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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 28, 2003
-------------------------------------------------
OR
[ ] 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 1-11257
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Checkpoint Systems, Inc.
- ----------------------------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Pennsylvania 22-1895850
-------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
101 Wolf Drive, P.O. Box 188, Thorofare, New Jersey 08086
- ----------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(856) 848-1800
---------------------------------------------------------------------------
(Registrant's telephone number, including area code)
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 X No
-- --
Indicate by check mark whether the Registrant is an accelerated filer, (as
defined in Rule 12b-2 of the Act).
Yes X No
-- --
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of October 20, 2003, there were 32,888,810 shares of the Common Stock
outstanding.
CHECKPOINT SYSTEMS, INC.
FORM 10-Q
INDEX
Page No.
--------
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statement of Shareholders' Equity 5
Consolidated Statements of Comprehensive
Income/(Loss) 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7-19
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 20-28
Item 3. Quantitative and Qualitative Disclosures
about Market Risk 28
Item 4. Controls and Procedures 28
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 29-31
Item 6. Exhibits and Reports on Form 8-K 32
SIGNATURES 33
INDEX TO EXHIBITS 34
CHECKPOINT SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
Sept. 28, Dec. 29,
2003 2002
-------- --------
(Unaudited)
ASSETS (Thousands)
CURRENT ASSETS
Cash and cash equivalents $ 47,157 $ 54,670
Accounts receivable, net of allowances
of $14,166 and $14,420 140,808 130,667
Inventories 87,530 80,152
Other current assets 32,557 22,051
Deferred income taxes 10,351 10,326
-------- --------
Total current assets 318,403 297,866
REVENUE EQUIPMENT ON OPERATING LEASE, net 4,155 4,895
PROPERTY, PLANT, AND EQUIPMENT, net 100,983 100,173
GOODWILL 199,540 185,758
OTHER INTANGIBLES, net 52,305 51,611
OTHER ASSETS 37,746 38,079
-------- --------
TOTAL ASSETS $713,132 $678,382
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Short-term borrowings and current
portion of long-term debt $ 20,299 $ 20,512
Accounts payable 43,920 47,418
Accrued compensation and related taxes 26,949 25,701
Other accrued expenses 32,106 27,969
Income taxes 20,061 17,860
Unearned revenues 31,184 28,493
Restructuring reserve 4,187 5,600
Other current liabilities 12,882 13,126
-------- --------
Total current liabilities 191,588 186,679
LONG-TERM DEBT, LESS CURRENT MATURITIES 44,497 68,813
CONVERTIBLE SUBORDINATED DEBENTURES 120,000 120,000
ACCRUED PENSIONS 60,650 54,006
OTHER LONG-TERM LIABILITIES 10,825 10,608
DEFERRED INCOME TAXES 14,119 12,189
MINORITY INTEREST 954 841
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Preferred stock, no par value, authorized
500,000 shares, none issued
Common Stock, par value $.10 per share, 3,924 3,904
authorized 100,000,000 shares, issued
39,240,650 and 39,039,506
Additional capital 265,400 263,386
Retained earnings 92,896 67,811
Common stock in treasury, at cost,
6,356,190 shares (64,379) (64,379)
Accumulated other comprehensive loss (27,342) (45,476)
-------- --------
TOTAL SHAREHOLDERS' EQUITY 270,499 225,246
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $713,132 $678,382
======== ========
See accompanying notes to consolidated financial statements.
