CPI Card Group Inc. - Quarter Report: 2021 September (Form 10-Q)

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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, 2021.

☐

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 26, 2021: 11,255,466

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		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		23

Item 3 — Quantitative and Qualitative Disclosures About Market Risk		35

Item 4 — Controls and Procedures		35


Part II — Other Information

Item 1 — Legal Proceedings		36

Item 1A — Risk Factors		36

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

(Amounts in Thousands, Except Share and Per Share Amounts)

(Unaudited)


	September 30,		December 31,
	2021		2020

Assets
Current assets:
Cash and cash equivalents	$	20,853	$	57,603
Accounts receivable, net of allowances of $226 and $289, respectively		65,450		54,592
Inventories		46,442		24,796
Prepaid expenses and other current assets		5,097		5,032
Income taxes receivable		116		10,511
Total current assets		137,958		152,534
Plant, equipment, leasehold improvements and operating lease right-of-use assets, net		38,347		39,403
Intangible assets, net		22,821		26,207
Goodwill		47,150		47,150
Other assets		5,999		857
Total assets	$	252,275	$	266,151
Liabilities and stockholders’ deficit
Current liabilities:
Accounts payable	$	18,795	$	18,883
Accrued expenses		32,097		28,149
Current portion of long-term debt		—		8,027
Deferred revenue and customer deposits		1,029		1,868
Total current liabilities		51,921		56,927
Long-term debt		303,251		328,681
Deferred income taxes		6,657		7,409
Other long-term liabilities		12,979		11,171
Total liabilities		374,808		404,188
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, 2021 and December 31, 2020		-		-
Stockholders’ deficit:
Common stock; $0.001 par value—100,000,000 shares authorized; 11,238,994 and 11,230,482 shares issued and outstanding at September 30, 2021 and December 31, 2020		11		11
Capital deficiency		(111,622)		(111,858)
Accumulated loss		(10,922)		(26,190)
Total stockholders’ deficit		(122,533)		(138,037)
Total liabilities and stockholders’ deficit	$	252,275	$	266,151

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

(Amounts in Thousands, Except Share and Per Share Amounts)

(Unaudited)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Net sales:
Products	$	52,276	$	43,462	$	146,445	$	125,040
Services		47,326		39,240		135,468		103,009
Total net sales		99,602		82,702		281,913		228,049
Cost of sales:
Products (exclusive of depreciation and amortization shown below)		31,493		27,490		86,708		79,780
Services (exclusive of depreciation and amortization shown below)		28,368		22,133		77,975		60,986
Depreciation and amortization		2,056		2,472		6,736		7,938
Total cost of sales		61,917		52,095		171,419		148,704
Gross profit		37,685		30,607		110,494		79,345
Operating expenses:
Selling, general and administrative (exclusive of depreciation and amortization shown below)		19,469		15,617		55,363		48,893
Depreciation and amortization		1,514		1,508		4,873		4,498
Total operating expenses		20,983		17,125		60,236		53,391
Income from operations		16,702		13,482		50,258		25,954
Other expense, net:
Interest, net		(7,183)		(6,298)		(23,196)		(19,158)
Other income (expense), net		(6)		27		23		(8)
Loss on debt extinguishment		—		—		(5,048)		(92)
Total other expense, net		(7,189)		(6,271)		(28,221)		(19,258)
Income from continuing operations before income taxes		9,513		7,211		22,037		6,696
Income tax (expense) benefit		(2,887)		(1,402)		(6,769)		2,178
Net income from continuing operations		6,626		5,809		15,268		8,874
Net loss from discontinued operations, net of tax (Note 1)		—		—		—		(30)
Net income	$	6,626	$	5,809	$	15,268	$	8,844

Basic and diluted earnings per share:
Basic earnings per share from continuing operations:	$	0.59	$	0.52	$	1.36	$	0.79
Diluted earnings per share from continuing operations:	$	0.56	$	0.52	$	1.30	$	0.79

Basic earnings per share:	$	0.59	$	0.52	$	1.36	$	0.79
Diluted earnings per share:	$	0.56	$	0.52	$	1.30	$	0.79

Basic weighted-average shares outstanding:		11,238,678		11,230,028		11,234,054		11,228,116
Diluted weighted-average shares outstanding:		11,799,321		11,231,821		11,755,381		11,235,098

Comprehensive income:
Net income	$	6,626	$	5,809	$	15,268	$	8,844
Total comprehensive income	$	6,626	$	5,809	$	15,268	$	8,844

See accompanying notes to condensed consolidated financial statements

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CPI Card Group Inc. and Subsidiaries

Condensed Consolidated Statements of Stockholders’ Deficit

(Dollars in Thousands, Excludes per Share Amounts)

(Unaudited)


	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
Stock option exercises	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
Stock option exercises	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)

	Common Stock			Capital		Accumulated
	Shares	Amount		deficiency		earnings (loss)		Total
June 30, 2020	11,229,819		11		(111,935)		(39,284)	$	(151,208)
Shares issued under stock-based compensation plans	663		—		—		—		—
Stock-based compensation			—		25		—		25
Components of comprehensive income:
Net income			—		—		5,809		5,809
September 30, 2020	11,230,482	$	11	$	(111,910)	$	(33,475)	$	(145,374)

	Common Stock			Capital		Accumulated
	Shares	Amount		deficiency		earnings (loss)		Total
December 31, 2019	11,224,191		11		(111,988)		(42,319)	$	(154,296)
Shares issued under stock-based compensation plans	6,291		—		—		—		—
Stock-based compensation			—		78		—		78
Components of comprehensive income:
Net income			—		—		8,844		8,844
September 30, 2020	11,230,482	$	11	$	(111,910)	$	(33,475)	$	(145,374)

See accompanying notes to condensed consolidated financial statements

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CPI Card Group Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Amounts in Thousands)

(Unaudited)


	Nine Months Ended September 30,
	2021		2020
Operating activities
Net income	$	15,268	$	8,844
Adjustments to reconcile net income to net cash provided by operating activities:
Loss from discontinued operations		—		30
Depreciation and amortization expense		11,609		12,436
Stock-based compensation expense		214		84
Amortization of debt issuance costs and debt discount		1,880		2,503
Loss on debt extinguishment		5,048		92
Deferred income taxes		(752)		290
Other, net		210		1,253
Changes in operating assets and liabilities:
Accounts receivable		(10,846)		(16,165)
Inventories		(21,831)		(1,109)
Prepaid expenses and other assets		(3,340)		49
Income taxes, net		10,603		(3,630)
Accounts payable		83		921
Accrued expenses		6,419		4,112
Deferred revenue and customer deposits		(843)		417
Other liabilities		793		81
Cash provided by operating activities - continuing operations		14,515		10,208
Cash used in operating activities - discontinued operations		—		(30)
Investing activities
Capital expenditures for plant, equipment and leasehold improvements		(4,827)		(3,320)
Other		156		—
Cash used in investing activities		(4,671)		(3,320)
Financing activities
Principal payments on First Lien Term loan		(312,500)		—
Principal payments on Senior Credit Facility		(30,000)		—
Principal payments on ABL Revolver		(15,000)		—
Proceeds from Senior Notes		310,000		—
Proceeds from ABL Revolver, net of discount		14,750		—
Proceeds from Senior Credit Facility, net of discount		—		29,100
Proceeds from exercises of stock options		34		—
Taxes withheld and paid on stock compensation		(12)		—
Debt issuance costs		(9,452)		(2,507)
Payments on debt extinguishment		(2,685)		—
Payments on finance lease obligations		(1,725)		(1,782)
Cash (used in) provided by financing activities		(46,590)		24,811
Effect of exchange rates on cash		(4)		(2)
Net (decrease) increase in cash and cash equivalents		(36,750)		31,667
Cash and cash equivalents, beginning of period		57,603		18,682
Cash and cash equivalents, end of period	$	20,853	$	50,349
Supplemental disclosures of cash flow information
Cash paid (refunded) during the period for:
Interest	$	22,107	$	17,454
Income taxes paid	$	4,708	$	1,205
Income taxes (refunded)	$	(9,846)	$	(259)
Right-to-use assets obtained in exchange for lease obligations:
Operating leases	$	3,666	$	141
Financing leases	$	484	$	1,618
Accounts payable, and accrued expenses for capital expenditures for plant, equipment and leasehold improvements	$	1,005	$	127

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 issued on the networks of the “Payment Card Brands” (Visa, Mastercard^®, American Express^® and Discover^® in the United States and Interac in Canada). The Company 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 banks 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 (the “PCI 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 effectively meet customers’ needs.

