balance as of September 30, 2022. The remaining unamortized net discount and debt issuance costs on the ABL Revolver and related Amendment were $1,670 and are recorded as other assets (current and long-term) on the condensed consolidated balance sheet as of September 30, 2022.

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During the nine months ended September 30, 2021, the Company recorded a $5,048 loss on debt extinguishment relating to the unamortized deferred financing costs and debt discount in connection with the termination of the Senior Credit Facility and First Lien Term Loan, as described earlier.

11. Income Taxes

The Company’s effective tax rates on pre-tax income were 25.8% and 30.3% for the three months ended September 30, 2022 and 2021, respectively, and 28.5% and 30.7% for the nine months ended September 2022 and 2021, respectively. The decrease in the Company’s effective tax rate for the three and nine months compared to the corresponding periods in the prior year was primarily due to a greater proportion of pre-tax income in relation to the impact of permanent items. The effective tax rate for the three months ended September 30, 2022 also decreased as a result of the release of a federal valuation allowance for increased deductibility of interest costs due to a tax election made in the current year.

For the nine months ended September 30, 2022 and 2021, the effective tax rate differs from the U.S. federal statutory income tax rate as follows:


	September 30,
	2022		2021
Tax at federal statutory rate	21.0	%	21.0	%
State taxes, net	5.5		6.2
Valuation allowance	—		—
Permanent items	1.3		2.8
Other	0.7		0.7
Effective income tax rate	28.5	%	30.7	%

12. Stockholders’ Deficit

Common Stock

Common Stock has a par value of $0.001 per share. Holders of Common Stock are entitled to receive dividends and distributions subject to the participation rights of holders of all classes of stock at the time outstanding, as such holders may have prior rights as to dividends pursuant to the rights of any series of Preferred Stock. Upon any liquidation, dissolution or winding up of the Company, after required payments are made to holders of any series of Preferred Stock, any remaining assets of the Company will be distributed ratably to the holders of Common Stock. Holders of Common Stock are entitled to one vote per share.

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13. Earnings per Share

Basic and diluted earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding during the period.

The following table sets forth the computation of basic and diluted earnings per share:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2022		2021		2022		2021
Numerator:
Net income	$	11,910	$	6,626	$	24,063	$	15,268

Denominator:
Basic weighted-average common shares outstanding		11,265,767		11,238,678		11,259,655		11,234,054
Dilutive shares		523,154		560,643		471,013		521,327
Diluted weighted-average common shares outstanding		11,788,921		11,799,321		11,730,668		11,755,381

Basic earnings per share	$	1.06	$	0.59	$	2.14	$	1.36

Diluted earnings per share	$	1.01	$	0.56	$	2.05	$	1.30

14. Commitments and Contingencies

Commitments

Refer to Note 9, “Financing and Operating Leases” for details on the Company’s future cash payments with respect to financing and operating leases. During the normal course of business, the Company enters into non-cancellable agreements to purchase goods and services, including production equipment and information technology systems. The Company leases real property for its facilities under non-cancellable operating lease agreements. Land and facility leases expire at various dates between 2023 and 2029 and contain various provisions for rental adjustments and renewals. The leases typically require the Company to pay property taxes, insurance and normal maintenance costs. The Company’s financing leases expire at various dates between 2022 and 2027 and contain purchase options which the Company may exercise to keep the machinery in use.

Contingencies

In accordance with applicable accounting guidance, the Company establishes an accrued expense when loss contingencies are both probable and estimable. In such cases, there may be an exposure to loss in excess of any amounts accrued. As a matter develops, the Company, in conjunction with any outside counsel handling the matter, evaluates on an ongoing basis whether such matter presents a loss contingency that is probable and estimable. Once the loss contingency is deemed to be both probable and estimable, the Company will establish an accrued expense and record a corresponding amount of expense. The Company expenses professional fees associated with litigation claims and assessments as incurred.

Smart Packaging Solutions SA v. CPI Card Group Inc.

On April 20, 2021, Smart Packaging Solutions, SA (“SPS”) filed a patent infringement lawsuit against the Company in the United States District Court for the District of Delaware seeking an unspecified amount of damages and equitable relief. In the complaint, SPS alleges that the Company infringed four patents that SPS has exclusively licensed from Feinics AmaTech Teoranta. The patents all relate to antenna technology. SPS alleges that the Company incorporates the patented technology into its products that use contactless communication. The Company does not manufacture antennas; it purchases certain antenna-related components from SPS and a number of other suppliers. The Company’s motion to dismiss the complaint is currently pending. Additionally, a third party, Infineon, has filed requests for Inter Parties Review (“IPR”) proceedings concerning each of the four patents. As a result, the Delaware District Court stayed the case pending resolution of the requests for review. Thus far, the United States Patent Office has instituted proceedings with respect to three of the IPR requests and the other remains pending. The current proceedings

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in the patent office are scheduled to run through June 22, 2023. Should the remaining IPR request be denied or should the patents survive review by the United States Patent Office, the Company intends to defend the suit vigorously. However, no assurance can be given that this matter will be resolved favorably. Due to the stage of this matter, the Company is unable to predict the outcome or the possible loss or range of loss, if any, associated with this matter, and no liability has been recorded as of September 30, 2022.

In addition to the matter described above, the Company may be subject to routine legal proceedings in the ordinary course of business. The Company believes that the ultimate resolution of any such matters will not have a material adverse effect on its business, financial condition or results of operations.

Estimated Sales Tax Liability

The Company has continued to evaluate a state sales tax liability analysis for states in which it has economic nexus and to collect exemption documentation from its customers. It is probable that the Company will be subject to sales tax liabilities plus interest and penalties relating to historical activity in certain states. The estimated liability for sales tax as of September 30, 2022 and December 31, 2021 was $762 and $1,019, respectively, and is recorded in accrued expenses in the condensed consolidated balance sheets. The liability decreased from the estimate recorded in the prior period primarily due to the Company remitting cash to the applicable state tax authorities for historical sales tax and interest. The Company may be subject to examination by the relevant state tax authorities. Due to the estimates involved in the analysis, the liability may change in the future. The Company is unable to predict a range of additional loss that is reasonably possible. Sales tax recovered from customers reduces the estimated expense when it is received or probable of collection. Future changes to the liability that impact the condensed consolidated statements of operations will be recorded within “Selling, general and administrative” (“SG&A”). During the nine months ended September 30, 2022 and 2021, the Company recorded sales tax expense of $74 and sales tax benefit of $465, respectively, within SG&A for current activity relating to updates to the estimated liability.

Voluntary Disclosure Program

The Company is subject to unclaimed or abandoned property (escheat) laws which require it to turn over to state governmental authorities the property of others held by the Company that has been unclaimed for specified periods of time. Property subject to escheat laws generally relates to uncashed checks, trade accounts receivable credits and unpaid payable balances. During the second quarter of 2022, the Company received a letter from the Delaware Secretary of State inviting the Company to participate in the Delaware Secretary of State’s Abandoned or Unclaimed Property Voluntary Disclosure Agreement Program to avoid being sent an audit notice by the Delaware Department of Finance. On August 31, 2022, the Company entered into Delaware’s Voluntary Disclosure Agreement Program in order to voluntarily comply with Delaware’s abandoned property law in exchange for certain protections and benefits. The Company intends to work in good faith to complete a review of its books and records related to unclaimed or abandoned property during the periods required under the program. Any potential loss, or range of loss, that may result from this matter is not currently reasonably estimable.

