Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation s
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 March 31, 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 March 31, 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,” “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 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; 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 evolving industry standards regarding consumer privacy and data use and security; new and developing technologies that make our existing technology solutions and
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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, including climate change 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 Securities and Exchange Commission (“SEC”) on March 8, 2022, 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 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 card issuing 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;
● the U.S. large issuer market, serving some of the largest U.S. debit and credit card issuers; and
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● 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 has impacted, and continues to impact economies and societies globally, including the locations where we, our customers and our suppliers conduct business. The long-term implications of COVID-19 on the Company’s results of operations and overall financial performance remain uncertain.
The Company believes the global impacts from COVID-19, along with other factors, have contributed to certain adverse effects on its supply chain, including increased lead times for, and higher costs of, certain raw materials and components, such as microchips, which are expected to continue in the future. The current environment has also affected the available labor pool in the areas in which the Company operates, which has resulted in increased labor cost and turnover in our facilities, challenges hiring production employees and shipping delays.
Though the Company has implemented measures to mitigate the impacts of the labor and supply chain challenges described above, the Company believes that such impacts, and the associated costs, may continue to increase throughout 2022 and possibly beyond. The Company may not be able to pass all of these costs through to its customers. The Company is experiencing increased production lead times, which it believes are likely to continue throughout 2022 and possibly beyond, depending on the duration of the staffing and supply chain challenges and the level of demand from its customers. The Company will continue to monitor and respond as the situation evolves, including mitigation efforts such as purchasing additional inventory and attempting to hire additional production employees. See Part I, Item 1A, Risk Factors in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021 for further discussion of the possible impact of the COVID-19 pandemic on the Company.
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.
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 three months ended March 31, 2022, the Company incurred increased employee compensation and recruiting expenses in Cost of Sales and Operating Expenses, which we expect to continue to increase throughout 2022 and possibly beyond as the Company continues to actively recruit additional employees and is affected by increasing 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
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disruptions and delays have caused the Company to lose or delay customer opportunities, and are likely to continue throughout 2022 and possibly 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. While we are taking actions to limit this pressure, including placing orders in advance and compiling buffer stock, we expect to experience supply chain impacts on our business and our ability to meet customer demand in future periods. 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 possibly 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 possibly beyond.
● Our Second Wave® payment cards feature a core made with recovered ocean-bound plastic (“ROBP”), which we currently source from Haiti and process using single source suppliers. Due to political instability and other factors in Haiti as well as the supply chain constraints described above, there is an increased likelihood that we may face challenges in obtaining an adequate supply of ROBP, which is necessary to meet customer demand for our Second Wave cards. The Company actively monitors and manages 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, to the extent we are able to secure one or more alternative suppliers of ROBP, such alternative suppliers may be similarly 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. 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 three months ended March 31, 2022. We expect these increased costs to continue throughout 2022 and possibly 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
March 31,
2022
2021
(dollars in thousands)
Net sales:
Products
$
68,316
$
47,013
Services
43,108
42,079
Total net sales
111,424
89,092
Cost of sales
72,146
53,371
Gross profit
39,278
35,721
Operating expenses
21,297
17,952
Income from operations
17,981
17,769
Other expense, net:
Interest, net
(7,865)
(8,976)
Other (expense) income, net
(1)
25
Loss on debt extinguishment
(395)
(5,048)
Income before taxes
9,720
3,770
Income tax expense
(3,718)
(1,360)
Net income
$
6,002
$
2,410
Segment Discussion
Three Months Ended March 31, 2022 Compared With Three Months Ended March 31, 2021
Net Sales
Three Months Ended March 31,
2022
2021
$ Change
% Change
(dollars in thousands)
Net sales by segment:
Debit and Credit
$
92,015
$
69,817
$
22,198
31.8
%
Prepaid Debit
19,461
19,458
3
0.0
%
Eliminations
(52)
(183)
131
*
Total
$
111,424
$
89,092
$
22,332
25.1
%
* Not meaningful
Debit and Credit:
Net sales for Debit and Credit increased $22.2 million, or 31.8%, for the three months ended March 31, 2022 compared to the corresponding period in the prior year. Product net sales increased due to increased volumes from existing customers, including the transition to contactless and eco-focused cards, and higher Card@Once instant issuance sales. Net sales from card personalization increased due to higher volumes of contactless cards, partially offset by a decrease in volumes for our existing customers in our CPI On-Demand service, which benefited in the prior year first quarter from COVID-19 related government disbursement work. Contactless cards have additional technology to process contactless transactions and generally have a higher selling price than contact-only EMV ® cards.
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Prepaid Debit:
Net sales for Prepaid Debit was flat for the three months ended March 31, 2022 compared to the corresponding period in the prior year. Prepaid Debit net sales in the prior year first quarter benefitted from the acquisition of new customer portfolios.