COVID-19 Update

The COVID-19 pandemic has impacted economies and societies globally. The long-term implications of COVID-19 on the Company’s results of operations and overall financial performance remain uncertain. The health and safety of CPI employees remain paramount, and the Company continues to follow response protocols based on precautions and other appropriate measures recommended by the Centers for Disease Control and Prevention, as well as various state and local executive orders, health orders and guidelines.  All of CPI’s operations have remained open and continue to provide direct and essential support to the financial services industry.

The Company believes the global impacts from COVID-19 have contributed to certain adverse effects on its supply chain, including increased lead times for, and higher costs for, certain raw materials and components, as well as a global chip shortage, which are expected to continue in the future. CPI closely monitors its supply chain and has purchased and may continue to purchase additional inventory to help mitigate supply chain constraints. 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. On November 4, 2021, the Occupational Safety and Health Administration (“OSHA”) filed an Emergency Temporary Standard (“ETS”) with the Office of the Federal Register that will require employers with 100 or more employees to require their employees to be fully vaccinated with a COVID-19 vaccine or to produce a negative COVID-19 test result on at least a weekly basis, along with certain other requirements. Based on the pre-publication version of the ETS, the Company believes the proposed rule would apply to the Company. Compliance with the ETS could result in increased costs as well as labor disruptions, employee attrition and/or difficulty recruiting new employees which could compound the labor shortage already impacting the Company.

The Company expects the labor and supply chain challenges described above, and the associated costs, to continue to increase through the fourth quarter of 2021 and beyond. The Company may not be able to pass all of these costs through to its customers. The Company has also experienced increased demand for its products and services. The Company is experiencing increased production lead times, which it believes is likely to continue in the fourth quarter of 2021 and 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.

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refunds, modifications to the net interest deduction limitation and technical corrections to tax depreciation methods for qualified improvement property. Refer to Note 11, Income Taxesfor a discussion of the CARES Act income tax impacts on the Company. In addition, CPI deferred employer social security payments in 2020 in accordance with the CARES Act, which are allowed to be paid in two installments in 2021 and 2022. While the Company is participating in certain programs under the CARES Act, the CARES Act and its guidance are subject to change.

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, 2020 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, 2020.

Discontinued Operations

On August 3, 2018, the Company completed the sale of its three facilities in the United Kingdom that produced retail cards, such as gift and loyalty cards, for customers in the United Kingdom and continental Europe, and provided personalization, packaging and fulfillment services. The facilities sold included Colchester, Liverpool and Derby locations. The Company reported the U.K. Limited reporting segment as discontinued operations in accordance with GAAP. The Company did not retain significant continuing involvement with the discontinued operations subsequent to the disposal. The impact of the discontinued operations was insignificant to the Company’s condensed consolidated statement of operations for the three and nine months ended September 30, 2021 and 2020.

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 in the current fiscal year 2021. 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 and results of operations.

Adjustment of Prior Period Financial Statements for Immaterial Items

In accordance with Securities and Exchange Commission Staff Accounting Bulletin 99, Materiality, codified in Accounting Standards Codification (“ASC”) 250, Presentation of Financial Statements, during the year ended December 31, 2020, the Company corrected two immaterial items relating to estimated sales tax expense and depreciation expense that related to prior periods. The condensed consolidated financial statements and other financial information for the

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prior year period reflect the corrected balances which included sales tax expense in Selling, General and Administrative expenses (“SG&A”) of $293 and depreciation expense of $124 for the nine months ended September 30, 2020. Refer to Note 14, Commitments and Contingencies for additional discussion of the estimated sales tax liability recorded in “Accrued expenses” on the condensed consolidated balance sheet.

2. Net Sales

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


	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

	Three Months Ended September 30, 2020
	Products		Services		Total
Debit and Credit	$	44,056	$	18,654	$	62,710
Prepaid Debit		—		20,604		20,604
Intersegment eliminations		(594)		(18)		(612)
Total	$	43,462	$	39,240	$	82,702

	Nine Months Ended September 30, 2020
	Products		Services		Total
Debit and Credit	$	126,507	$	54,348	$	180,855
Prepaid Debit		—		48,680		48,680
Intersegment eliminations		(1,467)		(19)		(1,486)
Total	$	125,040	$	103,009	$	228,049

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 manufactured 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 manufactured Financial Payment Cards, including contact-EMV^®, contactless dual-interface EMV, contactless and magnetic stripe cards, our 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.

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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, including CPI On-Demand^® personalization, providing tamper-evident secure packaging and fulfillment services to Prepaid Debit Card program managers and software-as-a-service personalization of instant issuance debit and credit cards. The Company also generates “Services” net sales from usage-fees generated from the Company’s patented card design software, known as MYCA^TM, which provides customers and cardholders the ability to design cards on the internet and customize cards with individualized digital images. 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.

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, 2021		December 31, 2020

Trade accounts receivable	$	53,668	$	44,305
Unbilled accounts receivable		12,008		10,576
		65,676		54,881
Less allowance for doubtful accounts		(226)		(289)
	$	65,450	$	54,592

4. Inventories

Inventories consisted of the following:


	September 30, 2021		December 31, 2020

Raw materials	$	43,734	$	23,009
Finished goods		5,741		4,635
Inventory reserve		(3,033)		(2,848)
	$	46,442	$	24,796

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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, 2021		December 31, 2020

Machinery and equipment	$	60,450	$	55,459
Machinery and equipment under financing leases		7,676		9,974
Furniture, fixtures and computer equipment		4,583		4,410
Leasehold improvements		13,967		15,083
Construction in progress		2,264		2,386
		88,940		87,312
Less accumulated depreciation and amortization		(59,853)		(55,092)
Operating lease right-of-use assets, net of accumulated amortization		9,260		7,183
	$	38,347	$	39,403

Depreciation expense of plant, equipment and leasehold improvements, including depreciation of assets under financing leases, was $2,482 and $2,831 for the three months ended September 30, 2021 and 2020, respectively, and $8,223 and $8,989 for the nine months ended September 30, 2021 and 2020, respectively.

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

6. Goodwill and Other Intangible Assets

The Company reports all of its goodwill in the Debit and Credit segment at September 30, 2021 and December 31, 2020. 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, 2021.

Intangible assets consist of customer relationships, technology and software, and trademarks. Intangible amortization expense was $1,088 and $1,149 for the three months ended September 30, 2021 and 2020, respectively, and $3,386 and $3,447 for the nine months ended September 30, 2021 and 2020, respectively.

At September 30, 2021 and December 31, 2020, intangible assets, excluding goodwill, were comprised of the following:


		September 30, 2021						December 31, 2020
	Weighted Average			Accumulated		Net Book				Accumulated		Net Book
	Life (Years)	Cost		Amortization		Value		Cost		Amortization		Value

Customer relationships	17.2	$	55,454	$	(34,600)	$	20,854	$	55,454		(32,141)	$	23,313
Technology and software	8		7,101		(6,517)		584		7,101		(5,881)		1,220
Trademarks	8.7		3,330		(1,947)		1,383		3,330		(1,656)		1,674
Intangible assets subject to amortization		$	65,885	$	(43,064)	$	22,821	$	65,885	$	(39,678)	$	26,207

The estimated future aggregate amortization expense for the identified amortizable intangibles noted above as of September 30, 2021 was as follows:


2021 (excluding the nine months ended September 30, 2021)	$	966
2022		3,867
2023		3,867
2024		3,630
2025		3,440
Thereafter		7,051
	$	22,821

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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.