15. Stock-Based Compensation

CPI Card Group Inc. Omnibus Incentive Plan

In October 2015, the Company adopted the CPI Card Group Inc. Omnibus Incentive Plan (the “Omnibus Plan”) pursuant to which cash and equity-based incentives may be granted to participating employees, advisors and directors. On May 27, 2021, the Company’s stockholders approved an amendment and restatement of the Omnibus Plan to, among other things, increase the total number of shares of the Company’s Common Stock reserved and available for issuance thereunder by 1,000,000 shares resulting in a total of 2,200,000 shares of Common Stock issuable under the Omnibus Plan. As of September 30, 2022, there were 879,197 shares of Common Stock available for grant under the Omnibus Plan.

During the nine months ended September 30, 2022, the Company granted 44,905 awards of non-qualified stock options. The Company granted 115,659 awards of non-qualified stock options of during the nine months ended September 30, 2021. The following is a summary of the activity in outstanding stock options under the Omnibus Plan:

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				Weighted-
		Weighted-		Average
		Average		Remaining
		Exercise		Contractual Term
	Options	Price		(in Years)
Outstanding as of December 31, 2021	778,835	$	18.02	5.59
Granted	44,905		14.95	6.47
Exercised	(18,186)		4.31
Expired	(1,320)		21.75
Forfeited	(10,457)		28.03
Outstanding as of September 30, 2022	793,777	$	18.02	4.92
Options vested and exercisable as of September 30, 2022	684,927	$	17.12	4.71
Options vested and expected to vest as of September 30, 2022	793,777	$	18.02	4.92

The following is a summary of the activity in unvested stock options under the Omnibus Plan:


		Weighted-Average
	Options	Grant-Date Fair Value

Unvested as of December 31, 2021	127,357	$	17.42
Granted	44,905		8.99
Vested	(52,955)		17.43
Forfeited	(10,457)		16.52
Unvested as of September 30, 2022	108,850	$	14.03

Unvested stock options of 108,850 as of September 30, 2022 have a seven year term and are expected to vest ratably over a two-year period on each anniversary of the grant date.

The fair value of the stock option awards granted during the nine months ended September 30, 2022, was determined using a Black-Scholes option-pricing model with the following weighted-average assumptions:


	Nine Months Ended
	September 30,
	2022		2021
Expected term in years ⁽¹⁾	4.3		4.3
Volatility ⁽²⁾	77.6	%	78.6	%
Risk-free interest rate ⁽³⁾	2.9	%	0.7	%
Dividend yield ⁽⁴⁾	—	%	—	%

(1)

The Company estimated the expected term based on the average of the weighted-average vesting period and the contractual term of the stock option awards by utilizing the “simplified method”, as the Company does not have sufficient available historical data to estimate the expected term of these stock option awards.

(2)

Volatility was based on a weighting of the Company’s historical volatility and its peer group, which is comprised of companies with similar industry, size and financial leverage.

(3)

The risk-free interest rate was determined by using the United States Treasury rate for the period consistent with the expected option term described above.

(4)

The Company’s expected annual dividend yield was zero based on current practice.

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


				Weighted-
				Average
		Weighted-		Remaining
		Average		Amortization
		Grant-Date		Period
	Shares	Fair Value		(in Years)
Outstanding as of December 31, 2021	261,982	$	13.19
Granted	27,007		14.95
Vested	(31,258)		29.62
Forfeited	(18,247)		10.89
Outstanding as of September 30, 2022	239,484	$	11.42	1.26

The restricted stock unit awards contain conditions associated with continued employment or service. Restricted stock units granted in 2022 are expected to vest ratably over a two-year period on each anniversary of the grant date. On the vesting date, shares of Common Stock will be issued to the award recipients.

Compensation expense for the Omnibus Plan for the three months ended September 30, 2022 and 2021 was $966 and $116, respectively. Compensation expense for the Omnibus Plan for the nine months ended September 30, 2022 and 2021 was $2,928 and $214, respectively. As of September 30, 2022, the total unrecognized compensation expense related to unvested options and restricted stock units is $1,892, which the Company expects to recognize over an estimated weighted-average period of approximately 1.14 years.

16. Segment Reporting

The Company has identified reportable segments that represent 10% or more of its net sales, EBITDA (as defined below) or total assets, or when the Company believes information about the segment would be useful to the readers of the financial statements. The Company’s chief operating decision maker is its Chief Executive Officer, who is charged with management of the Company and is responsible for the evaluation of operating performance and decision making about the allocation of resources to operating segments based on measures, such as net sales and EBITDA.

EBITDA is the primary measure used by the Company’s chief operating decision maker to evaluate segment operating performance. As the Company uses the term, “EBITDA” is defined as income before interest expense, income taxes, depreciation and amortization. The Company’s chief operating decision maker believes EBITDA is a meaningful measure and is useful as a supplement to GAAP measures as it represents a transparent view of the Company’s operating performance that is unaffected by fluctuations in property, equipment and leasehold improvement additions. The Company’s chief operating decision maker uses EBITDA to perform periodic reviews and comparison of operating trends and to identify strategies to improve the allocation of resources amongst segments.

As of September 30, 2022, the Company’s reportable segments were as follows:

● Debit and Credit;

● Prepaid Debit; and

● Other.

Debit and Credit Segment

The Debit and Credit segment primarily produces Financial Payment Cards and provides integrated card services to card-issuing banks primarily in the United States. Products produced by this segment primarily include EMV and non-EMV Financial Payment Cards, including contact and contactless cards, and Earth Elements^TM Eco-Focused Cards. The Company also sells Card@Once instant card issuance solutions, and private label credit cards that are not issued on the networks of the Payment Card Brands. The Company provides CPI On-Demand^® services, where images, personalized payment cards, and related collateral are produced on a one-by-one, on demand basis for customers. This segment also provides a variety of integrated card services, including card personalization and fulfillment services and instant issuance services. The Debit and Credit segment facilities and operations are audited for compliance with the standards of the Payment Card Industry Security Standards Counsel by multiple Payment Card Brands.

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Prepaid Debit Segment

The 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 facilities and operations are audited for compliance with the standards of the Payment Card Industry Security Standards Counsel by multiple Payment Card Brands.

Other

The Other segment includes corporate expenses.