Gross Profit and Gross Profit Margin
Three Months Ended March 31,
% of 2022
% of 2021
2022
Net Sales
2021
Net Sales
$ Change
% Change
(dollars in thousands)
Gross profit by segment:
Debit and Credit
$
32,230
35.0
%
$
27,549
39.5
%
$
4,681
17.0
%
Prepaid Debit
7,048
36.2
%
8,172
42.0
%
(1,124)
(13.8)
%
Total
$
39,278
35.3
%
$
35,721
40.1
%
$
3,557
10.0
%
Debit and Credit:
Gross profit for Debit and Credit increased $4.7 million, or 17.0%, for the three months ended March 31, 2022 compared to the corresponding period in the prior year primarily due to the net sales increase described above, partially offset by higher materials and labor costs. Gross profit margin decreased to 35.0% during the three months ended March 31, 2022, compared to 39.5% in the corresponding period in the prior year, primarily due to increased materials and labor costs as a percentage of sales .
Prepaid Debit:
Gross profit for Prepaid Debit decreased $1.1 million, or 13.8%, for the three months ended March 31, 2022 compared to the corresponding period in the prior year. Gross profit margin for Prepaid Debit decreased to 36.2% for the three months ended March 31, 2022 compared to 42.0% in the corresponding period in the prior year. The decreases in gross profit and gross profit margin were primarily due to increases in labor and materials costs.
Operating Expenses
Three Months Ended March 31,
% of 2022
% of 2021
2022
Net Sales
2021
Net Sales
$ Change
% Change
(dollars in thousands)
Operating expenses by segment:
Debit and Credit
$
8,120
8.8
%
$
7,395
10.6
%
$
725
9.8
%
Prepaid Debit
1,080
5.5
%
1,154
5.9
%
(74)
(6.4)
%
Other
12,097
*
%
9,403
*
%
2,694
28.7
%
Total
$
21,297
19.1
%
$
17,952
20.1
%
$
3,345
18.6
%
Debit and Credit:
Debit and Credit operating expenses increased $0.7 million, or 9.8%, for the three months ended March 31, 2022 compared to the corresponding period in the prior year, primarily due to increased selling and compensation costs due to strong business performance.
Prepaid Debit:
Prepaid Debit operating expenses decreased less than $0.1 million, or 6.4%, for the three months ended March 31, 2022 compared to the corresponding period in the prior year.
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Other:
Other operating expenses increased $2.7 million, or 28.7%, primarily due to a $1.9 million increase in compensation expenses, resulting from increased employee headcount and higher labor cost, and an $0.8 million increase in professional fees and other costs related to compliance with the Sarbanes-Oxley Act.
Income from Operations and Operating Margin
Three Months Ended March 31,
% of 2022
% of 2021
2022
Net Sales
2021
Net Sales
$ Change
% Change
(dollars in thousands)
Income from operations by segment:
Debit and Credit
$
24,110
26.2
%
$
20,154
28.9
%
$
3,956
19.6
%
Prepaid Debit
5,968
30.7
%
7,018
36.1
%
(1,050)
(15.0)
%
Other
(12,097)
*
%
(9,403)
*
%
(2,694)
28.7
%
Total
$
17,981
16.1
%
$
17,769
19.9
%
$
212
1.2
%
* Not meaningful
Debit and Credit:
Income from operations for Debit and Credit increased $4.0 million, or 19.6%, for the three months ended March 31, 2022 compared to the corresponding period in the prior year, primarily due to higher net sales, partially offset by increased material and labor costs. Operating margin decreased to 26.2% for the three months ended March 31, 2022 compared to 28.9% in the corresponding period in the prior year primarily due to increased materials and labor costs as a percentage of sales.
Prepaid Debit:
Income from operations for Prepaid Debit decreased $1.1 million, or 15.0%, for the three months ended March 31, 2022 compared to the corresponding period in the prior year, primarily due to lower gross profit. Operating margin decreased to 30.7% for the three months ended March 31, 2022 compared to 36.1% in the corresponding period in the prior year primarily due to increased labor and materials costs as a percentage of sales.
Other :
The loss from operations in Other increased $2.7 million, or 28.7%, for the three months ended March 31, 2022 compared to the corresponding period in the prior year primarily due to the factors described above under “Operating Expenses.”
Interest, net :
Interest expense decreased to $7.9 million for the three months ended March 31, 2022 from $9.0 million in the corresponding period in the prior year. Interest expense was higher in the first quarter of 2021 primarily due to $2.6 million of “make-whole” interest premium paid in connection with the termination of our $30 million senior credit agreement (the “Senior Credit Facility”) on March 15, 2021. This was partially offset by higher interest rates on our 8.625% Senior Secured Notes (the “Senior Notes”) issued in 2021, compared to the interest rates on the debt facilities in the prior year period.
Loss on debt extinguishment:
During the three months ended March 31, 2022, we recorded a $0.4 million loss on debt extinguishment relating to the $20.0 million early redemption the Senior Notes as we expensed the associated portion of the unamortized deferred financing costs.
