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 September 30, 2023. 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, 2022 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, 2023 (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: a deterioration in general economic conditions, including inflationary conditions and resulting in reduced consumer confidence and business spending, and a decline in consumer credit worthiness impacting demand for our products; the unpredictability of our operating results, including an inability to anticipate changes in customer inventory management practices and its impact on our business; adverse conditions in the banking system and financial markets, including the failure of banks and financial institutions; a disruption or other failure in our supply chain, including as a result of the Russia-Ukraine or other foreign conflicts and with respect to single source suppliers, or the failure or inability of suppliers to comply with our code of conduct or contractual requirements, or political unrest in countries in which our suppliers operate, 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; our failure to retain our existing customers or identify and attract new customers; our status as 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; our inability to recruit, retain and develop qualified personnel, including key personnel; the potential effects of COVID-19 and responses thereto on our business, including our supply chain, customer demand, workforce, operations; system security risks, data protection breaches and cyber-attacks; interruptions in our operations, including our information technology systems, or in the operations of the third parties that operate computing infrastructure on which we rely; our inability to develop, introduce and commercialize new products; 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; disruptions in production at one or more of our facilities; defects in our software; 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; our limited ability to raise capital; problems in production quality, materials and process; 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 or unclaimed property, 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,
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saturated and consolidated nature of our marketplace; the effects of restrictions, delays or interruptions in our ability to source raw materials and components used in our products from foreign countries; the effects on the global economy of the ongoing military action by Russia in Ukraine and other foreign conflicts; costs and potential liabilities associated with compliance or 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 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; the impact of stockholder activism or securities litigation on the trading price and volatility of our common stock; 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, 2022 filed with the SEC on March 8, 2023, 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 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 network of high-security production facilities allows us to optimize our solutions offerings and to serve the needs of our diverse customer base.
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Driven by a combination of our strong relationships, quality, technology, innovation, and supply-chain management, we believe we have strong positions in the following markets:
● the U.S. prepaid debit market, including the largest U.S. Prepaid Debit Card program managers;
● the U.S. small-to mid-sized financial institutions 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
● 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 financial institutions 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.
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 believe some customers have reduced demand for our products and services and we may experience reduced demand from customers in the future due to the following:
● Some large banks point toward the possibility that the U.S. economy will experience an economic slowdown in the near future, which we believe has caused, and may continue to cause, some of our customers, particularly in the banking and financial services industry, to have concerns about the broader economic environment and therefore reduce overall spending, delay spending into future periods, or request pricing concessions, including on card programs or other products and services we offer.
● Some of our customers anticipated supply-chain-related delays and correspondingly increased their own inventory of the Company’s products on hand during 2022. As supply-chain lead times have improved and given the economic concerns noted above, we believe some customers are now more focused on reducing their inventory levels.
● Certain banks have experienced negative liquidity events, including some being taken over by industry regulators and others experiencing deposit outflows, deteriorating share prices and limited access to capital, leading to cautionary signals and uncertainty in the financial services industry. Following these events, we experienced reduced demand in the Debit and Credit segment.
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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,
2023
2022
$ Change
% Change
2023
2022
$ Change
% Change
(dollars in thousands)
Net sales: (1)
Products
$
55,689
$
71,606
$
(15,917)
(22.2)
%
$
195,425
$
208,867
$
(13,442)
(6.4)
%
Services
50,174
52,971
(2,797)
(5.3)
%
146,250
140,442
5,808
4.1
%
Total net sales
105,863
124,577
(18,714)
(15.0)
%
341,675
349,309
(7,634)
(2.2)
%
Cost of sales (1)
69,711
76,137
(6,426)
(8.4)
%
221,604
221,040
564
0.3
%
Gross profit
36,152
48,440
(12,288)
(25.4)
%
120,071
128,269
(8,198)
(6.4)
%
Operating expenses
23,191
24,995
(1,804)
(7.2)
%
69,020
71,789
(2,769)
(3.9)
%
Income from operations
12,961
23,445
(10,484)
(44.7)
%
51,051
56,480
(5,429)
(9.6)
%
Other expense, net:
Interest, net
(6,714)
(7,323)
609
(8.3)
%
(20,235)
(22,334)
2,099
(9.4)
%
Other expense, net
(53)
(63)
10
*
(245)
(474)
229
(48.3)
%
Income before taxes
6,194
16,059
(9,865)
(61.4)
%
30,571
33,672
(3,101)
(9.2)
%
Income tax expense
(2,337)
(4,149)
1,812
(43.7)
%
(9,318)
(9,609)
291
(3.0)
%
Net income
$
3,857
$
11,910
$
(8,053)
(67.6)
%
$
21,253
$
24,063
$
(2,810)
(11.7)
%
Gross profit margin
34.1%
38.9%
35.1%
36.7%
* Calculation not meaningful
(1) For both the three months ended September 30, 2023, and 2022, net sales and cost of sales each include $0.3 million of intersegment eliminations. For the nine months ended September 30, 2023, and 2022, net sales and cost of sales each include $0.6 million and $0.4 million of intersegment eliminations, respectively.