Performance Measures of Reportable Segments

Net Sales and EBITDA of the Company’s reportable segments for the three and nine months ended September 30, 2022 and 2021, were as follows:


	Net Sales
	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Debit and Credit	$	99,512	$	76,121	$	285,708	$	218,798
Prepaid Debit		25,335		23,498		64,010		63,339
Intersegment eliminations		(270)		(17)		(409)		(224)
Total	$	124,577	$	99,602	$	349,309	$	281,913


	EBITDA
	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Debit and Credit	$	31,675	$	22,356	$	85,042	$	67,078
Prepaid Debit		9,638		9,040		22,101		24,719
Other		(14,094)		(11,130)		(40,119)		(34,955)
Total	$	27,219	$	20,266	$	67,024	$	56,842

The following table provides a reconciliation of total segment EBITDA to net income for the three and nine months ended September 30, 2022 and 2021:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2022		2021		2022		2021
Total segment EBITDA	$	27,219	$	20,266	$	67,024	$	56,842
Interest, net		(7,323)		(7,183)		(22,334)		(23,196)
Income tax expense		(4,149)		(2,887)		(9,609)		(6,769)
Depreciation and amortization		(3,837)		(3,570)		(11,018)		(11,609)
Net income	$	11,910	$	6,626	$	24,063	$	15,268

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

Each of the Company’s Net Sales, Property, Equipment and Leasehold Improvements, and Long-Lived Assets relating to geographic locations outside of the United States is insignificant.

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

References to the “Company,” “our,” “us” or “we” refer to CPI Card Group Inc. and its subsidiaries. For an understanding of the significant factors that influenced our results, the following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q for the quarter ended September 30, 2022. This management’s discussion and analysis should also be read in conjunction with the management’s discussion and analysis and consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2021 filed with the Securities and Exchange Commission (“SEC”).

Cautionary Statement Regarding Forward-Looking Information

Certain statements and information in this Quarterly Report on Form 10-Q for the quarter ended September 30, 2022 (as well as information included in other written or oral statements we make from time to time) may contain or constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The words “believe,” “estimate,” “project,” “expect,” “anticipate,” “plan,” “intend,” “foresee,” “should,” “would,” “could,” “continue,” “committed,” “attempt,” “target,” “objective,” “guides,” “seek,” “focus,” “provides guidance,” “provides outlook” or other similar expressions are intended to identify forward-looking statements, which are not historical in nature. These forward-looking statements, including statements about our strategic initiatives and market opportunities, are based on our current expectations and beliefs concerning future developments and their potential effect on us and other information currently available. Such forward-looking statements, because they relate to future events, are by their very nature subject to many important risks and uncertainties that could cause actual results or other events to differ materially from those contemplated.

These risks and uncertainties include, but are not limited to: the potential effects of COVID-19 and responses thereto on our business, including our supply chain, customer demand, workforce, operations and ability to comply with certain covenants related to our indebtedness; our transition to being an accelerated filer and complying with Section 404 of the Sarbanes-Oxley Act of 2002 and the costs associated with such compliance and implementation of procedures thereunder; our failure to maintain effective internal control over financial reporting or remediate material weaknesses; our inability to recruit, retain and develop qualified personnel, including key personnel; a disruption or other failure in our supply chain, including as a result of the Russia-Ukraine conflict, or labor pool resulting in increased costs and inability to pass those costs on to our customers and extended production lead times and difficulty meeting customers’ delivery expectations; a decline in U.S. and global market and economic conditions and resulting decreases in consumer and business spending, declines in consumer credit worthiness impacting demand for credit cards and ongoing or accelerating inflationary pressure; our failure to retain our existing customers or identify and attract new customers; system security risks, data protection breaches and cyber-attacks, including as retaliation for U.S. sanctions in connection with the Russia-Ukraine conflict; our substantial indebtedness, including inability to make debt service payments or refinance such indebtedness; the restrictive terms of our indebtedness and covenants of future agreements governing indebtedness and the resulting restraints on our ability to pursue our business strategies; interruptions in our operations, including our information technology (“IT”) systems, or in the operations of the third parties that operate the data centers or computing infrastructure on which we rely; disruptions in production at one or more of our facilities; environmental, social and governance preferences and demands of various stakeholders and our ability to conform to such preferences and demands and to comply with any related regulatory requirements; the effects of climate change, negative perceptions of our products due to the impact of our products and production processes on the environment and other ESG-related risks; disruptions in production due to weather conditions, climate change, political instability or social unrest; our inability to adequately protect our trade secrets and intellectual property rights from misappropriation, infringement claims brought against us and risks related to open source software; defects in our software; our limited ability to raise capital in the future; problems in production quality, materials and process; our inability to develop, introduce and commercialize new products; costs and impacts to our financial results relating to the obligatory collection of sales tax and claims for uncollected sales tax in states that impose sales tax collection requirements on out-of-state businesses, as well as potential new U.S. tax legislation increasing the corporate income tax rate and challenges to our income tax positions; our inability to successfully execute on our divestitures or acquisitions; our inability to realize the full value of our long-lived assets; costs relating to product defects and any related product liability and/or warranty claims; our inability to renew licenses with key technology licensors; the highly competitive, saturated and consolidated nature of our marketplace; the effects of delays or interruptions in our ability to source raw materials and components used in our products from foreign countries; failure to comply with regulations, customer contractual requirements and

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evolving industry standards regarding consumer privacy and data use and security; new and developing technologies that make our existing technology solutions and products obsolete or less relevant or our failure to introduce new products and services in a timely manner; quarterly variation in our operating results; our failure to operate our business in accordance with the Payment Card Industry Security Standards Council security standards or other industry standards; our failure to comply with environmental, health and safety laws and regulations that apply to our products and the raw materials we use in our production processes; risks associated with the majority stockholders’ ownership of our stock; potential conflicts of interest that may arise due to our board of directors being comprised in part of directors who are principals of our majority stockholders; the influence of securities analysts over the trading market for and price of our common stock; failure to meet the continued listing standards of the Nasdaq Global Market; certain provisions of our organizational documents and other contractual provisions that may delay or prevent a change in control and make it difficult for stockholders other than our majority stockholders to change the composition of our board of directors; our ability to comply with a wide variety of complex laws and regulations and the exposure to liability for any failure to comply; the effect of legal and regulatory proceedings; and other risks that are described in Part I, Item 1A – Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2021 filed with the SEC on March 8, 2022, in Part II, Item 1A – Risk Factors of this Quarterly Report on Form 10-Q and our other reports filed from time to time with the SEC.

We caution and advise readers not to place undue reliance on forward-looking statements, which speak only as of the date hereof. These statements are based on assumptions that may not be realized and involve risks and uncertainties that could cause actual results or other events to differ materially from the expectations and beliefs contained herein. We undertake no obligation to publicly update or revise any forward-looking statements after the date they are made, whether as a result of new information, future events or otherwise.

Overview

We are a payment 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 bank 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 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 leading 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:

●

the U.S. prepaid debit market, serving many of the top U.S. Prepaid Debit Card program managers;

●

the U.S. small to mid-sized issuer market, which includes independent community banks and credit unions;

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●

the U.S. large issuer market, serving some of the largest U.S. debit and credit card issuers; and

●

the U.S. fintech market, where we produce and personalize Financial Payment Cards for financial technology companies.