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, 2021
	September 30,		September 30,		(Using Fair Value Hierarchy)
	2021		2021		Level 1		Level 2		Level 3
Liabilities:
Senior Notes	$	310,000	$	337,993	$	—	$	337,993	$	—


	Carrying		Estimated
	Value as of		Fair Value as of		Fair Value Measurement at December 31, 2020
	December 31,		December 31,		(Using Fair Value Hierarchy)
	2020		2020		Level 1		Level 2		Level 3
Liabilities:
First Lien Term Loan	$	312,500	$	287,500	$	—	$	287,500	$	—
Senior Credit Facility		30,000		30,000	$	—	$	—	$	30,000

The aggregate fair value of the Company’s Senior Notes (as defined in Note 10, Long-Term Debt) was based on bank quotes. The carrying amounts for cash and cash equivalents, accounts receivable and accounts payable each approximate fair value.

8. Accrued Expenses

Accrued expenses consisted of the following:


	September 30, 2021		December 31, 2020

Accrued payroll and related employee expenses	$	8,018	$	4,938
Accrued employee performance bonus		7,194		4,873
Employer payroll tax, including social security deferral		3,171		3,034
Accrued rebates		1,510		1,178
Sales tax liability		1,228		1,696
Accrued interest		1,197		4,145
Operating and financing lease liability (current portion)		3,549		4,407
Income taxes payable		2,015		-
Other		4,215		3,878
Total accrued expenses	$	32,097	$	28,149

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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.

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



	Three Months Ended		Three Months Ended
	September 30, 2021		September 30, 2020
Operating lease costs	$	538	$	664
Variable lease costs		181		175
Short-term operating lease costs		122		-
Total expense from operating leases	$	841	$	839

Finance lease cost:
Right-of-use amortization expense		256		326
Interest on lease liabilities		92		110
Total financing lease costs	$	348	$	436


	Nine Months Ended		Nine Months Ended
	September 30, 2021		September 30, 2020
Operating lease costs	$	1,580	$	2,006
Variable lease costs		509		524
Short-term operating lease costs		416		-
Total expense from operating leases	$	2,505	$	2,530

Finance lease cost:
Right-of-use amortization expense		751		982
Interest on lease liabilities		297		356
Total financing lease costs	$	1,048	$	1,338

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The following table reflects balances for operating and financing leases:



	September 30, 2021		December 31, 2020
Operating leases
Operating lease right-of-use assets, net of amortization	$	9,260	$	7,183

Operating lease liability (current)	$	1,781	$	2,267
Long-term operating liability		8,034		5,491
Total operating lease liabilities	$	9,815	$	7,758

Financing leases
Property, equipment and leasehold improvements	$	7,676	$	9,974
Accumulated depreciation		(2,188)		(2,422)
Total property, equipment and leasehold improvements, net	$	5,488	$	7,552

Financing lease liability (current)	$	1,768	$	2,140
Long-term financing liability		2,183		3,052
Total financing lease liabilities	$	3,951	$	5,192

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.”

Future cash payment with respect to lease obligations as of September 30, 2021 were as follows:


		Operating		Financing
		Lease		Leases

2021 (excluding the nine months ended September 30, 2021)		747		518
2022		2,377		2,136
2023		2,250		1,188
2024		2,049		390
2025		1,477		132
Thereafter		3,706		55
Total lease payments		12,606		4,419
Less imputed interest		(2,791)		(468)
Total	$	9,815	$	3,951

10. Long-Term Debt

At September 30, 2021 and December 31, 2020, long-term debt consisted of the following:


	Interest		September 30,		December 31,
	Rate ⁽¹⁾		2021		2020
Senior Notes	8.625	%	$	310,000	$	—
ABL Revolver	—	%		—		—
First Lien Term Loan	5.500	%		—		312,500
Senior Credit Facility	9.500	%		—		30,000
Unamortized deferred financing costs				(6,749)		(3,804)
Unamortized discount				—		(1,988)
Total long-term debt			$	303,251	$	336,708
Less current maturities				—		(8,027)
Long-term debt, net of current maturities			$	303,251	$	328,681

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(1) The Senior Notes bear interest at a fixed rate. The variable interest rate on the First Lien Term Loan and Senior Credit Facility was 5.5% and 9.5%, respectively, as of December 31, 2020.

On March 15, 2021, the Company completed a private offering by its wholly-owned subsidiary, CPI CG Inc. (the “Issuer”), of $310,000 aggregate principal amount of 8.625% senior secured notes due 2026 (the “Senior Notes”) and related guarantees. The notes and related guarantees were offered and sold in a private transaction exempt from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”), to persons reasonably believed to be qualified institutional buyers in accordance with Rule 144A under the Securities Act and outside the United States to certain non-U.S. persons in compliance with Regulation S under the Securities Act. In addition, 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”).

In connection with the issuance of the Senior Notes and entry into the ABL Revolver, the Company terminated its existing credit facilities consisting of a $30,000 senior credit agreement, dated as of March 6, 2020, among the Company, CPI CG Inc., as borrower, the lenders party thereto and Guggenheim Credit Services, LLC as administrative agent and collateral agent (the “Senior Credit Facility”), and a $435,000 first lien term loan, dated as of August 17, 2015 as amended, among the Company, the borrower, the lenders party thereto, GLAS USA LLC, as administrative agent and GLAS Americas LLC, as collateral agent (the “First Lien Term Loan”).

Net proceeds from the Senior Notes, together with cash on hand and initial borrowings of $15,000 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. As of March 15, 2021, the Company had outstanding borrowings of $30,000, plus accrued and unpaid interest, under the Senior Credit Facility, and $304,746, plus accrued and unpaid interest, under the First Lien Term Loan. In addition, 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 nine months ended September 30, 2021.

During the second quarter of 2021, the Company used $15,000 of cash on hand to pay down the ABL Revolver to zero and had no borrowings outstanding thereunder as of September 30, 2021.

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, beginning on September 15, 2021. 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. Borrowings under the ABL Revolver bear interest at a rate per annum that ranges from the LIBOR Rate plus 1.25% to the LIBOR Rate plus 1.75%, or the Base Rate plus 0.25% to the Base Rate plus 0.75%, based on the average daily borrowing capacity under the ABL Revolver over the most recently completed month. The Base Rate as defined in the ABL Revolver is the greater of the Federal Funds Rate plus 0.5%, the LIBOR Rate for a one month interest period plus 1.0%, or the Wells Fargo Bank, National Association “prime rate”. The Company may elect to apply either the LIBOR Rate or Base Rate interest to borrowings at its discretion. 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 the immediately preceding month.

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

The Senior Notes and the ABL Revolver contain covenants limiting the ability of the Company, the Issuer 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 the Issuer 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.

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The Company may have 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 Issuer, 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.

As of December 31, 2020, $8,027 of debt principal was classified as a current liability as a result of an excess free cash flow calculation for 2020 pursuant to the terms of the Senior Credit Facility and the First Lien Term Loan. The Company offered to prepay the balance, pursuant to the terms of the Senior Credit Facility and the First Lien Term Loan, which resulted in a required principal prepayment of $7,754 to the First Lien Term Loan lenders on March 4, 2021, plus accrued interest thereon.

Deferred Financing Costs and Discount

Certain costs and discounts incurred with borrowings or the establishment or modification of credit facilities 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 debt issuance costs recorded on the Senior Notes were $7,558 and are reported as a reduction to the long-term debt balance as of September 30, 2021. The net discount and debt issuance costs on the ABL Revolver were $2,144 and are recorded as other assets (current and long term) on the condensed consolidated balance sheet as of September 30, 2021.

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.

11. Income Taxes

During the three months ended September 30, 2021, the Company recognized an income tax expense of $2,887 on pre-tax income of $9,513, compared to income tax expense of $1,402 on pre-tax income of $7,211 for the prior year period. During the nine months ended September 30, 2021, the Company recognized income tax expense of $6,769 on pre-tax income of $22,037, representing an effective income tax rate of 30.7%. For the nine months ended September 30, 2020, the Company recognized an income tax benefit of $2,178 on pre-tax income from continuing operations of $6,696, representing an effective income tax rate of (32.5%).