CHECKPOINT SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Quarter Nine Months
(13 weeks) Ended (39 weeks) Ended
--------------------- --------------------
Sept. 28, Sept. 29, Sept. 28, Sept. 29,
2003 2002 2003 2002
-------- -------- -------- --------
(Thousands, except per share data)
Net revenues $177,229 $158,800 $509,366 $463,178
Cost of revenues 104,039 93,187 297,416 272,051
-------- -------- -------- --------
Gross profit 73,190 65,613 211,950 191,127
Selling, general, and
administrative expenses 56,118 53,337 167,638 157,136
Other operating income - 904 - 904
-------- -------- -------- --------
Operating income 17,072 13,180 44,312 34,895
Interest income 307 444 1,031 1,313
Interest expense 2,632 3,836 8,603 11,463
Other gain/(loss), net 271 (366) 810 (466)
-------- -------- -------- --------
Earnings before income taxes 15,018 9,422 37,550 24,279
Income taxes 4,956 3,015 12,391 7,769
Minority interest 40 33 74 55
-------- -------- -------- --------
Earnings before cumulative
effect of change in
accounting principle 10,022 6,374 25,085 16,455
Cumulative effect of change
in accounting principle - - - (72,861)
-------- -------- -------- --------
Net earnings/(loss) $ 10,022 $ 6,374 $ 25,085 $(56,406)
======== ======== ======== ========
Earnings per share before
cumulative effect of change
in accounting principle:
Basic $ .31 $ .20 $ .77 $ .51
======== ======== ======== ========
Diluted $ .27 $ .19 $ .70 $ .49
======== ======== ======== ========
Net earnings/(loss) per
share:
Basic $ .31 $ .20 $ .77 $ (1.75)
======== ======== ======== ========
Diluted $ .27 $ .19 $ .70 $ (1.36)
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
CHECKPOINT SYSTEMS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(Unaudited)
Nine Months (39 weeks) Ended September 28, 2003
------------------------------------------------------
Accumu-
lated
Other
Addit- Compre-
Common ional Retained hensive Treasury
Stock Capital Earnings Loss Stock Total
------ ------- -------- ------- -------- -----
(Thousands)
Balance,
December 29, 2002 $3,904 $263,386 $67,811 $(45,476) $(64,379) $225,246
(Common shares:
issued 39,039,506
reacquired 6,356,190)
Net earnings 25,085 25,085
Exercise of stock
options 20 2,014 2,034
(201,144 shares)
Net loss on interest
rate swap 9 9
Foreign currency
translation adjustment 18,125 18,125
------ -------- ------- -------- -------- --------
Balance,
September 28, 2003 $3,924 $265,400 $92,896 $(27,342) $(64,379) $270,499
====== ======== ======= ======== ======== ========
(Common shares:
issued 39,240,650
reacquired 6,356,190)
See accompanying notes to consolidated financial statements.
CHECKPOINT SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)
(Unaudited)
Quarter Nine Months
(13 weeks) Ended (39 weeks) Ended
--------------------- --------------------
Sept. 28, Sept. 29, Sept. 28, Sept. 29,
2003 2002 2003 2002
-------- -------- -------- --------
(Thousands)
Net earnings/(loss) $ 10,022 $ 6,374 $ 25,085 $(56,406)
Net gain/(loss) on interest
rate swap, net of tax 70 (473) 6 (684)
Foreign currency
translation adjustment 1,857 (5,171) 18,125 15,323
-------- -------- -------- --------
Comprehensive income/(loss) $ 11,949 $ 730 $ 43,216 $(41,767)
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
CHECKPOINT SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months (39 weeks) Ended
----------------------------
Sept. 28, Sept. 29,
2003 2002
-------- --------
(Thousands)
Cash flows from operating activities:
Net earnings/(loss) $ 25,085 $(56,406)
Adjustments to reconcile net earnings
to net cash provided by operating activities:
Cumulative effect of change in accounting
principle, net of tax - 72,861
Revenue equipment under operating lease (1,340) (958)
Long-term customer contracts 169 1,792
Depreciation and amortization 22,358 23,636
(Gain)/loss on disposal of fixed assets (195) -
(Increase)/decrease in current assets, net
of the effects of acquired companies:
Accounts receivable (1,480) 15,036
Inventories (2,135) 8,572
Other current assets (9,084) (134)
Increase/(decrease) in current liabilities,
net of the effects of acquired companies:
Accounts payable (5,809) (5,135)
Income taxes 406 (2,555)
Unearned revenues 1,185 6,441
Restructuring reserve (1,659) (9,661)
Other current and accrued liabilities 952 5,344
-------- --------
Net cash provided by operating activities $ 28,453 $ 58,833
-------- --------
Cash flows from investing activities:
Acquisition of property, plant, and equipment (9,991) (4,559)
Acquisitions, net of cash acquired - (681)
Other investing activities 590 1,029
-------- --------
Net cash used in investing activities $ (9,401) $ (4,211)
-------- --------
Cash flows from financing activities:
Proceeds from stock issuances 1,869 7,019
Net change in short-term debt 1,983 754
Payment of long-term debt (33,126) (68,177)
-------- --------
Net cash used in financing activities $(29,274) $(60,404)
-------- --------
Effect of foreign currency rate fluctuations
on cash and cash equivalents 2,709 1,710
-------- --------
Net (decrease)/increase in cash and cash
equivalents $ (7,513) $ (4,072)
Cash and cash equivalents:
Beginning of period 54,670 43,698
-------- --------
End of period $ 47,157 $ 39,626
======== ========
See accompanying notes to consolidated financial statements.