Our business consists of the following reportable segments:

●

Debit and Credit, which primarily produces Financial Payment Cards and provides integrated card services to card-issuing banks primarily in the United States;

●

Prepaid Debit, which primarily provides integrated prepaid card services to Prepaid Debit Card program managers primarily in the United States; and

●

“Other,” which includes corporate expenses.

COVID-19 Update

The COVID-19 pandemic and associated counteracting measures implemented by governments and businesses around the world have impacted, and continue to impact, economies and societies globally, including the locations where we, our customers and our suppliers conduct business. We believe the global impacts from COVID-19, along with other macro-economic factors, have contributed to, among other things certain adverse effects on our supply chain, production lead times, labor availability, employee absenteeism and costs. Though we have implemented measures to attempt to mitigate the impacts of the challenges described above, we believe that such impacts, and the associated costs, may continue throughout 2022 and beyond. The long-term implications of COVID-19 on our results of operations and overall financial performance remain uncertain, though the health and safety of our employees remains paramount.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was signed into law. The CARES Act, among other things, included provisions relating to refundable payroll tax credits, deferment of employer social security payments, changes in net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitation and technical corrections to tax depreciation methods for qualified improvement property. We deferred employer social security payments in 2020 in accordance with the CARES Act, and the first installment repayment was made in the fourth quarter of 2021. The second installment payment is permitted to be paid no later than the fourth quarter of 2022 and had not been paid as of September 30, 2022.

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 have experienced, and expect to continue to experience, labor availability issues, particularly in the Company’s production facilities. In the nine months ended September 30, 2022, the Company incurred increased employee compensation and recruiting expenses in Cost of Sales and Operating Expenses, which we expect to continue throughout 2022 and beyond as the Company continues to actively recruit additional employees, including temporary contractors, and is affected by inflationary pressure. Also as a result of labor shortages and supply chain constraints, as described below, the Company has experienced extended production lead times in some areas of the business and difficulty meeting some customers’ delivery expectations. We continue to proactively monitor, assess and take steps to minimize disruptions and delays in production; however, these disruptions and delays have caused the Company to lose or delay customer opportunities, and are likely to continue throughout 2022 and beyond.

●

We have experienced, and continue to experience, inflationary pressure in our supply chain, as well as delays and difficulties in sourcing key materials and components needed for our products. Such issues as well as other factors such as staffing challenges, have continued to strain the global supply chain network, which has resulted in increased costs of certain raw materials and components, increased shipping costs, freight and logistics delays, longer lead times, shortages of raw materials we use in our products, such as the on-going global microchip shortage, and unpredictability. Certain of our suppliers have also required us to place orders that commit us to purchase goods as long as a year or more in advance of our anticipated production need, which is

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a significant change from the historical practice of placing non-binding purchase orders for delivery within weeks of the order. While we are taking actions to limit the impact of the dynamics described above, including compiling buffer stock, we expect to experience supply chain impacts on our business and our ability to meet customer demand in future periods. We also believe some of our customers may have anticipated, or may anticipate in the future, supply chain-related delays and correspondingly have increased, or may seek to increase, their own inventory of the Company’s products on hand. Also, geopolitical uncertainties associated with the ongoing Russia and Ukraine conflict, as well as recent COVID-19 impacts in China, are introducing additional supply chain disruptions on a macro-economic level, which may further compound the Company’s supply chain challenges. Additionally, certain microchip manufacturers have indicated they plan to limit the types of microchips that they manufacture, which will affect our ability to continue to provide lower-cost contact microchips for certain of our customers. This could cause us and affected customers to migrate programs to more expensive microchip options or to contactless cards at a faster pace than expected, which may be disruptive for the Company and affected customers. While we may be able to pass on some of our increased labor and material costs to our customers, cost inflation has increased at a faster pace than anticipated, and we expect these factors will impact profitability throughout 2022 and beyond. In addition, given that raw materials inventory is recognized on a first-in, first-out basis, we expect the impact of increasing raw materials costs to be realized into our statement of operations throughout 2022 and beyond.

●

Our Second Wave® payment cards feature a core made with recovered ocean-bound plastic (“ROBP”), which we historically have sourced from Haiti and processed using single source suppliers. Due to political instability and other factors in Haiti as well as the supply chain constraints described above, we have faced challenges in obtaining consistent supply of ROBP from Haiti. We recently began sourcing ROBP from Thailand, and the supply chain for this material includes single source suppliers similar to the materials sourced from Haiti. We have tested this material and believe that cards that incorporate the material meet or exceed applicable quality standards, and we believe we will be able to procure sufficient supply from this new source country. However, if we encounter production challenges with this material or are unable to obtain adequate or consistent supply from the source country, we may not have sufficient supply of ROBP to meet customer demand for our Second Wave cards. The Company continues to actively monitor and manage its supply chain, including compiling buffer stock of materials and evaluating alternative suppliers and sources for ROBP, but it is uncertain how issues in Haiti and other factors in the ROBP supply chain will affect our ability to continue obtaining sufficient ROBP. Additionally, alternative suppliers of ROBP in other source countries may be constrained by local or global geopolitical challenges, instability and unpredictability, and we may be subject to increased shipping and materials costs, which we may not be able to pass through to our customers.

●

As of June 30, 2021, the market value of outstanding shares of our common stock owned by non-affiliates exceeded $75 million, which triggered the Company being classified as an accelerated filer with respect to SEC regulations and filing requirements effective with the year ended December 31, 2021. The Company continues to be classified as an accelerated filer in 2022. As a result, our annual assessment of the effectiveness of our internal control over financial reporting must be audited by our external audit firm in compliance with the provisions of Section 404 of the Sarbanes-Oxley Act of 2002 (“the Sarbanes-Oxley Act”). Continued compliance with this new requirement has significantly increased our compensation expense, professional fees and other administrative costs during the nine months ended September 30, 2022. We expect these increased costs to continue throughout 2022 and beyond. In connection with our evaluation and testing during 2021, management identified deficiencies that they determined resulted in material weaknesses in internal controls, and the related remediation efforts have also increased such costs. For additional information, see Part I, Item 4, Controls and Procedures.