For the nine months ended September 30, 2021 and 2020, the effective tax rate differs from the U.S. federal statutory income tax rate as follows:


	September 30,
	2021		2020
Tax at federal statutory rate	21.0	%	21.0	%
State taxes, net	6.2		7.4
Valuation allowance	0.0		(18.1)
Permanent items	2.8		7.2
Tax benefit CARES Act	0.0		(54.7)
Other	0.7		4.7
Effective income tax rate	30.7	%	(32.5)	%

During the nine months ended September 30, 2021, the Company received cash income tax refunds of $9,846 related primarily to U.S. federal income taxes for prior tax years, including net operating loss (“NOL”) carrybacks relating to the CARES Act.

In March 2020, the CARES Act was signed into law. The CARES Act allowed companies with NOLs originating in 2018, 2019, or 2020 to carry back those losses for five years and temporarily eliminated the tax law provision that limits the use of NOLs to 80% of taxable income. The CARES Act increased the Internal Revenue Code Section 163(j) interest deduction limit for 2019 and 2020, and allowed for the acceleration of refunds of alternative

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minimum tax credits. For the nine months ended September 30, 2020, the Company recorded an estimated tax benefit for certain provisions in the CARES Act including the carryback of losses and the increase to the interest deduction limitation, resulting in a tax rate benefit of 54.7%.

The Company believes that it is reasonably possible that approximately $208 of its unrecognized tax benefits may be recognized within a year as a result of settlement with the taxing authorities. As such, this balance is reflected in “Accrued Expenses” in the Company’s consolidated balance sheet as of September 30, 2021.

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.

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,
	2021		2020		2021		2020
Numerator:
Net income from continuing operations		6,626		5,809		15,268		8,874
Net loss from discontinued operations		—		—		—		(30)
Net income	$	6,626	$	5,809	$	15,268	$	8,844

Denominator:
Basic weighted-average common shares outstanding		11,238,678		11,230,028		11,234,054		11,228,116
Dilutive shares		560,643		1,793		521,327		6,982
Diluted weighted-average common shares outstanding		11,799,321		11,231,821		11,755,381		11,235,098

Basic earnings per share from continuing operations:		0.59		0.52		1.36		0.79
Basic earnings per share from discontinued operations:		—		—		—		(0.00)
Basic earnings per share:	$	0.59	$	0.52	$	1.36	$	0.79

Diluted earnings per share from continuing operations:		0.56		0.52		1.30		0.79
Diluted earnings per share from discontinued operations:		—		—		—		(0.00)
Diluted earnings per share:		0.56	$	0.52	$	1.30	$	0.79

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-

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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 2022 and 2028 and contain various provisions for rental adjustments and renewals. The leases typically require the Company to pay property taxes, insurance and normal maintenance costs.

Contingencies

In accordance with applicable accounting guidance, the Company establishes an accrued liability 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 liability 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 was served with the complaint and is in the process of preparing an answer. The Company intends to investigate and pursue its rights relating to the claims and 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, 2021.

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, 2021 and December 31, 2020 was $1,228 and $1,696, 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 SG&A. During the nine months ended September 30, 2021, the Company recorded a sales tax benefit of $465 within SG&A for current activity relating to sales tax recovered from customers and net changes to the estimated liability.

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

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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, 2021, there were 970,832 shares of Common Stock available for grant under the Omnibus Plan.

During the nine months ended September 30, 2021, the Company granted 115,659 awards of non-qualified stock options, and during the fiscal year ended December 31, 2020, the Company did not grant any awards of non-qualified stock options. The following is a summary of the activity in outstanding stock options under the Omnibus Plan:


				Weighted-
		Weighted-		Average
		Average		Remaining
		Exercise		Contractual Term
	Options	Price		(in Years)
Outstanding as of December 31, 2020	706,372	$	15.20	6.44
Granted	115,659		29.62	6.98
Exercised	(10,513)		5.25
Forfeited	(19,381)		23.03
Outstanding as of September 30, 2021	792,137	$	17.35	5.65
Options vested and exercisable as of September 30, 2021	676,478	$	15.25	5.42
Options vested and expected to vest as of September 30, 2021	792,137	$	17.35	5.65

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, 2020	45,319	$	1.10
Granted	115,659		17.43
Vested	(45,319)		1.10
Unvested as of September 30, 2021	115,659	$	17.43

Unvested stock options of 115,659 as of September 30, 2021 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, 2021, was

determined using a Black-Scholes option-pricing model with the following weighted-average assumptions:


	Nine Months
	Ended
	September 30
	2021
Expected term in years ⁽¹⁾	4.3
Volatility ⁽²⁾	78.6	%
Risk-free interest rate ⁽³⁾	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, 2020	180,001	$	2.12
Granted	98,622		29.62
Forfeited	(22,485)		2.12
Outstanding as of September 30, 2021	256,138	$	12.71	1.77

The Company granted 98,622 restricted stock units to employees and directors on September 21, 2021, and granted 180,001 restricted stock units to employees on October 2, 2020. The restricted stock unit awards contain conditions associated with continued employment or service. The restricted stock units granted in 2021 are expected to either vest ratably over a two-year period on each anniversary of the grant date or vest entirely on the year-and-a-half anniversary of the grant date. The restricted stock units granted in 2020 are expected to vest on the two-year anniversary of the date of grant. 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, 2021 and 2020 was $116 and $25, respectively. Compensation expense for the Omnibus Plan for the nine months ended September 30, 2021 and 2020 was $214 and $84, respectively. As of September 30, 2021, the total unrecognized compensation expense related to unvested options and restricted stock units is $5,015, which the Company expects to recognize over an estimated weighted-average period of approximately 1.9 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, 2021, 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, including card personalization and fulfilment services, to card-issuing banks primarily in the United States. Products manufactured by this segment primarily include EMV and non-EMV Financial Payment Cards, including contact and contactless dual-interface cards, and plastic and encased metal cards, and our eco-focused solutions including Second Wave payment cards featuring a core made with recovered ocean bound plastic and Earthwise cards made with upcycled plastic. 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 Cards Brands. The Company provides CPI On-Demand

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services, where images, personalized payment cards, and related collateral are produced on a one-by-one, on-demand basis for customers. The Debit and Credit segment facilities are audited for compliance with the standards of the PCI Security Standards Council by multiple Payment Card Brands.

Prepaid Debit Segment

The Prepaid Debit segment primarily provides integrated 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 are audited for compliance with the standards of the PCI Security Standards Council by multiple Payment Card Brands.

Other

The Other segment includes corporate expenses and the loss on debt extinguishment.

Performance Measures of Reportable Segments

Net Sales and EBITDA of the Company’s reportable segments for the three and nine months ended September 30, 2021 and 2020, were as follows:


	Net Sales
	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Debit and Credit	$	76,121	$	62,710	$	218,798	$	180,855
Prepaid Debit		23,498		20,604		63,339		48,680
Intersegment eliminations		(17)		(612)		(224)		(1,486)
Total	$	99,602	$	82,702	$	281,913	$	228,049


	EBITDA
	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Debit and Credit	$	22,356	$	16,993	$	67,078	$	45,073
Prepaid Debit		9,040		8,332		24,719		16,974
Other		(11,130)		(7,836)		(34,955)		(23,757)
Total	$	20,266	$	17,489	$	56,842	$	38,290

The following table provides a reconciliation of total segment EBITDA to net income for the three and nine months ended September 30, 2021 and 2020:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2021		2020		2021		2020
Total segment EBITDA	$	20,266	$	17,489	$	56,842	$	38,290
Interest, net		(7,183)		(6,298)		(23,196)		(19,158)
Income tax (expense) benefit		(2,887)		(1,402)		(6,769)		2,178
Depreciation and amortization		(3,570)		(3,980)		(11,609)		(12,436)
Net loss from discontinued operations		—		—		—		(30)
Net income	$	6,626	$	5,809	$	15,268	$	8,844

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Balance Sheet Data of Reportable Segments

Total assets of the Company’s reportable segments at September 30, 2021 and December 31, 2020, were as follows:


	September 30, 2021		December 31, 2020

Debit and Credit	$	190,534	$	215,846
Prepaid Debit		35,753		34,734
Other		25,988		15,571
Total assets	$	252,275	$	266,151