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF ACCOUNTING
The consolidated financial statements include the accounts of Checkpoint
Systems, Inc. and its majority-owned subsidiaries ("Company"). All
inter-company transactions are eliminated in consolidation. The consolidated
financial statements and related notes are unaudited and do not contain all
disclosures required by generally accepted accounting principles in annual
financial statements. Refer to the Company's Annual Report on Form 10-K for the
fiscal year ended December 29, 2002 for the most recent disclosure of the
Company's accounting policies.
The consolidated financial statements include all adjustments, consisting only
of normal recurring adjustments, necessary to present fairly the Company's
financial position at September 28, 2003 and December 29, 2002 and its results
of operations and changes in cash flows for the thirteen and thirty-nine week
periods ended September 28, 2003 and September 29, 2002.
Certain reclassifications have been made to the 2002 financial statements and
related footnotes to conform to the 2003 presentation.
2. INVENTORIES
September 28, December 29,
2003 2002
------------ -----------
(Thousands)
Raw materials $ 8,998 $ 8,184
Work in process 4,688 3,387
Finished goods 73,844 68,581
-------- --------
$ 87,530 $ 80,152
======== ========
Inventories are stated at the lower of cost (first-in, first-out method) or
market.
3. GOODWILL AND OTHER INTANGIBLE ASSETS
The Company had intangible assets with a net book value of $52.3 million and
$51.6 million as of September 28, 2003 and December 29, 2002, respectively. The
following table reflects the components of intangible assets as of September 28,
2003 and December 29, 2002:
September 28, 2003 December 29, 2002
---------------------- ----------------------
Amortizable Gross Gross
Life Carrying Accumulated Carrying Accumulated
(years) Amount Amortization Amount Amortization
----------- -------- ------------ -------- ------------
(Thousands)
Customer lists 20 $28,761 $13,236 $26,363 $10,544
Trade name 30 26,387 3,298 24,405 2,440
Patents, license
agreements 5 to 14 34,959 21,785 32,364 19,095
Other 3 to 6 810 293 778 220
------- ------- ------- -------
$90,917 $38,612 $83,910 $32,299
======= ======= ======= =======
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The Company has determined that the life previously assigned to these
finite-lived assets is still appropriate, and has recorded $3.6 million and $3.9
million of amortization expense in the first nine months of fiscal 2003 and
2002, respectively.
Estimated amortization expense for 2003 and each of the five succeeding years
is:
(Thousands)
2003 $4,808
2004 $4,536
2005 $3,987
2006 $3,312
2007 $3,296
2008 $3,281
The changes in the carrying amount of goodwill for the nine months ended
September 28, 2003, are as follows:
Labeling Retail
Security Services Merchandising Total
-------- -------- ------------- -------
(Thousands)
Balance as of
beginning of
fiscal year 2003
(December 30, 2002) $91,072 $36,895 $57,791 $185,758
Foreign currency
translation adjustment 7,771 795 5,216 13,782
------- ------- ------- --------
Balance as of
September 28, 2003 $98,843 $37,690 $63,007 $199,540
======= ======= ======= ========
Pursuant to SFAS 142, the Company will perform its annual assessment of goodwill
by comparing each individual reporting unit's carrying amount of net assets,
including goodwill, to their fair value during the fourth quarter of each fiscal
year. Future annual assessments could result in impairment charges, which would
be accounted for as an operating expense.