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Results of Operations

The following table presents the components of our condensed consolidated statements of operations for each of the periods presented:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2022		2021		2022		2021

	(dollars in thousands)
Net sales:
Products	$	71,606	$	52,276	$	208,867	$	146,445
Services		52,971		47,326		140,442		135,468
Total net sales		124,577		99,602		349,309		281,913
Cost of sales		76,137		61,917		221,040		171,419
Gross profit		48,440		37,685		128,269		110,494
Operating expenses		24,995		20,983		71,789		60,236
Income from operations		23,445		16,702		56,480		50,258
Other expense, net:
Interest, net		(7,323)		(7,183)		(22,334)		(23,196)
Other (expense) income, net		(63)		(6)		(79)		23
Loss on debt extinguishment		—		—		(395)		(5,048)
Income before taxes		16,059		9,513		33,672		22,037
Income tax expense		(4,149)		(2,887)		(9,609)		(6,769)
Net income	$	11,910	$	6,626	$	24,063	$	15,268

Segment Discussion

Three Months Ended September 30, 2022 Compared With Three Months Ended September 30, 2021

Net Sales:


	Three Months Ended September 30,
	2022		2021		$ Change		% Change

	(dollars in thousands)
Net sales by segment:
Debit and Credit	$	99,512	$	76,121	$	23,391	30.7	%
Prepaid Debit		25,335		23,498		1,837	7.8	%
Eliminations		(270)		(17)		(253)	*	%
Total	$	124,577	$	99,602	$	24,975	25.1	%

* Not meaningful

Debit and Credit:

Net sales for Debit and Credit increased $23.4 million, or 30.7%, for the three months ended September 30, 2022 compared to the corresponding period in the prior year. Products net sales increased primarily due to increased volumes of contactless cards. Contactless cards have additional technology to process contactless transactions and generally have a higher selling price than contact-only EMV^® cards. Services net sales increased due to growth from card personalization, higher CPI On-Demand sales from existing customers and higher Card@Once services.

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Prepaid Debit:

Net sales for Prepaid Debit increased $1.8 million, or 7.8%, for the three months ended September 30, 2022 compared to the corresponding period in the prior year primarily due to increased volumes from existing customers and the benefit of price increases. We historically have generated higher net sales in the third quarter 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.

Gross Profit and Gross Profit Margin:


	Three Months Ended September 30,
			% of 2022				% of 2021
	2022		Net Sales		2021		Net Sales		$ Change		% Change

	(dollars in thousands)
Gross profit by segment:
Debit and Credit	$	38,071	38.3	%	$	28,176	37.0	%	$	9,895	35.1	%
Prepaid Debit		10,369	40.9	%		9,509	40.5	%		860	9.0	%
Total	$	48,440	38.9	%	$	37,685	37.8	%	$	10,755	28.5	%

Debit and Credit:

Gross profit for Debit and Credit increased $9.9 million, or 35.1%, for the three months ended September 30, 2022 compared to the corresponding period in the prior year primarily due to the net sales increase described above, partially offset by the inflationary impact on production costs. Gross profit margin increased to 38.3% during the three months ended September 30, 2022, compared to 37.0% in the corresponding period in the prior year, primarily due to operating leverage from higher net sales, including the benefit of price increases, partially offset by higher production costs, primarily materials.

Prepaid Debit:

Gross profit for Prepaid Debit increased $0.9 million, or 9.0%, for the three months ended September 30, 2022 compared to the corresponding period in the prior year primarily due to the net sales increase described above, partially offset by the inflationary impact on production costs. Gross profit margin for Prepaid Debit increased to 40.9% for the three months ended September 30, 2022 compared to 40.5% in the corresponding period in the prior year primarily due to operating leverage from higher net sales, including the benefit of price increases, partially offset by increased materials costs as a percentage of sales.

Operating Expenses:


	Three Months Ended September 30,
			% of 2022				% of 2021
	2022		Net Sales		2021		Net Sales		$ Change		% Change

	(dollars in thousands)
Operating expenses by segment:
Debit and Credit	$	8,653	8.7	%	$	7,677	10.1	%	$	976	12.7	%
Prepaid Debit		1,260	5.0	%		1,017	4.3	%		243	23.9	%
Other		15,082	*	%		12,289	*	%		2,793	22.7	%
Total	$	24,995	20.1	%	$	20,983	21.1	%	$	4,012	19.1	%

Debit and Credit:

Debit and Credit operating expenses increased $1.0 million, or 12.7%, for the three months ended September 30, 2022 compared to the corresponding period in the prior year, primarily due to increased selling, compensation and other costs.

Prepaid Debit:

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Prepaid Debit operating expenses increased $0.2 million, or 23.9%, for the three months ended September 30, 2022 compared to the corresponding period in the prior year.

Other:

Other operating expenses increased $2.8 million, or 22.7%, for the three months ended September 30, 2022 compared to the corresponding period in the prior year, primarily due to a $1.7 million increase in compensation expenses as a result of increased employee headcount and higher labor costs in addition to $0.8 million of increased stock compensation, and a $1.1 million increase in professional services and other costs.

Income from Operations and Operating Margin:


	Three Months Ended September 30,
			% of 2022				% of 2021
	2022		Net Sales		2021		Net Sales		$ Change		% Change

	(dollars in thousands)
Income from operations by segment:
Debit and Credit	$	29,418	29.6	%	$	20,499	26.9	%	$	8,919	43.5	%
Prepaid Debit		9,109	36.0	%		8,492	36.1	%		617	7.3	%
Other		(15,082)	*	%		(12,289)	*	%		(2,793)	22.7	%
Total	$	23,445	18.8	%	$	16,702	16.8	%	$	6,743	40.4	%

Debit and Credit:

Income from operations for Debit and Credit increased $8.9 million, or 43.5%, for the three months ended September 30, 2022 compared to the corresponding period in the prior year, primarily due to higher net sales and operating leverage, partially offset by higher production costs. Operating margin increased to 29.6% for the three months ended September 30, 2022 compared to 26.9% in the corresponding period in the prior year primarily due to the factors discussed above.

Prepaid Debit:

Income from operations for Prepaid Debit increased $0.6 million, or 7.3%, for the three months ended September 30, 2022 compared to the corresponding period in the prior year, primarily due to higher net sales, partially offset by higher production costs. Operating margin decreased slightly to 36.0% for the three months ended September 30, 2022 compared to 36.1% in the corresponding period in the prior year.

Other:

The loss from operations in Other increased $2.8 million, or 22.7%, for the three months ended September 30, 2022 compared to the corresponding period in the prior year due to the factors described above under “Operating Expenses.”

Interest, net:

Interest expense increased to $7.3 million for the three months ended September 30, 2022 from $7.2 million in the corresponding period in the prior year, due to higher average debt balances offset by a lower average interest rate and interest income received of approximately $0.2 million in 2021 related to income tax refunds.

Loss on debt extinguishment:

During the three months ended September 30, 2022, we did not record any loss on debt extinguishment.

Income tax expense:

Our effective tax rates on pre-tax income were 25.8% and 30.3% for the three months ended September 30, 2022 and 2021, respectively. The decrease in our effective tax rate for the three months ended September 30, 2022 compared to the corresponding period in the prior year was primarily due to the release of a federal valuation allowance

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for increased deductibility of interest costs due to a tax election made in the current year and a greater proportion of pre-tax income in relation to the impact of permanent items.

Net income:

During the three months ended September 30, 2022, net income was $11.9 million, compared to net income of $6.6 million in the corresponding period in the prior year. The increase was primarily due to higher net sales resulting in higher gross profit, partially offset by higher “Selling, general and administrative” costs and income tax expense.