The following discussion of our consolidated results of operations and segment results refers to the three and nine months ended September 30, 2023, compared to the corresponding periods in the prior year. The results of operations should be read in conjunction with the discussion of our segment results of operations, which provide more detailed discussions concerning certain components of the Condensed Consolidated Statements of Income.
Net Sales:
Net sales decreased for the three months ended September 30, 2023, primarily due to decreased Products net sales in our Debit and Credit segment, due to lower volumes.
Net sales decreased for the nine months ended September 30, 2023, primarily due to decreased Products net sales due to lower volumes, partially offset by higher personalization and Card@Once services, in our Debit and Credit segment. Net sales also benefited from price increases, which were primarily implemented in 2022.
Gross Profit and Gross Profit Margin:
Gross profit and gross profit margin decreased for the three months ended September 30, 2023, primarily due to lower net sales and higher production costs.
Gross profit and gross profit margin decreased for the nine months ended September 30, 2023, primarily due to higher production costs.
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Operating Expenses:
Operating expenses decreased for the three and nine months ended September 30, 2023. For the three months ended September 30, 2023, the decrease was primarily due to a decrease in professional services. Compensation expenses decreased, as lower employee short-term incentive compensation was offset by the impacts of compensation related to an executive retention agreement, increased employee headcount and salary increases.
For the nine months ended September 30, 2023, the decrease was primarily due to a decrease in professional services, partially offset by an increase in compensation expenses. Compensation expenses increased due to the impacts of compensation related to an executive retention agreement and increased employee headcount and salary increases, partially offset by lower employee short-term incentive compensation.
Interest, net :
Interest expense decreased for the three and nine months ended September 30, 2023, primarily due to lower outstanding principal balances on our borrowings. For the nine months ended September 30, 2022, interest expense also included a $0.6 million premium paid relating to the $20.0 million early redemption of the 8.625% Senior Secured Notes due 2026 (the “Senior Notes”).
Other Expense, net:
Other expense, net was relatively consistent for both the three and nine months ended September 30, 2023.
Income Tax Expense:
Our effective tax rate on pre-tax income was 37.7% and 25.8% for the three months ended September 30, 2023, and 2022, respectively, and 30.5% and 28.5% for the nine months ended September 30, 2023, and 2022, respectively. The increase in the effective tax rate for the three and nine months ended September 30, 2023, was due to tax deduction limitations on executive compensation. The effective tax rate for the three months ended September 30, 2023, also increased due to the reduction of the federal valuation allowance as a result of increased deductibility of interest costs due to a tax election made by the Company in the third quarter of 2022.
Segment Discussion
Debit and Credit:
Three Months Ended
Nine Months Ended
September 30,
September 30,
2023
2022
$ Change
% Change
2023
2022
$ Change
% Change
(dollars in thousands)
Net sales
$
83,780
$
99,512
$
(15,732)
(15.8)
%
$
278,959
$
285,708
$
(6,749)
(2.4)
%
Gross profit
$
28,381
$
38,071
$
(9,690)
(25.5)
%
$
99,603
$
104,389
$
(4,786)
(4.6)
%
Income from operations
$
20,791
$
29,418
$
(8,627)
(29.3)
%
$
75,898
$
78,847
$
(2,949)
(3.7)
%
Gross profit margin
33.9%
38.3%
35.7%
36.5%
Net Sales:
Net sales for Debit and Credit decreased for the three months ended September 30, 2023, primarily due to a decrease in Products net sales, driven by volume declines in contactless cards, including eco-focused, as well as EMV cards.