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
4. LONG-TERM DEBT
Long-term debt at September 28, 2003 and December 29, 2002 consisted of the
following:
September 28, December 29,
2003 2002
------------ -----------
(Thousands)
Six and one-half year EUR 244 million
variable interest rate collateralized
term loan maturing in 2006 $ 46,148 $ 64,447
Six and one-half year $25 million
variable interest rate
collateralized term loan maturing in
2006 - 7,882
Six and one-half year $100 million
multi-currency variable interest
rate collateralized revolving
credit facility maturing in 2006 2,687 2,502
Twenty-two and one-half year
EUR 9.5 million capital lease
maturing in 2021 9,967 9,267
Eight and one-half year
EUR 2.7 million capital lease
maturing in 2007 1,657 1,757
Other capital leases with maturities
through 2004 38 1,385
-------- --------
Total 60,497 87,240
Less current portion (16,000) (18,427)
-------- --------
Total long-term portion (excluding
convertible subordinated debentures) 44,497 68,813
Convertible subordinated debentures 120,000 120,000
-------- --------
Total long-term portion $164,497 $188,813
======== ========
During the third quarter 2003, an unscheduled repayment of $2.0 million was made
on the $25 million collateralized term loan to fully satisfy the outstanding
balance. At September 28, 2003, EUR 40.3 million (approximately $46.1 million)
was outstanding under the multi-currency term loan. The outstanding borrowings
under the revolving credit facility were JPY 300 million (approximately $2.7
million). The availability under the $100 million multi-currency revolving
credit facility has been reduced by letters of credit totaling $12.3 million,
primarily related to the surety bond posted in connection with ID Security
Systems Canada Inc. litigation.
The Company has called $35.0 million of the convertible subordinated debentures
for redemption on November 8, 2003. The called debentures are convertible at any
time prior to the close of business on November 3, 2003. Each Note in the
denomination of $1,000 is convertible, at the holder's option, into 54.4218
shares of the Company's common stock, which is equivalent to a conversion price
of $18.375 per share.
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
5. INCOME TAXES
Income taxes are provided for on an interim basis at an estimated effective
annual tax rate. The Company's net earnings generated by the operations of its
Puerto Rico subsidiary are exempt from Federal income taxes under Section 936 of
the Internal Revenue Code (as amended under the Small Business Job Protection
Act of 1996) and substantially exempt from Puerto Rico income taxes. Under
current law, this exemption from Federal income tax is subject to certain limits
during the years 2002 through 2005 and will be eliminated thereafter. The
Company's exemption was not negatively impacted in 2002. The Company does not
expect its exemption to be negatively impacted in the years 2003 through 2005.
Under Statement of Financial Accounting Standards No. 109 (SFAS 109),
"Accounting for Income Taxes", deferred tax liabilities and assets are
determined based on the difference between financial statement and tax basis of
assets and liabilities using enacted statutory tax rates in effect at the
balance sheet date.
6. PER SHARE DATA
The following data shows the amounts used in computing earnings per share and
the effect on income and the weighted average number of shares of dilutive
potential common stock:
Quarter Nine Months
(13 weeks) Ended (39 weeks) Ended
-------------------- --------------------
Sept. 28, Sept. 29, Sept. 28, Sept. 29,
2003 2002 2003 2002
-------- -------- -------- --------
(Thousands, except per share amounts)
Basic earnings/(loss)
per share:
Earnings before cumulative
effect of change in
accounting principle $ 10,022 $ 6,374 $ 25,085 $ 16,455
Cumulative effect of change
in accounting principle - - - (72,861)(2)
-------- -------- -------- --------
Net earnings/(loss) $ 10,022 $ 6,374 $ 25,085 $(56,406)
======== ======== ======== ========
Weighted average common
stock outstanding 32,847 32,403 32,777 32,193
======== ======== ======== ========
Basic earnings per share
before cumulative effect
of change in accounting
principle $ .31 $ .20 $ .77 $ .51
Cumulative effect of
change in accounting