Nine Months Ended September 30, 2022 Compared With Nine Months Ended September 30, 2021

Net Sales:


	Nine Months Ended September 30,
	2022		2021		$ Change		% Change

	(dollars in thousands)
Net sales by segment:
Debit and Credit	$	285,708	$	218,798	$	66,910	30.6	%
Prepaid Debit		64,010		63,339		671	1.1	%
Eliminations		(409)		(224)		(185)	*	%
Total	$	349,309	$	281,913	$	67,396	23.9	%

* Not meaningful

Debit and Credit:

Net sales for Debit and Credit increased $66.9 million, or 30.6%, for the nine months ended September 30, 2022 compared to the corresponding period in the prior year. Products net sales increased due to increased volumes from existing customers, including the acquisition of new portfolios by an existing customer and the transition to eco-focused and other contactless cards, and higher Card@Once instant issuance sales. Contactless cards have additional technology to process contactless transactions and generally have a higher selling price than contact-only EMV cards. Services net sales increased due to growth from card personalization, as well as higher Card@Once services, partially offset by a decrease in volumes for our existing customers in our CPI On-Demand service, which benefited in the corresponding prior period from COVID-19 related government disbursement work.

Prepaid Debit:

Net sales for Prepaid Debit increased $0.7 million, or 1.1%, for the nine months ended September 30, 2022 compared to the corresponding period in the prior year primarily due to the benefit of price increases. Prepaid Debit net sales in the prior year period benefited from the acquisition of new portfolios by our existing customers and customer replenishment of retail inventory, which had been maintained at lower levels in 2020 due to COVID-19 uncertainties.

Gross Profit and Gross Profit Margin:


	Nine Months Ended September 30,
			% of 2022				% of 2021
	2022		Net Sales		2021		Net Sales		$ Change		% Change

	(dollars in thousands)
Gross profit by segment:
Debit and Credit	$	104,389	36.5	%	$	83,988	38.4	%	$	20,401	24.3	%
Prepaid Debit		23,880	37.3	%		26,506	41.8	%		(2,626)	(9.9)	%
Total	$	128,269	36.7	%	$	110,494	39.2	%	$	17,775	16.1	%

Debit and Credit:

Gross profit for Debit and Credit increased $20.4 million, or 24.3%, for the nine months ended September 30, 2022 compared to the corresponding period in the prior year primarily due to the net sales increase described above,

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partially offset by the inflationary impact on production costs. Gross profit margin decreased to 36.5% during the nine months ended September 30, 2022, compared to 38.4% in the corresponding period in the prior year, primarily due to higher production costs, primarily materials, partially offset by operating leverage from higher sales including the benefit of price increases.

Prepaid Debit:

Gross profit for Prepaid Debit decreased $2.6 million, or 9.9%, for the nine months ended September 30, 2022 compared to the corresponding period in the prior year. Gross profit margin for Prepaid Debit decreased to 37.3% for the nine months ended September 30, 2022 compared to 41.8% in the corresponding period in the prior year. The decreases in gross profit and gross profit margin were primarily due to higher production costs, primarily materials, partially offset by higher sales as described above.

Operating Expenses:


	Nine Months Ended September 30,
			% of 2022				% of 2021
	2022		Net Sales		2021		Net Sales		$ Change		% Change

	(dollars in thousands)
Operating expenses by segment:
Debit and Credit	$	25,542	8.9	%	$	23,077	10.5	%	$	2,465	10.7	%
Prepaid Debit		3,487	5.4	%		3,446	5.4	%		41	1.2	%
Other		42,760	*	%		33,713	*	%		9,047	26.8	%
Total	$	71,789	20.6	%	$	60,236	21.4	%	$	11,553	19.2	%

Debit and Credit:

Debit and Credit operating expenses increased $2.5 million, or 10.7%, for the nine months ended September 30, 2022 compared to the corresponding period in the prior year, primarily due to increased selling, compensation and other costs.

Prepaid Debit:

Prepaid Debit operating expenses were essentially flat and increased less than $0.1 million, or 1.2%, for the nine months ended September 30, 2022 compared to the corresponding period in the prior year.

Other:

Other operating expenses increased $9.0 million, or 26.8%, for the nine months ended September 30, 2022 compared to the corresponding period in the prior year, primarily due to a $5.7 million increase in compensation expenses as a result of increased employee headcount and higher labor costs in addition to $2.7 million of increased stock compensation, and a $3.0 million increase in professional services and other costs, including costs related to compliance with the Sarbanes-Oxley Act.

Income from Operations and Operating Margin:


	Nine Months Ended September 30,
			% of 2022				% of 2021
	2022		Net Sales		2021		Net Sales		$ Change		% Change

	(dollars in thousands)
Income from operations by segment:
Debit and Credit	$	78,847	27.6	%	$	60,911	27.8	%	$	17,936	29.4	%
Prepaid Debit		20,393	31.9	%		23,060	36.4	%		(2,667)	(11.6)	%
Other		(42,760)	*	%		(33,713)	*	%		(9,047)	26.8	%
Total	$	56,480	16.2	%	$	50,258	17.8	%	$	6,222	12.4	%

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Debit and Credit:

Income from operations for Debit and Credit increased $17.9 million, or 29.4%, for the nine months ended September 30, 2022 compared to the corresponding period in the prior year, primarily due to higher net sales, partially offset by increased production costs and operating expenses. Operating margin decreased to 27.6% for the nine months ended September 30, 2022 compared to 27.8% in the corresponding period in the prior year primarily due to the factors discussed above.

Prepaid Debit:

Income from operations for Prepaid Debit decreased $2.7 million, or 11.6%, for the nine months ended September 30, 2022 compared to the corresponding period in the prior year, primarily due to lower gross profit. Operating margin decreased to 31.9% for the nine months ended September 30, 2022 compared to 36.4% in the corresponding period in the prior year, primarily due to the factors discussed above under “Gross Profit and Gross Profit Margin.”

Other:

The loss from operations in Other increased $9.0 million, or 26.8%, for the nine months ended September 30, 2022 compared to the corresponding period in the prior year due to the factors described above under “Operating Expenses.”

Interest, net:

Interest expense decreased to $22.3 million for the nine months ended September 30, 2022 from $23.2 million in the corresponding period in the prior year. Interest expense was higher in the first nine months of 2021 primarily due to $2.6 million of “make-whole” interest premium paid in connection with the termination of our $30.0 million senior credit agreement (the “Senior Credit Facility”) on March 15, 2021. The decrease in interest expense due to the “make-whole” interest premium was partially offset by higher average interest rates on our borrowings during the nine months ended September 30, 2022.

Loss on debt extinguishment:

During the nine months ended September 30, 2022, we recorded a $0.4 million loss on debt extinguishment relating to the $20.0 million early redemption of the 8.625% Senior Secured Notes due 2026 (the “Senior Notes”), as we expensed the associated portion of the unamortized deferred financing costs.

During the nine months ended September 30, 2021 we recorded a $5.0 million loss on debt extinguishment relating to the termination of both our previous Senior Credit Facility and First Lien Term Loan as we expensed the unamortized deferred financing costs and debt discount. This was completed in connection with the issuance of the Senior Notes and entry into our new asset-based, senior secured revolving credit facility (the “ABL Revolver”) on March 15, 2021.