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, 2021. 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, 2020 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, 2021 (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 “Exchange Act”). The words “believe,” “estimate,” “project,” “expect,” “anticipate,” “plan,” “intend,” “foresee,” “should,” “would,” “could,” “continue,” “committed,” “guides,” “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; a disruption or other failure in our supply chain or labor pool resulting in increased costs and inability to pass those costs on to our customers; our inability to recruit, retain and develop qualified personnel, including key personnel; 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 lack of eligibility to participate in government relief programs related to COVID-19 or inability to realize material benefits from such programs; 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; our limited ability to raise capital in the future; the effects of current or additional U.S. government tariffs as well as economic downturns or disruptions, including delays or interruptions in our ability to source raw materials and components used in our products; 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 the data centers or computing infrastructure on which we rely; failure to comply with regulations, customer contractual requirements and evolving industry standards regarding consumer privacy and data use and security; disruptions in production at one or more of our facilities; our failure to retain our existing customers or identify and attract new customers; 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; problems in production quality, materials and process; a loss of market share or a decline in profitability resulting from competition; our inability to develop, introduce and commercialize new products; 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; 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; failure to meet the continued listing standards of the Nasdaq Global Market; quarterly variation in our operating results; our inability to realize the full value of our long-lived assets; our failure to operate our business in accordance with the Payment Card Industry Security Standards Council security standards or other industry standards; a decline in U.S. and global market and economic conditions and resulting decreases in consumer and business spending; costs relating to product defects and any related product liability and/or warranty claims; our dependence on licensing arrangements; risks associated with international operations; non-compliance with, and changes in, laws in the United States and in foreign jurisdictions in which we

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operate and sell our products and services; the effect of legal and regulatory proceedings; our ability to comply with a wide variety of environmental, health and safety laws and regulations and the exposure to liability for any failure to comply; risks associated with the majority stockholders’ ownership of our stock; the influence of securities analysts over the trading market for and price of our common stock; our inability to sell, exit, reconfigure or consolidate businesses or facilities that no longer meet with our strategy; 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; 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; 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, 2020 filed with the SEC on February 25, 2021, 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 issued on the networks of the “Payment Card Brands” (Visa, Mastercard^®, American Express^® and Discover^® in the United States and Interac in Canada). 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 market through more than 20 years of experience. We serve a diverse set of approximately 2,000 direct customers and several thousand indirect customers, including some of the largest issuers of debit and credit cards in the United States, and the largest Prepaid Debit Card program managers, as well as thousands of independent community banks, credit unions, “Group Service Providers” (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) and card processors.

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 several of the top U.S. Prepaid Debit Card program managers;

●

the U.S. small to mid-sized issuer market, which includes independent community banks, credit unions, and financial technology companies (“FinTechs”); and

●

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

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, and Prepaid Debit, which primarily provides integrated card services to Prepaid Debit Card providers in the United States. Our “Other” segment includes corporate expenses and the loss on debt extinguishment.

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COVID-19 Update

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was signed into law. The CARES Act, among other things, includes 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. Refer to Part I, Item 1, Financial Statements, Note 11, Income Taxesfor a discussion of the CARES Act income tax impacts on the Company. In addition, we deferred employer social security payments in 2020 in accordance with the CARES Act, which are allowed to be paid in two installments in 2021 and 2022. While we are participating in certain programs under the CARES Act, the CARES Act and its guidance are subject to change.

Trends and Key Factors Affecting our Financial Performance

We believe the following key factors may have a meaningful impact on our business performance and 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, 2021, the Company incurred increased employee compensation and recruiting expenses in Cost of Sales and Operating Expenses, which we expect to continue to increase for the fourth quarter of 2021 and beyond as the Company continues to actively recruit additional employees. 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, and may continue to cause, the Company to lose or delay customer opportunities.

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●

Surges in demand for certain raw materials and components, 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 such raw materials and components, increased shipping costs, freight and logistics delays, longer lead times and unpredictability. In particular, shortages of raw materials and components that we use in many of our products is expected to continue for the foreseeable future and may adversely affect our ability to meet customer demand for our products. Although we strive to place orders for materials and components sufficiently in advance, to compile buffer stock to mitigate the impacts of freight and logistics delays and to bolster our access to raw materials and components, it is difficult to predict the ability of our suppliers to continue to fulfill such orders, and it is likely that such delays as well as costs to obtain such raw materials and components will increase for the fourth quarter of 2021 and beyond. Additionally, certain chip manufacturers recently indicated they plan to limit the types of chips that they manufacture, which will affect our ability to continue to provide lower-cost contact chips for certain of our customers. This could cause us and affected customers to migrate programs to more expensive chip options or to contactless cards at a faster pace than expected, which may be costly and 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, we expect these factors will impact profitability for the fourth quarter of 2021 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 in 2022 and beyond.

●

Our Second Wave payment cards feature a core made with recovered ocean-bound plastic (“ROBP”), which we 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 seeking alternative suppliers, but it is uncertain how the current political climate 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, we may be subject to increased shipping and materials costs imposed by such suppliers.

●

As of June 30, 2021, the market capitalization 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 December 31, 2021. As a result, our annual assessment of the effectiveness of our internal control over financial reporting must be audited by our independent registered public accounting firm, and the result of that audit will be included in our next Annual Report on Form 10-K in compliance with the provisions of Section 404 of the Sarbanes-Oxley Act of 2002. Preparations to comply and 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, 2021. We expect these increased costs to continue for the fourth quarter of 2021 and beyond. In connection with our evaluation and testing during the third quarter of 2021, management identified deficiencies that they determined resulted in material weaknesses in internal controls. 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,
	2021		2020		2021		2020

	(dollars in thousands)
Net sales:
Products	$	52,276	$	43,462	$	146,445	$	125,040
Services		47,326		39,240		135,468		103,009
Total net sales		99,602		82,702		281,913		228,049
Cost of sales		61,917		52,095		171,419		148,704
Gross profit		37,685		30,607		110,494		79,345
Operating expenses		20,983		17,125		60,236		53,391
Income from operations		16,702		13,482		50,258		25,954
Other expense, net:
Interest, net		(7,183)		(6,298)		(23,196)		(19,158)
Other income (expense), net		(6)		27		23		(8)
Loss on debt extinguishment		—		—		(5,048)		(92)
Income (loss) before taxes		9,513		7,211		22,037		6,696
Income tax (expense) benefit		(2,887)		(1,402)		(6,769)		2,178
Net income from continuing operations		6,626		5,809		15,268		8,874
Net loss from discontinued operations		—		—		—		(30)
Net income	$	6,626	$	5,809	$	15,268	$	8,844

Note: The Company revised its prior year financial statements to adjust immaterial items, relating to estimated sales tax expense and depreciation expense. Refer to Note 1, Business Overview and Summary of Significant Accounting Policies, for an explanation of the immaterial prior period adjustments.

Segment Discussion

Three Months Ended September 30, 2021 Compared With Three Months Ended September 30, 2020

Net Sales



	Three Months Ended September 30,
	2021		2020		$ Change		% Change


	(dollars in thousands)
Net sales by segment:
Debit and Credit	$	76,121	$	62,710	$	13,411	21.4	%
Prepaid Debit		23,498		20,604		2,894	14.0	%
Eliminations		(17)		(612)		595	*
Total	$	99,602	$	82,702	$	16,900	20.4	%

* Not meaningful

Debit and Credit:

Net sales for Debit and Credit increased $13.4 million, or 21.4%, due primarily to the ongoing transition to contactless cards and new customer growth. Product net sales increased due to higher volumes of contactless cards, including new customer growth, and higher Card@Once instant issuance sales. Additionally, net sales from card personalization services increased due to higher volumes of contactless cards, including new customer growth and higher CPI On-Demand sales. Contactless cards have additional technology to process contactless transactions and

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generally have a higher selling price than contact-only EMV^® cards. Debit and Credit net sales in the prior year third quarter were impacted by lower customer demand than expected, which we believe was primarily attributable to the COVID-19 pandemic.