principle - - - (2.26)
-------- -------- -------- --------
Basic earnings/(loss)
per share $ .31 $ .20 $ .77 $ (1.75)
======== ======== ======== ========
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Diluted earnings/(loss) per share:
Earnings before cumulative
effect of change in
accounting principle $ 10,022 $ 6,374 $ 25,085 $ 16,455
Interest on subordinated
debentures, net of tax 961 961 2,882 2,882
-------- -------- -------- --------
Net earnings before
cumulative effect of change
in accounting principle
available for dilutive
securities 10,983 7,335 27,967 19,337
Cumulative effect of change
in accounting principle - - - (72,861)(2)
-------- -------- -------- --------
Net earnings/(loss) after
cumulative effect of change
in accounting principle
available for dilutive
securities $ 10,983 $ 7,335 $ 27,967 $(53,524)
======== ======== ======== ========
Weighted average common
stock outstanding 32,847 32,403 32,777 32,193
Additional common shares
resulting from stock
options (1) 803 285 465 579
Additional common shares
resulting from subordinated
debentures 6,528 6,528 6,528 6,528
-------- -------- -------- --------
Weighted average common
stock and dilutive stock
outstanding 40,178 39,216 39,770 39,300
======== ======== ======== ========
Diluted earnings per share
before cumulative effect
of change in accounting
principle $ .27 $ .19 $ .70 $ .49
Cumulative effect of change
in accounting principle - - - (1.85)
-------- -------- -------- --------
Diluted earnings/(loss)
per share $ .27 $ .19 $ .70 $ (1.36)
======== ======== ======== ========
(1) Excludes approximately 878, 2,146, 1,779, and 1,267 anti-dilutive
outstanding stock options for the third quarters of 2003 and 2002,
and the first nine months of 2003 and 2002, respectively.
(2) No tax effect as goodwill amortization is non-deductible for tax.
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
7. SUPPLEMENTAL CASH FLOW INFORMATION
Cash payments for interest and income taxes for the thirteen and thirty-nine
week periods ended September 28, 2003 and September 29, 2002 were as follows:
Quarter Nine Months
(13 weeks) Ended (39 weeks) Ended
-------------------- --------------------
Sept. 28, Sept. 29, Sept. 28, Sept. 29,
2003 2002 2003 2002
-------- -------- -------- --------
(Thousands)
Interest $ 1,120 $ 2,248 $ 7,108 $ 9,742
Income tax payments, net $ 10,842 $ 4,234 $ 13,949 $ 7,493
8. PROVISION FOR RESTRUCTURING
Accrual Cash Accrual
at Payments at
Beginning (and Exchange March 30,
of 2003 Rate Changes) 2003
--------- ------------ --------
(Thousands)
Severance and
other employee
related charges $ 3,788 $ (639) $ 3,149
Lease termination
costs 1,812 (128) 1,684
------- ------- -------
$ 5,600 $ (767) $ 4,833
======= ======= =======
Accrual Cash Accrual
at Payments at
March 30, (and Exchange June 29,
2003 Rate Changes) 2003
--------- ------------ --------
(Thousands)
Severance and
other employee
related charges $ 3,149 $ (263) $ 2,886
Lease termination
costs 1,684 (54) 1,630
------- ------- -------
$ 4,833 $ (317) $ 4,516
======= ======= =======
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Accrual Cash Accrual
at Payments at
June 29, (and Exchange Sept. 28,
2003 Rate Changes) 2003
--------- ------------ --------
(Thousands)
Severance and
other employee
related charges $ 2,886 $ (118) $ 2,768
Lease termination
costs 1,630 (211) 1,419
------- ------- -------
$ 4,516 $ (329) $ 4,187
======= ======= =======
At the end of the third quarter 2003, 52 of the 61 planned employee
terminations, related to the 2002 restructuring, and 294 of the 322 planned
employee terminations, related to the 2001 restructuring, had occurred. The
Company expects the terminations and restructuring actions to be completed by
the first half of 2004. Termination benefits are being paid out over a period of
1 to 24 months after termination.
9. CONTINGENT LIABILITIES
The Company is involved in certain legal and regulatory actions, all of which
have arisen in the ordinary course of business, except for the matters described
in the following paragraphs. Management believes it is remotely possible that
the ultimate resolution of such matters will have a material adverse effect on
the Company's consolidated results of operations and/or financial condition,
except as described below.