Net sales for Debit and Credit decreased for the nine months ended September 30, 2023, primarily due to a decrease in Products net sales, driven by volume declines in eco-focused and EMV cards, partially offset by increased sales of other contactless and non-EMV cards. The decrease in Products net sales was partially offset by an increase in
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Services net sales due to higher card personalization sales and higher Card@Once services driven by a higher printer installation base. Net sales also benefited from price increases, which were primarily implemented in 2022.
Gross Profit and Gross Profit Margin:
Gross profit and gross profit margin for Debit and Credit decreased for the three months ended September 30, 2023, primarily due to lower net sales and higher production costs.
Gross profit and gross profit margin for Debit and Credit decreased for the nine months ended September 30, 2023, primarily due to higher production costs.
Income from Operations:
Income from operations for Debit and Credit decreased for the three and nine months ended September 30, 2023, primarily due to the factors discussed in “Gross Profit and Gross Profit Margin” above, partially offset by decreases in operating expenses related to compensation related expenses and professional services.
Prepaid Debit:
Three Months Ended
Nine Months Ended
September 30,
September 30,
2023
2022
$ Change
% Change
2023
2022
$ Change
% Change
(dollars in thousands)
Net sales
$
22,335
$
25,335
$
(3,000)
(11.8)
%
$
63,286
$
64,010
$
(724)
(1.1)
%
Gross profit
$
7,771
$
10,369
$
(2,598)
(25.1)
%
$
20,468
$
23,880
$
(3,412)
(14.3)
%
Income from operations
$
6,631
$
9,109
$
(2,478)
(27.2)
%
$
17,936
$
20,393
$
(2,457)
(12.0)
%
Gross profit margin
34.8%
40.9%
32.3%
37.3%
Net Sales:
Net sales for Prepaid Debit decreased for the three and nine months ended September 30, 2023, primarily due to decreased volumes from existing customers. For the nine months ended September 30, 2023, the decrease in net sales was offset by the benefit of price increases, which were primarily implemented in 2022.
Gross Profit and Gross Profit Margin:
Gross profit and gross profit margin for Prepaid Debit decreased for the three months ended September 30, 2023, primarily due to lower net sales, and increased labor costs as a result of a change in our production staffing model.
Gross profit and gross profit margin for Prepaid Debit decreased for the nine months ended September 30, 2023, primarily due to increased labor costs and other expenses as a result of a change in our production staffing model, as well as lower net sales.
Income from Operations:
Income from operations for Prepaid Debit decreased for the three and nine months ended September 30, 2023, primarily due to the factors discussed in “Gross Profit and Gross Profit Margin” above. For the nine months ended September 30, 2023, income from operations also benefited from lower operating expenses.
Other:
As the Other segment is comprised entirely of corporate expenses, income from operations for Other consists of operating expenses shown below.
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Three Months Ended
Nine Months Ended
September 30,
September 30,
2023
2022
$ Change
% Change
2023
2022
$ Change
% Change
(dollars in thousands)
Operating expenses
$
14,461
$
15,082
$
(621)
(4.1)
%
$
42,783
$
42,760
$
23
0.1
%
Operating Expenses:
Other operating expenses decreased for the three months ended September 30, 2023, primarily due to lower employee short-term incentive compensation and decreased professional services, partially offset by increased compensation expenses driven by compensation related to an executive retention agreement, increased employee headcount and salary increases.
Other operating expenses were relatively consistent for the nine months ended September 30, 2023, as increased compensation expenses as a result of compensation related to an executive retention agreement and increased employee headcount and salary increases, were offset by decreases in professional services, employee short-term incentive compensation and employee healthcare expenses.
Liquidity and Capital Resources
As of September 30, 2023, we had $10.5 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.
Senior Notes
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.