Income tax expense:

Our effective tax rate on pre-tax income was 28.5% and 30.7% for the nine months ended September 30, 2022 and 2021, respectively. The decrease in our effective tax rate for the nine months ended September 30, 2022 compared to the corresponding period in the prior year was primarily due to a greater proportion of pre-tax income in relation to the impact of permanent items.

Net income:

During the nine months ended September 30, 2022, net income was $24.1 million, compared to net income of $15.3 million in the corresponding period in the prior year. The increase was primarily due to higher gross profit partially offset by increased “Selling, general and administrative” costs and income tax expense, and a decrease in other expenses due to the impact of debt refinancing costs incurred in the 2021 first quarter.

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Liquidity and Capital Resources

At September 30, 2022, we had $21.5 million of cash and cash equivalents.

Our ability to make investments in and grow our business, service our debt and improve our debt leverage ratios, while maintaining strong liquidity, will depend upon our ability to generate excess operating cash flows through our operating subsidiaries. Although we can provide no assurances, we believe that our cash flows from operations, combined with our current cash levels, will be adequate to fund debt service requirements and provide cash, as required, to support our ongoing operations, capital expenditures, lease obligations and working capital needs.

On March 11, 2022, we used the available borrowing capacity under the ABL Revolver to fund the redemption of $20.0 million aggregate principal amount of the Senior Notes at a redemption price equal to 103% of the principal amount thereof plus accrued and unpaid interest thereon to the redemption date.

On March 15, 2021, we completed a private offering of $310.0 million aggregate principal amount of the 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.

On March 15, 2021, we entered into a credit agreement with Wells Fargo Bank, National Association providing for an ABL Revolver of up to $50.0 million. On March 3, 2022, we entered into Amendment No. 1 to Credit Agreement (the “Amendment”), which amended the ABL Revolver. The Amendment, among other things, increased the available borrowing capacity under the ABL Revolver to $75.0 million, increased the uncommitted accordion feature to $25.0 million and revised the interest rate provisions to replace the 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 the treatment of certain inventory.

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. For each quarter through March 31, 2023, the applicable interest rate margin ranges from 1.50% to 1.75% depending on the average unused capacity of the facility for the previous quarter. The unused portion of the ABL Revolver commitment accrues a monthly commitment fee, 0.50% per annum through March 31, 2023, based on the average daily borrowing capacity under the ABL Revolver over the previous month. The interest rate margin and unused commitment fee percentage changes, effective April 1, 2023, to between 1.25% and 1.75% (interest rate margin) and 0.375% and 0.50% (unused commitment fee).

As of September 30, 2022, we have $25.0 million in ABL Revolver borrowings outstanding and $50.0 million available to borrow under the ABL Revolver. 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).

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.

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As permitted by the indenture governing the Senior Notes, the Company may from time to time repurchase some or all of the Senior Notes in open market transactions, in privately negotiated transactions or otherwise. Prior to March 15, 2023, the Company may also redeem some or all of the Senior Notes at a “make-whole” redemption price, and on or after March 15, 2023, the Company may redeem some or all of the Senior Notes at a redemption price initially set at 104.313% of the principal amount of the notes to be redeemed, and reducing over time to 100%, in each case plus accrued and unpaid interest. Additionally, prior to March 15, 2023, the Company may redeem, on one or more occasions, up to 40% of the aggregate principal amount of the Senior Notes with the proceeds of certain equity offerings, at a redemption price equal to 108.625% of the principal amount of the notes to be redeemed, plus accrued and unpaid interest. Furthermore, prior to March 15, 2023, but not more than once during each consecutive twelve-month period, the Company may also redeem up to 10% of the aggregate principal amount of the Senior Notes at a redemption price equal to 103% of the principal amount of the notes being redeemed, plus accrued and unpaid interest. The timing and amount of any such redemptions or repurchases will depend upon market conditions, contractual commitments, the Company’s capital needs and other factors.

The Company has 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 pursuant to the terms of the related indenture, with any required payments to be made after the issuance of the Company’s annual financial statements. No such payment was required based on the Company’s 2021 operating results.

In connection with the issuance of the Senior Notes and entry into the ABL Revolver, we terminated our previous Senior Credit Facility and previous First Lien Term Loan. Net proceeds from the Senior Notes, together with cash on hand and initial borrowings of $15.0 million under the ABL Revolver, were used to pay in full and terminate the Senior Credit Facility and First Lien Term Loan on March 15, 2021, and to pay related fees and expenses. During the three months ended March 31, 2021, prior to the termination of the First Lien Term Loan, we paid an excess free cash flow balance of $7.8 million pursuant to the terms of the Senior Credit Facility and the First Lien Term Loan. As of September 30, 2022, the Company had $290.0 million aggregate principal amount outstanding on the Senior Notes, plus accrued and unpaid interest.

Operating Activities

Cash provided by operating activities for the nine months ended September 30, 2022 was $11.7 million compared to cash provided by operating activities of $14.5 million during the nine months ended September 30, 2021. Cash generated from earnings for the nine months ended September 30, 2022 was negatively impacted by working capital increases, including an increase in accounts receivable of $14.9 million due to higher net sales compared to the previous period. We also increased inventories by $13.9 million during the nine months ended September 30, 2022, to maintain certain levels of inventory to help mitigate supply chain constraints. We also decreased accrued expenses by $3.2 million during the nine months ended September 30, 2022, primarily related to payments on accrued interest and employee performance incentive compensation during the period. Additionally, we benefited from the collection of $9.8 million of income tax refunds during the nine months ended September 30, 2021.

Investing Activities

Cash used in investing activities for the nine months ended September 30, 2022 was $14.3 million, compared to $4.7 million during the nine months ended September 30, 2021. Cash used in investing activities was related primarily to capital expenditures, including investments to support the business, such as machinery and information technology equipment. As presented in our supplemental disclosures of non-cash information on the statement of cash flows, finance leases were executed for the acquisition of right-of-use machinery and equipment assets totaling $7.8 million during the nine months ended September 30, 2022, compared to $0.5 million during the corresponding period of the prior year.

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Financing Activities

During the nine months ended September 30, 2022, cash provided by financing activities was $3.5 million. Net proceeds from the ABL Revolver were $25.0 million and in connection with the Amendment to the ABL revolver, we paid $0.3 million of debt issuance costs. A portion of the proceeds from the ABL Revolver was used to redeem $20.0 million of Senior Notes and to pay $0.6 million of early redemption costs. We received $2.1 million under financing leases and we paid $2.5 million of principal on financing leases during the nine months ended September 30, 2022, compared to $1.7 million of principal payments during the corresponding period of the prior year.

During the nine months ended September 30, 2021, cash used in financing activities was $46.6 million. Proceeds from the Senior Notes and ABL Revolver, net of discount, were $310.0 million and $14.8 million, respectively. We paid $9.5 million of debt issuance costs and $2.7 million of debt extinguishment costs, which included an early termination “make-whole” interest premium of $2.6 million on the Senior Credit Facility. We used proceeds from the Senior Notes and initial borrowings under the ABL Revolver, plus cash on hand, to pay in full and terminate the Senior Credit Facility balance of $30.0 million and the First Lien Term Loan balance of $304.7 million on March 15, 2021. Prior to the termination of the First Lien Term Loan, we paid an excess free cash flow balance of $7.8 million pursuant to the terms of the Senior Credit Facility and First Lien Term Loan.