On May 24, 2002, the jury in the Civil Action No. 99-CV-577 in the United States
District Court for the Eastern District of Pennsylvania, filed by plaintiff ID
Security Systems Canada Inc. against Checkpoint Systems, Inc., held in favor of
the Company on the plaintiff's claim for Monopolization of Commerce, but against
the Company on claims of Attempted Monopolization and Conspiracy to Monopolize.
In addition, the jury held against the Company on two tort claims related to
tortious interference and unfair competition. Judgment was entered on the
verdict in favor of the plaintiff, after trebling, in the amount of $79.2
million plus attorneys' fees and costs to be determined by the Court.
On June 14, 2002, in response to Motions filed by the Company, the Court stayed
the execution of the judgments pending disposition of the Company's Motion for
Post-Trial Relief and ordered the Company to post a bond in the amount of $26.4
million and to place into escrow 3,179,600 shares of the Company's treasury
stock. The Company complied with the Court's order.
On March 28, 2003, in response to the Company's Motion for Post-Trial Relief,
the Court issued an order which vacated the jury verdict on the antitrust claims
and reduced the damages award related to tortious interference and unfair
competition from $19 million to $13 million. The Company subsequently
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
filed an additional motion to further reduce the $13 million by $2.1 million
based on a prior agreement between the parties and a previous Order by the
Court. The Court granted the Company's motion, and on May 20, 2003 further
reduced the judgment from $13 million to $10.9 million. On the same date, the
Court (1) authorized the release to the Company of the $26.4 million bond and
escrowed treasury shares previously posted as security by the Company, (2)
directed the Company to post a replacement bond in the reduced amount of $11.3
million, which amount was subsequently amended to $11.4 million, and (3) stayed
execution of the judgment upon the posting of said bond by the Company. The
Company promptly posted the requisite bond and execution on the judgment in the
amount of $10.9 million is now stayed.
Both ID Security Systems Canada Inc. and the Company have filed appeals to the
Third Circuit Court of Appeals related to the various decisions of the Court. ID
Security Systems Canada Inc.'s brief is due by November 17, 2003 and the
Company's brief is due 30 days after ID Security Systems Canada Inc.'s brief is
filed. Based on input from outside legal counsel, management is of the opinion
that the Judge's Order is consistent with the law as it relates to the antitrust
issues, and is not consistent with the law as it relates to the tortious
interference and unfair competition aspects of the case. Accordingly, no
liability has been recorded for this litigation, as management believes that, at
this time, it is not probable the remaining judgment will be upheld and that the
reasonably possible range of the contingent liability is between zero and $11
million. Management believes it is remotely possible that the Court of Appeals
could reverse the decision of the lower Court as it relates to the antitrust
claims and reinstate the original judgment of $79.2 million plus attorneys' fees
and costs. If the final outcome of this litigation, after all appeals have been
exhausted, results in certain of the plaintiff's claims being upheld, the
potential damages could be material to the Company's consolidated results of
operations and/or financial condition and could cause the Company to be in
default of certain bank covenants. Although management expects to be successful
in the appeal process, should the appeal be unsuccessful, management anticipates
that any final judgment would not be paid prior to the end of 2004 and is of the
opinion that the Company will have sufficient financial resources in the form of
cash and borrowing capacity, due to the cash flow generated during the
intervening period, to satisfy any judgment.
A certain number of follow-on purported class action suits have arisen in
connection with the jury decision in the ID Security Systems Canada Inc.
litigation. The purported class action complaints generally allege a claim of
monopolization and are substantially based upon the same allegations as
contained in the ID Security Systems Canada Inc. case (Civil Action No.
99-CV-577) as discussed below.
On August 1, 2002, a civil action was filed in United States District Court for
the Eastern District of Pennsylvania, designated as Civil Action No. 02-6379(ER)
by plaintiff Diane Furs, Inc. t/a Diane Furs against Checkpoint Systems, Inc.
and served on August 21, 2002. On August 21, 2002, a Notice of Substitution of
Plaintiff and Filing of Amended Complaint was filed by the plaintiff, and the
named plaintiff was changed to Medi-Care Pharmacy, Inc.