During the three months ended March 31, 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
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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:
During the three months ended March 31, 2022, we recorded income tax expense of $3.7 million on pre-tax income of $9.7 million, representing an effective income tax rate of 38.2%. During the three months ended March 31, 2021, we recorded income tax expense of $1.4 million on pre-tax income of $3.8 million, representing an effective income tax rate of 36.1%. For the quarter ended March 31, 2022, the effective income tax rate differs from the federal U.S. statutory rate of 21.0% primarily due to the impact of state taxes and a valuation allowance related to the more restrictive interest deduction limitation in Section 163(j) of the Internal Revenue Code that took effect in 2022. For the quarter ended March 31, 2021, the effective income tax rate differs from the federal U.S. statutory rate of 21.0% primarily due to the impact of state taxes and permanent items.
Net income:
During the three months ended March 31, 2022, net income was $6.0 million, compared to net income of $2.4 million in the corresponding period in the prior year. The increase was primarily due to the impact of debt refinancing costs incurred in the 2021 first quarter, as well as increased sales growth, partially offset by the increased material, labor, and “Selling, general & administrative” costs.
Liquidity and Capital Resources
At March 31, 2022, we had $12.1 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 8.625% senior secured notes due 2026 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 ABL Revolver’s prior LIBOR interest benchmark with updated benchmark provisions using the secured overnight financing rate (“SOFR”) as administered by the Federal Reserve Bank of New York.
Borrowings under the amended ABL Revolver bear interest at a rate per annum equal to the applicable term SOFR rate selected and adjusted for a credit spread, plus an applicable interest rate margin based on the average unused capacity of the facility. We may select a one, three or six month term SOFR rate, which is adjusted for a credit spread of 0.10% to 0.30% depending on the term selected. 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 applicable interest rate margin range changes, effective April 1, 2023, to between 1.25% and 1.75%, depending on the average unused capacity of the facility. The unused portion of the ABL Revolver commitment accrues a commitment fee, which ranges from 0.375% to 0.50% per annum, based on the average daily borrowing capacity under the ABL Revolver over
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the immediately preceding month. The fee percentage and calculation of the unused commitment fee changes, effective April 1, 2023, to between 0.375% and 0.50% (determined based on the average revolver usage over a specified period of time) of the unused portion of the facility.
As of March 31, 2022, we have $30.0 million in ABL Revolver borrowings outstanding and $45.0 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 during periods in which 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 availability is below $7.5 million and until such time that borrowing availability 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.
Prior to March 15, 2023, the Company may 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, 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 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 is 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 Senior Credit Facility and First Lien Term Loan. Net proceeds from the Senior Notes, together with cash on hand and initial borrowings of $15 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 debt agreements. As of March 31, 2022, the Company had $290 million aggregate principal amount outstanding on the Senior Notes, plus accrued and unpaid interest.
Operating Activities
Cash used in operating activities for the three months ended March 31, 2022 was $16.0 million compared to cash provided by operating activities of $0.1 million during the three months ended March 31, 2021. Cash generated from earnings for the three months ended March 31, 2022 was offset by working capital increases, including an increase in accounts receivable of $10.3 million due to higher net sales compared to the previous quarter. We also increased inventories by $12.6 million during the quarter ended March 31, 2022, including procurement of EMV contactless chips to support our business, and to maintain certain levels of inventory to help mitigate supply chain constraints. We also decreased accrued expenses by $8.8 million during the quarter ended March 31, 2022, primarily related to payments on accrued interest and employee performance incentive compensation during the period.
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Investing Activities
Cash used in investing activities for the three months ended March 31, 2022 was $3.1 million, compared to $2.4 million during the three months ended March 31, 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 $3.5 million during the three months ended March 31, 2022, compared to $0.5 million during the corresponding period of the prior year.
Financing Activities
During the three months ended March 31, 2022, cash provided by financing activities was $10.6 million. Proceeds from the ABL Revolver were $30.0 million and in connection with the ABL Amendment, we paid $0.3 million of debt issuance costs . A portion of the proceeds from the ABL Revolver were 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 $0.6 million of principal on financing leases during each of the three months ending March 31, 2022 and 2021.
During the three months ended March 31, 2021, cash used in financing activities was $30.5 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 debt agreements.
Working Capital
Our working capital as of March 31, 2022 was $99.4 million, compared to $80.9 million as of December 31, 2021. During the three months ended March 31, 2022 , our inventory balance increased $12.5 million to support the business, accounts receivable increased $10.2 million, and accrued expenses decreased $7.5 million. These increases were partially offset by a decrease in our cash balance of $8.5 million and an increase in accounts payable of $3.9 million.
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 March 31, 2022, the total projected principal and interest payments on our borrowings were $421.9 million, primarily related to the Senior Notes, of which $25.9 million of interest and principal 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. 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.
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 March 31, 2022, included:
● Revenue recognition, including estimates of work performed but not completed , and
● Income taxes, including valuation allowances and uncertain tax positions.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.