Prepaid Debit:

Net sales for Prepaid Debit increased $2.9 million, or 14.0%, due primarily to higher volumes from existing customers which included the acquisition of new customer portfolios and the replenishment of inventory by our customers which had been maintained at lower levels in the prior year period due to COVID-19 uncertainties. Prepaid Debit net sales in the prior year third quarter were impacted by lower customer demand than expected, which we believe was primarily attributable to the COVID-19 pandemic.

Eliminations:

This includes the elimination of intercompany sales between segments in the consolidation of our financial statements. The decrease in eliminations is due to lower sales between the segments during the three months ended September 30, 2021 compared to the prior year period.

Gross Profit and Gross Profit Margin


	Three Months Ended September 30,
			% of 2021				% of 2020
	2021		Net Sales		2020		Net Sales		$ Change		% Change

	(dollars in thousands)
Gross profit by segment:
Debit and Credit	$	28,176	37.0	%	$	21,720	34.6	%	$	6,456	29.7	%
Prepaid Debit		9,509	40.5	%		8,887	43.1	%		622	7.0	%
Total	$	37,685	37.8	%	$	30,607	37.0	%	$	7,078	23.1	%

Debit and Credit:

Gross profit for Debit and Credit increased $6.5 million, or 29.7%, driven primarily by the net sales increase described above. The increase in net sales was partially offset by higher labor costs in the current year. Gross profit margin increased to 37.0% during the three months ended September 30, 2021, compared to 34.6% in the prior year period, due primarily to operating leverage from higher net sales, partially offset by labor cost increases.

Prepaid Debit:

Gross profit for Prepaid Debit increased $0.6 million, or 7.0%, due primarily to higher net sales and favorable overhead cost absorption, partially offset by increased labor costs. Gross profit margin for Prepaid Debit decreased to 40.5% compared to 43.1% for the three months ended September 30, 2020 due primarily to increased labor costs as a percentage of sales.

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Operating Expenses



	Three Months Ended September 30,
			% of 2021				% of 2020
	2021		Net Sales		2020		Net Sales		$ Change		% Change

	(dollars in thousands)
Operating expenses by segment:
Debit and Credit	$	7,677	10.1	%	$	6,986	11.1	%	$	691	9.9	%
Prepaid Debit		1,017	4.3	%		1,059	5.1	%		(42)	(4.0)	%
Other		12,289	*	%		9,080	*	%		3,209	35.3	%
Total	$	20,983	21.1	%	$	17,125	20.7	%	$	3,858	22.5	%

Debit and Credit:

Debit and Credit operating expenses increased $0.7 million, or 9.9%, due primarily to increased selling and compensation costs due to strong business performance.

Prepaid Debit:

Prepaid Debit operating expenses were essentially flat and decreased less than $0.1 million, or 4.0%, compared to the prior year period.

Other:

Other operating expenses increased $3.2 million, or 35.3%, due primarily to $1.7 million of compensation expenses including from employee performance incentive compensation due to strong business performance and from additional efforts associated with new compliance requirements, $1.1 million of executive severance charges, and increased professional fees and compliance costs.

Income from Operations and Operating Margin


	Three Months Ended September 30,
			% of 2021				% of 2020
	2021		Net Sales		2020		Net Sales		$ Change		% Change

	(dollars in thousands)
Income from operations by segment:
Debit and Credit	$	20,499	26.9	%	$	14,734	23.5	%	$	5,765	39.1	%
Prepaid Debit		8,492	36.1	%		7,829	38.0	%		663	8.5	%
Other		(12,289)	*	%		(9,081)	*	%		(3,208)	35.3	%
Total	$	16,702	16.8	%	$	13,482	16.3	%	$	3,220	23.9	%
* Not meaningful

Debit and Credit:

Income from operations for Debit and Credit increased $5.8 million, or 39.1%, due primarily to higher net sales and gross profit as described above. Operating margins increased to 26.9% compared to 23.5% for the three months ended September 30, 2020 due to primarily higher net sales and operating leverage.

Prepaid Debit:

Income from operations for Prepaid Debit increased $0.7 million, or 8.5%, primarily due to higher net sales and gross profit. Operating income margin for the three months ended September 30, 2021 decreased to 36.1% from 38.0% for the same period in 2020, due primarily to increased labor costs as a percentage of sales.

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Other:

The loss from operations in Other increased $3.2 million, or 35.3%, primarily due to an increase in compensation expenses including from employee performance incentive compensation due to strong business performance and from compliance requirements, executive severance charges, and increased professional fees and compliance costs.

Interest, net:

Interest expense for the three months ended September 30, 2021 increased to $7.2 million compared to $6.3 million for the three months ended September 30, 2020. Interest expense was higher in the third quarter of 2021 primarily due to higher interest rates on the Senior Notes issued in 2021, compared to the interest rates on the debt facilities in the prior year period. This increase was partially offset by less debt principal outstanding in the current year period compared to the prior year period, and from interest income received of approximately $0.2 million in 2021 related to income tax refunds.

Income tax (expense) benefit:

During the three months ended September 30, 2021, we recorded an income tax expense of $2.9 million on pre-tax income of $9.5 million, representing an effective income tax rate of 30.3%. During the three months ended September 30, 2020, we recorded an income tax expense of $1.4 million on pre-tax income of $7.2 million, representing an effective income tax rate of 19.4%. For the quarter ended September 30, 2021, the effective tax rate differs from the federal U.S. statutory rate of 21.0% primarily due to the impact of state taxes and permanent items. For the quarter ended September 30, 2020, the effective income tax rate differs from the federal U.S. statutory rate of 21.0% primarily due to the reduction of a partial valuation allowance for the limitation on the deductibility of interest expense, offset by permanent items and state taxes.

Net income:

During the three months ended September 30, 2021, net income was $6.6 million, compared to net income of $5.8 million during the three months ended September 30, 2020. The increase was primarily due to higher net sales and gross profit, partially offset by higher operating expenses, income tax expense and interest expense during the three months ended September 30, 2021, compared to the prior year period.

Nine Months Ended September 30, 2021 Compared With Nine Months Ended September 30, 2020

Net Sales


	Nine Months Ended September 30,
	2021		2020		$ Change		% Change

	(dollars in thousands)
Net sales by segment:
Debit and Credit	$	218,798	$	180,855	$	37,943	21.0	%
Prepaid Debit		63,339		48,680		14,659	30.1	%
Eliminations		(224)		(1,486)		1,262	*	%
Total	$	281,913	$	228,049	$	53,864	23.6	%

Debit and Credit:

Net sales for Debit and Credit increased $37.9 million, or 21.0%, due primarily to new customer growth and the ongoing transition to contactless cards. Product net sales increased due to higher volumes of contactless cards, including new customer growth, and higher Card@Once instant issuance sales. Additionally, net sales from card personalization services increased due to higher volumes of contactless cards, including new customer growth and higher CPI On-Demand sales. Contactless cards have additional technology to process contactless transactions and generally have a

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higher selling price than contact-only EMV^® cards. Debit and Credit net sales in the prior year period were impacted by lower customer demand than expected, which we believe was primarily attributable to the COVID-19 pandemic.

Prepaid Debit:

Net sales for Prepaid Debit increased $14.7 million, or 30.1%, due primarily to higher volumes from existing customers which included the acquisition of new customer portfolios and the replenishment of inventory by our customers which had been maintained at lower levels in the prior year period due to COVID-19 uncertainties. Prepaid Debit net sales in the prior year period were impacted by lower customer demand than expected, which we believe was primarily attributable to the COVID-19 pandemic.

Eliminations:

This includes the elimination of intercompany sales between segments in the consolidation of our financial statements. The decrease in eliminations is due to lower sales between the segments during the nine months ended September 30, 2021 compared to the prior year period.