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 based on an adjusted net income calculation pursuant to the terms of the indenture, and varies based on the Company’s annual net leverage ratio. The Company is required to offer to pay 50% of excess cash flow if the net leverage ratio exceeds 4.5 to 1; 25% if the net leverage ratio is between 4 to 1 and 4.5 to 1, and 0% if the net leverage ratio is less than or equal to 4 to 1. Any required prepayments are to be made within 125 days after the issuance of the Company’s annual financial statements. No such payment was required to be made in 2023 based on the Company’s operating results for the year ended December 31, 2022.
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. Beginning March 15, 2023, the Company may redeem some or all of the Senior Notes pursuant to the terms of the indenture 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. 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.
As of September 30, 2023, the Company had $267.9 million aggregate principal amount outstanding on the Senior Notes, plus accrued and unpaid interest.
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ABL
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 the Credit Agreement, which amended the ABL Revolver to among other things, increase the available borrowing capacity to $75.0 million, increase the uncommitted accordion feature to $25.0 million and revise the interest rate provisions to replace the prior 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. Through March 31, 2023, the applicable interest rate margin ranged from 1.50% to 1.75% depending on the average excess availability of the facility for the most recently completed quarter. The unused portion of the ABL Revolver commitment accrued a monthly unused line fee, 0.50% per annum through March 31, 2023, multiplied by the aggregate amount of Revolver commitments less the average Revolver usage during the immediately preceding month. The interest rate margin and unused line fee percentage changed, effective April 1, 2023, to between 1.25% and 1.75% (interest rate margin) and 0.375% and 0.50% (unused line fee).
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).
As of September 30, 2023, the Company had $8.0 million in ABL Revolver borrowings outstanding, plus accrued and unpaid interest.
Operating Activities
Cash provided by operating activities for the nine months ended September 30, 2023 was $22.3 million compared to $11.7 million during the nine months ended September 30, 2022.
The increase in cash provided by operating activities compared to the prior year period was primarily generated by reductions in accounts receivable, due to collections on outstanding receivables as of the prior year end, and a decrease in inventory purchases in 2023 as inventory levels were increased in 2022 to help mitigate supply-chain constraints. These positive increases to cash flow were partially offset by higher employee performance incentive compensation payments in 2023 related to 2022 performance.
Investing Activities
Cash used in investing activities for the nine months ended September 30, 2023 was $5.9 million, compared to $14.3 million during the nine months ended September 30, 2022. Cash used in investing activities was related primarily to capital expenditures, including investments to support the business, such as machinery and information technology equipment, although at a slower pace than in the prior year. 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 $7.0 million during the nine months ended September 30, 2023, compared to $7.8 million during the corresponding period in the prior year.
Financing Activities
During the nine months ended September 30, 2023, cash used in financing activities was $16.9 million. Proceeds from the ABL Revolver of $13.0 million were offset by payments of $10.0 million on the ABL Revolver and payments of $17.0 million to retire a portion of the Senior Notes, and $2.7 million of principal on financing leases.
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 we paid $0.3 million of debt issuance costs in connection with
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the Amendment to the ABL Revolver. 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 and paid $2.5 million of principal on financing leases.
Working Capital
Our working capital as of September 30, 2023 was $115.2 million, compared to $99.6 million as of December 31, 2022. The increase in our working capital as of September 30, 2023 was primarily due to a decrease in accrued expenses of $12.1 million, a decrease in accounts payable of $7.5 million, an increase in inventories of $5.7 million, and decreased deferred revenue and customer deposits of $2.8 million, partially offset by decreased accounts receivable of $13.0 million. Our working capital needs are typically highest in the first and third quarters due to the timing of payments for interest on outstanding borrowings and employee incentive compensation.
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, 2023, the total projected principal and interest payments on our borrowings were $335.0 million, primarily related to the Senior Notes, of which $24.1 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 Supplementary Data , Note 9, Financing and Operating Leases, in our Annual Report on Form 10-K for the year ended December 31, 2022 for details on our leasing arrangements, including future maturities of our operating lease liabilities.
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, 2023, 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, 2022.
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, 2022, for which there were no material changes as of September 30, 2023, included:
● Revenue recognition, including estimates of work performed but not completed , and
● Income taxes, including estimates regarding future compensation for covered individuals, valuation allowances and uncertain tax positions.
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