During the second quarter of 2021, we used $15.0 million of cash on hand to pay down the ABL Revolver to zero and had no borrowings outstanding thereunder as of September 30, 2021.

Working Capital

Our working capital as of September 30, 2022 was $112.7 million, compared to $80.9 million as of December 31, 2021. Our working capital during the nine months ended September 30, 2022 was primarily affected by borrowings of $25.0 million on our ABL Revolver, principal payments of $20.0 million on the Senior Notes, an increase in inventories of $14.2 million, and an increase in accounts receivable of $14.8 million. Our working capital needs are typically highest in the first and third quarters due to the timing of payments for employee incentives and interest on outstanding borrowings. A large portion of our employee incentive compensation payments are made in the first quarter, with smaller payments made in each subsequent quarter. The majority of our interest payments are due in the first and third quarters.

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 September 30, 2022, the total projected principal and interest payments on our borrowings were $404.8 million, primarily related to the Senior Notes, of which $26.5 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, no early voluntary or required repayment of the borrowings under the ABL Revolver within the next twelve months, 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 Supplemental Data, Note 9, “Financing and Operating Leases” for details on our leasing arrangements, including future maturities of our operating lease liabilities.

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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 September 30, 2022, there have not been any material changes to the purchase obligations disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021.

Subsequent to quarter end, the Company entered into a capacity reservation agreement with one of the Company’s chip suppliers to reserve manufacturing supply capacity due to the current global supply shortage environment. Under the agreement, the Company has agreed to pay certain fees in exchange for the supplier’s commitment to reserve capacity, subject to certain conditions, to produce a set quantity of chips from 2023 through 2025, and the Company has committed to purchase those chips. The total value of the minimum non-cancellable commitment is $194.9 million over the term of the agreement, $69.6 million of which is expected to be paid in 2023. 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.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts and disclosures in the financial statements and accompanying notes. Actual results could differ from those estimates. Our Critical Accounting Policies and Estimates disclosed in our Annual Report on Form 10-K for the year ended December 31, 2021, for which there were no material changes as of September 30, 2022, included:

●

Revenue recognition, including estimates of work performed but not completed, and

●

Income taxes, including valuation allowances and uncertain tax positions.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Not required due to smaller reporting company status.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a–15(e) and 15d–15(e) under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”)) as of September 30, 2022. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2022, our disclosure controls and procedures were not effective due to material weaknesses in internal control over financial reporting previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2021. As of the date of this report, the material weaknesses did not result in any identified material misstatements to the financial statements and there were no changes to previously reported financial results.

Remediation Plan for Material Weaknesses

To remediate the material weaknesses referenced above, the Company has been pursuing the remediation steps identified in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.

We have conducted trainings, hired additional qualified resources and have engaged a nationally recognized accounting firm to assist with the design and implementation of control procedures to address the identified risks of material misstatements in key process areas. We have implemented system controls and manual monitoring activities to ensure appropriate segregation of duties over journal entries processed in batches. We have enhanced user access controls over the revenue system at certain locations. We have enhanced our change management controls relating to the development and changes to custom reports in certain information technology systems and have been performing additional analysis over source documentation to implement controls over information, primarily in the purchasing and revenue processes. Management also implemented internal controls requiring appropriate reviews and retention of documentation of those reviews with regard to our revenue process, as well as controls over the accuracy of the sales

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price within the revenue system at certain locations. Finally, we have enhanced our controls requiring appropriate reviews and approvals and retention of documentation with regard to the purchasing process.

The material weaknesses will not be considered remediated until the applicable controls operate for a sufficient period of time and are tested for operating effectiveness.

Changes in Internal Control over Financial Reporting

Except for the changes in internal control over financial reporting related to the material weaknesses described above, there have been no changes in our internal control over financial reporting identified in connection with the evaluation required by Rules 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during our third quarter of 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II – Other Information

Item 1. Legal Proceedings

Smart Packaging Solutions SA v. CPI Card Group Inc.

Item 1A. Risk Factors

The risk factors disclosed in Part I, Item 1A Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2021 set forth information relating to various risks and uncertainties that could materially adversely affect our business, financial condition and operating results. Such risk factors continue to be relevant to an understanding of our business, financial condition and operating results. As of the date of this Quarterly Report on Form 10-Q, there have been the following material changes with respect to such risk factors.

The ongoing military action by Russia in Ukraine has impacted and may continue to have adverse effects on the global economy, and such effects could materially adversely affect our business, operations, operating results and financial condition.

On February 24, 2022, Russian forces launched significant military action against Ukraine, and the region has since experienced sustained conflict and disruption, which may continue in 2022 and beyond. Governments in the United States, United Kingdom and European Union have each imposed export controls on certain products and financial and economic sanctions on certain industry sectors and parties in Russia. These actions and the broader Russia-Ukraine conflict have not had a material impact on the Company's financial condition or results of operations; however, the continuation or escalation of geopolitical tensions or military action related to the conflict and the imposition of additional economic sanctions could continue to adversely affect the global economy and financial markets, disrupt trade and accelerate inflationary pressures, among other things, which could negatively affect the demand for our products and further intensify problems in the global supply chain. Although we have no operations in Russia or Ukraine, we believe we have experienced shortages in raw materials and increased costs for transportation and energy due in part to the negative impact of the Russia-Ukraine conflict on the global economy, which impacts may persist or worsen as the conflict continues or escalates. The conflict also increases the risk of retaliatory acts from Russia impacting U.S. companies, which may include disruptions to our or our customers’ or suppliers’ technology infrastructure, including through cyberattack, ransom attack or cyber-intrusion. The extent and duration of the military action, sanctions and resulting market and economic disruptions are impossible to predict but could be substantial.

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Item 6. Exhibits

Exhibit Number		Exhibit Description
10.1		Amendment No. 2 to ABL Credit Agreement, among CPI Card Group Inc., CPI CG Inc., the lenders from time to time party thereto and Wells Fargo Bank, National Association, as administrative agent and collateral agent.
31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS		XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH		Inline XBRL Taxonomy Extension Schema Document.
101.CAL		Inline XBRL Taxonomy Extension Calculation Linkbase Document.
101.LAB		Inline XBRL Taxonomy Extension Label Linkbase Document.
101.PRE		Inline XBRL Taxonomy Extension Presentation Linkbase Document.
101.DEF		Inline XBRL Taxonomy Extension Definition Linkbase Document.
104		Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).

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SIGNATURES

Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	CPI CARD GROUP INC.


November 3, 2022	/s/ Amintore Schenkel
	Amintore Schenkel
	Chief Financial Officer
	(Principal Financial Officer)

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CPI Card (PMTS) 10-Q2022 Q3 Quarterly report

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