Gross Profit and Gross Profit Margin


	Nine Months Ended September 30,
			% of 2021				% of 2020
	2021		Net Sales		2020		Net Sales		$ Change		% Change

	(dollars in thousands)
Gross profit by segment:
Debit and Credit	$	83,988	38.4	%	$	60,681	33.6	%	$	23,307	38.4	%
Prepaid Debit		26,506	41.8	%		18,664	38.3	%		7,842	42.0	%
Total	$	110,494	39.2	%	$	79,345	34.8	%	$	31,149	39.3	%

Debit and Credit:

Gross profit for Debit and Credit increased $23.3 million, or 38.4%, driven primarily by the net sales increase as described above. Gross profit margin increased to 38.4% during the nine months ended September 30, 2021, compared to 33.6% in the prior year period, due primarily to operating leverage from higher net sales.

Prepaid Debit:

Gross profit for Prepaid Debit increased $7.8 million, or 42.0% and Gross profit margin for Prepaid Debit for the nine months ended September 30, 2021 increased to 41.8% compared to 38.3% for the nine months ended September 30, 2020. The increase in gross profit and margin was primarily attributed to higher net sales and favorable overhead cost absorption, partially offset by increased labor costs.

Operating Expenses, net


	Nine Months Ended September 30,
			% of 2021				% of 2020
	2021		Net Sales		2020		Net Sales		$ Change		% Change

Operating expenses by segment:	(dollars in thousands)
Debit and Credit	$	23,077	10.5	%	$	22,767	12.6	%	$	310	1.4	%
Prepaid Debit		3,446	5.4	%		3,286	6.8	%		160	4.9	%
Other		33,713	*	%		27,338	*	%		6,375	23.3	%
Total	$	60,236	21.4	%	$	53,391	23.4	%	$	6,845	12.8	%

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Debit and Credit:

Debit and Credit operating expenses increased $0.3 million, or 1.4%, primarily due to increased selling and compensation costs due to strong business performance, partially offset by a benefit recorded in 2021 relating to estimated sales taxes, which is further described in Item 1 - Financial Statements, Note 14, Commitments and Contingencies.

Prepaid Debit:

Prepaid Debit operating expenses increased $0.2 million, or 4.9%, due primarily to increased selling and compensation costs due to strong business performance in the current year period.

Other:

Other operating expenses increased $6.4 million, or 23.3%, due primarily to $3.7 million of compensation expenses including from employee performance incentive compensation due to strong business performance and from additional efforts associated with new compliance requirements, $1.1 million of executive severance charges, $0.9 million of increased healthcare expenses, and increased professional fees and compliance costs.

Income from Operations and Operating Margin


	Nine Months Ended September 30,
			% of 2021				% of 2020
	2021		Net Sales		2020		Net Sales		$ Change		% Change

	(dollars in thousands)
Income (loss) from operations by segment:
Debit and Credit	$	60,911	27.8	%	$	37,914	21.0	%	$	22,997	60.7	%
Prepaid Debit		23,060	36.4	%		15,379	31.6	%		7,681	49.9	%
Other		(33,713)	*	%		(27,339)	*	%		(6,374)	23.3	%
Total	$	50,258	17.8	%	$	25,954	11.4	%	$	24,304	93.6	%

Debit and Credit:

Income from operations for Debit and Credit increased $23.0 million, or 60.7%, driven primarily by higher net sales and gross profit as described above. Operating margins for the nine months ended September 30, 2021 increased to 27.8% compared to 21.0% for the nine months ended September 30, 2020, due to the higher net sales and operating leverage.

Prepaid Debit:

Income from operations for Prepaid Debit increased $7.7 million, or 49.9% due primarily to higher net sales and gross margin as described above. Operating income margin for the nine months ended September 30, 2021 increased to 36.4% from 31.6% for the same period in 2020, due to higher net sales and favorable overhead cost absorption, partially offset by increased labor costs.

Other:

The loss from operations in Other increased $6.4 million, or 23.3%, primarily due to an increase in operating expenses from employee performance incentive compensation, other compensation expenses and compliance costs, healthcare expenses and executive severance charges.

Interest, net:

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Interest expense for the nine months ended September 30, 2021 increased to $23.2 million compared to $19.2 million for the nine months ended September 30, 2020. Interest expense was higher in 2021 primarily due to $2.6 million of “make-whole” premium interest expense incurred a result of the termination of our Senior Credit Facility on March 15, 2021, as well higher interest rates on the Senior Notes issued in 2021, compared to the interest rates on the debt facilities in the prior year period. This increase was partially offset by less debt principal outstanding in the current year period compared to the prior year, and from interest income received of approximately $0.4 million in 2021 related to income tax refunds.

Loss on debt extinguishment:

During the nine months ended September 30, 2021, we recorded a $5.0 million loss on debt extinguishment relating to the termination of our 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 new Senior Notes and entrance into the new ABL Revolver on March 15, 2021.

Income tax (expense) benefit:

During the nine months ended September 30, 2021, we recorded an income tax expense of $6.8 million on pre-tax income of $22.0 million, representing an effective income tax rate of 30.7%. During the nine months ended September 30, 2020, we recorded an income tax benefit of $2.2 million on pre-tax income of $6.7 million, representing an effective income tax rate of (32.5%). The effective income tax rate differs from the federal U.S. statutory rate in 2021 primarily due to the impact of state taxes and permanent items. In the prior year period, the effective income tax rate differs from the federal U.S. statutory rate primarily due to the impact of the CARES Act which was signed into law in March 2020 and due to the reduction of a partial valuation allowance for the limitation on the deductibility of interest expense.

Net income:

During the nine months ended September 30, 2021, net income was $15.3 million, compared to $8.8 million during the nine months ended September 30, 2020. The increase was primarily due to higher net sales and gross profit, partially offset by higher operating expenses, the loss on debt extinguishment, and higher interest expense and income tax expense during the nine months ended September 30, 2021 compared to the prior year period.

Liquidity and Capital Resources

At September 30, 2021, we had $20.9 million of cash and cash equivalents. Of this amount, $0.3 million was held in accounts outside of the United States.

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 15, 2021, we completed a private offering of $310 million aggregate principal amount of 8.625% senior secured notes due 2026 (the “Senior Notes”) and related guarantees at an issue price of 100%. In addition, we entered into a credit agreement with Wells Fargo Bank, National Association, as lender, administrative agent and collateral agent, providing for an ABL revolver of up to $50 million (the “ABL Revolver”), subject to a borrowing base.

In connection with the issuance of the Senior Notes and entrance into the ABL Revolver, we terminated our existing credit facilities, consisting of a $30 million senior credit agreement (the “Senior Credit Facility”), and a $435 million first lien term loan (the “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 September 30, 2021, the Company had $310 million aggregate principal amount outstanding on the Senior Notes, plus accrued and unpaid interest. As of September

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30, 2021, the Company had no borrowings outstanding and $50 million available for borrowing under the ABL Revolver.

While not impacting the third quarter ended September 30, 2021, the ABL Revolver includes limitations on our ability to borrow in certain situations, including during periods in which the amount available to borrow under the ABL Revolver is less than $5 million. Commencing with the month immediately following a date on which borrowing availability is below $5 million until such time that borrowing availability equals or exceeds $5 million for 30 consecutive days, in order to borrow under the ABL Revolver, we must maintain a fixed charge coverage ratio (as defined in the credit agreement for the ABL Revolver) of at least 1.00 to 1.00, calculated for the trailing 12 months, tested monthly during such period. Borrowings under the ABL Revolver are also subject to limitations based on the borrowing base.

The Senior Notes and the ABL Revolver also contain covenants limiting the ability of the Company, the borrower and the Company’s restricted subsidiaries to, among other things, incur or guarantee additional indebtedness or issue disqualified stock or certain preferred stock; create or incur liens; pay dividends, redeem stock or make other distributions; make certain investments; 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 the agreement, with any required payments to be made after the issuance of the Company’s annual financial statements.

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, beginning on September 15, 2021. 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. Borrowings under the ABL Revolver bear interest at a rate per annum that ranges from the LIBOR Rate plus 1.25% to the LIBOR Rate plus 1.75%, or the Base Rate plus 0.25% to the Base Rate plus 0.75%, based on the average daily borrowing capacity under the ABL Revolver over the most recently completed month. The borrower may elect to apply either the LIBOR Rate or Base Rate interest to borrowings at its discretion. 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 the immediately preceding month.

Operating Activities

Cash provided by operating activities for the nine months ended September 30, 2021 was $14.5 million compared to cash provided by operating activities of $10.2 million during the nine months ended September 30, 2020. The year over year increase was due primarily to higher net income and profitability, and working capital cash improvements including the collection of $9.8 million of income tax refunds during the nine months ended September 30, 2021. These increases were partially offset by cash used in operating activities to increase inventory, including EMV dual interface chips to support our business, and to maintain certain levels of inventory to help alleviate supply chain constraints.

Investing Activities

Cash used in investing activities for the nine months ended September 30, 2021 was $4.7 million, compared to a usage of $3.3 million during the nine months ended September 30, 2020. 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 $0.5 million during the nine months ended September 30, 2021, compared to $1.6 million during the prior year period.

Financing Activities

During the nine months ended September 30, 2021, cash used in financing activities was $46.6 million. Proceeds from the new Senior Notes and ABL Revolver, net of discount, were $310 million and $14.8 million,

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respectively. We used proceeds from the Senior Notes and ABL Revolver, plus cash on hand from our balance sheet, to pay in full and terminate the Senior Credit Facility balance of $30 million and the First Lien Term Loan balance of $304.7 million on March 15, 2021. During the nine months ended September 30, 2021, 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. During the nine months ended September 30, 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.

During the second quarter of 2021 we used $15 million of cash on hand to pay down the ABL Revolver to zero and had no borrowings outstanding thereunder as of September 30, 2021.

During the nine months ended September 30, 2020, we entered into the Senior Credit Facility which provided $29.1 million of cash, net of discount, partially offset by $2.5 million of associated debt issuance costs. We also paid $1.7 million and $1.8 million of principal on finance leases during the nine months ended September 30, 2021 and 2020, respectively.

Off-Balance Sheet Arrangements

We had no material off-balance sheet arrangements at September 30, 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 filed for the year ended December 31, 2020, for which there were no material changes as of September 30, 2021, included:

●

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

●

Income taxes, including valuation allowances and uncertain tax positions, and

●

Sales tax, including an estimated contingent liability.

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

We are required to maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to assure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15(b) and 15d-15(b). Based on this evaluation, and due to the material weaknesses in internal control over financial reporting described below, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of September 30, 2021 were not effective. As a result of that conclusion, our management re-evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2020 and, based on this re-evaluation, and due to the material weaknesses in internal control over financial reporting described below, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of December 31, 2020.

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principally relating to the review and authorization of certain transactions within portions of our purchasing and revenue processes. Management determined these deficiencies resulted in material weaknesses in internal control over financial reporting. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements would not be prevented or detected on a timely basis. As of the date of this report, we have not identified any financial statement misstatements as a result of these control deficiencies.

We are in the process of enhancing our internal controls in the aforementioned areas to remediate the material weaknesses. We are assessing and revising the controls over user access privileges to focus on determining that appropriate authorities and responsibilities are assigned to all individuals. In addition, management is continuing to develop the design and implementation of internal controls to require appropriate reviews as well as retain documentation of those reviews with regards to our purchasing and revenue processes.

The Company determined the above deficiencies were primarily due to an inadequate complement of personnel with requisite experience in internal control process design and documentation requirements, and therefore we intend to implement training programs and hire additional resources with the appropriate skills and knowledge to address these internal control deficiencies. We continuously evaluate the effectiveness of our internal control over financial reporting and may implement changes or additional remediation efforts if additional deficiencies or material weaknesses are discovered.

Changes in Internal Control over Financial Reporting

Except for the changes relating to the material weaknesses discussed above, there have been no other changes in the Company’s internal control over financial reporting that occurred during the third quarter of 2021 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – Other Information

Item 1. Legal Proceedings

Smart Packaging Solutions SA v. CPI Card Group Inc.

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 our business, financial condition or results of operations.

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, 2020 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.

Our transition to being an accelerated filer and compliance with Section 404 of the Sarbanes-Oxley Act of 2002 will be time consuming and costly, and because we have identified material weaknesses in our internal control over

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financial reporting, our inability to maintain effective internal controls could result in investors losing confidence in the accuracy and completeness of our financial reports or our inability to accurately or timely produce our financial reports, any of which could negatively affect the market price of our common stock, perhaps significantly.

As a public company, we are required to maintain internal control over financial reporting and to report any material weaknesses in such internal controls. Because we will become an accelerated filer effective December 31, 2021, Section 404 of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) requires our independent registered public accounting firm to attest to the effectiveness of our internal control over financial reporting. Our transition to becoming subject to additional requirements of Section 404 of the Sarbanes-Oxley Act has been and will continue to be time-consuming. Further, the costs associated with the compliance with and implementation of procedures under these and future laws and related rules could have a material impact on our results of operations.

In connection with our evaluation and testing of controls during the third quarter of 2021, our management identified deficiencies in our general information technology controls which were not designed to restrict users’ access privileges to their appropriate authorities and responsibilities. We also identified deficiencies principally relating to the review and authorization of certain transactions within portions of our purchasing and revenue processes. Management determined these deficiencies resulted in material weaknesses in internal control over financial reporting.

We are in the process of enhancing our internal controls in the aforementioned areas to remediate the material weaknesses. However, we can give no assurance that these measures will be sufficient to remediate the material weaknesses, that additional material weaknesses or significant deficiencies in our internal controls will not be identified in the future or that we will otherwise be able to establish and maintain an effective system of internal controls. As a result of the material weaknesses in our internal control over financial reporting, we may not detect errors on a timely basis, our financial statements may be materially misstated, investors may lose confidence in the accuracy and completeness of our financial reports and we may be unable to timely produce our financial reports. Any of the foregoing could negatively affect the market price of our common stock, perhaps significantly. In addition, we could become subject to investigations by any stock exchange on which our securities are listed, the SEC or other regulatory authorities, or litigation or disputes with stockholders, which could require additional financial and management resources and result in more costly directors’ and officers’ insurance, which could have an adverse impact on our business.

The failure to effectively recruit, retain and develop qualified personnel and implement effective succession processes could adversely affect our success and could have a material adverse effect on our business, financial condition and results of operations.

Our business functions are complex and require wide-ranging expertise and intellectual capital. If we fail to recruit, retain and develop personnel who can provide the needed expertise across the entire spectrum of our intellectual capital needs, then the ability of our business to successfully compete and grow may be adversely affected. In addition, the loss of key personnel without adequate succession plans in place may cause a failure to maintain continuity in key business functions. The market for qualified personnel is highly competitive, particularly in the states in which our operations are concentrated, and we have experienced labor availability issues in several of our facilities. This shortage of labor has resulted, and may continue to result, in increased compensation and recruiting expenses, which could have a material adverse effect on our profitability, particularly if we are unable to pass all of such expenses on to our customers. We may not succeed in recruiting sufficient personnel to support our production needs or may fail to effectively replace current personnel who depart with qualified or effective successors. Personnel shortages have resulted, and may continue to result, in extended production lead times and difficulty in meeting customers’ delivery expectations, which could result in the loss of customers and damage to our reputation and have a material adverse effect on our business, financial condition and results of operations.

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Item 6. Exhibits

Exhibit Number		Exhibit Description
3.1		Certificate of Amendment of the Third Amended and Restated Certificate of Incorporation of CPI Card Group Inc. (incorporated by reference to the Company’s Registration Statement on Form S-3 (File No. 333-259511)).
10.1		Form of Executive Nonqualified Stock Option Agreement under the CPI Card Group Inc. Omnibus Incentive Plan.
10.2		Form of Executive Restricted Stock Unit Agreement under the CPI Card Group Inc. Omnibus Incentive Plan.
10.3		Form of Director Restricted Stock Unit Agreement under the CPI Card Group Inc. Omnibus Incentive Plan.
10.4		Offer Letter, dated October 1, 2021 by and between CPI Card Group Inc. and Amintore Schenkel.
10.5		Offer Letter, dated October 1, 2021 by and between CPI Card Group Inc. and John Lowe.
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 5, 2021	/s/ Amintore Schenkel
	Amintore Schenkel
	Chief Financial Officer
	(Principal Financial Officer)