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
On August 2, 2002, a civil action was filed in the United States District Court,
District of New Jersey (Camden) designated as Docket No. 02-CV-3730(JEI) by
plaintiff Club Sports International, Inc., d/b/a Soccer CSI against Checkpoint
Systems, Inc. and served on August 26, 2002.
On October 2, 2002, a civil action was filed in the United States District
Court, District of New Jersey (Camden) designated as Docket No. 02-CV-4777 (JBS)
by plaintiff Baby Mika, Inc. against Checkpoint Systems, Inc. and served on
October 7, 2002.
On October 23, 2002, a civil action was filed in the United States District
Court, District of New Jersey (Camden) designated as Docket No. 02-CV-5001 (JEI)
by plaintiff Washington Square Pharmacy, Inc. against Checkpoint Systems, Inc.
and served on November 1, 2002.
On October 18, 2002, The United States District, District of New Jersey (Camden)
entered an Order staying the proceedings in the Club Sports International, Inc.
and Baby Mika, Inc. cases referred to above. In accordance with the Order, the
Stay will also apply to the Washington Square Pharmacy, Inc. case referred to
above. In addition, the Medi-Care Pharmacy, Inc. case, referred to above, will
be voluntarily dismissed, and it has been re-filed in New Jersey and is included
in the Stay Order. The Stay is expected to remain in place until such time as
the ID Security Systems case, referred to above, is either terminated or any
appeals have been exhausted in the Third Circuit Court of Appeals.
On November 13, 2002, a civil action was filed in the United States District
Court, District of New Jersey (Camden) designated as Docket No. 02-CV-5319 (JEI)
by plaintiff 1700 Pharmacy, Inc. against Checkpoint Systems, Inc. and served on
November 15, 2002.
On December 30, 2002, a civil action was filed in the United States District
Court, District of New Jersey (Camden) designated as Docket No. 02-CV-6131 (JEI)
by plaintiff Medi-Care Pharmacy, Inc. against Checkpoint Systems, Inc. and
served on January 3, 2003.
Both the 1700 Pharmacy, Inc. case and the Medi-Care Pharmacy, Inc. case were
consolidated with the previously mentioned cases and are included in the October
18, 2002 Stay Order referred to above. No liability has been recorded for any of
the purported class action suits as management believes that, based on input
from outside legal counsel, it is remotely possible that the Court of Appeals
could reverse the decision of the lower Court in the ID Security Systems Canada
Inc. litigation as it relates to the antitrust claims.
On February 28, 2003 a civil action was filed in the Superior Court of New
Jersey, Bergen County, by Franklin Graphics, Inc. against Checkpoint Systems,
Inc. and Christopher Clarke, (Docket No. BER-L-1575-03) seeking compensatory
damages in excess of $1 million, treble damages, punitive damages, and
attorneys' fees. The plaintiff alleges tortious interference with a contractual
relationship and prospective economic relations, unfair competition, violation
of duty loyalty, breach of contract and consumer fraud.
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
The factual basis for the suit may be summarized as follows. The Company
performed clothing label tag printing services as a subcontractor to the
plaintiff for a number of apparel manufacturers who were customers of the
plaintiff. Co-defendant Clarke was an employee of the plaintiff who had
responsibility for interfacing with apparel manufacturers and the Company.
Co-defendant Clarke left the plaintiff's employment early in 2002, establishing
his own business. Subsequently, co-defendant Clarke joined the Company as an
employee. Certain of the plaintiff's customers ceased doing business with the
plaintiff and engaged Checkpoint directly to perform the clothing label tag
printing services.
The Company disputes any liability to the plaintiff and intends to defend this
matter vigorously. The Company filed a motion to dismiss the consumer
fraud/treble damage claim, and the Court denied that motion in August 2003. The
Company has since filed an answer denying liability, a counterclaim for
approximately $0.1 million for goods and services provided, and its own
counterclaim under the consumer fraud statute. Management is unable to predict
the outcome of this proceeding, but does not believe that the ultimate
resolution will have a material adverse affect on the consolidated financial
position or results of operations of the Company, however, if such matter were
determined adversely to the Company, the ultimate liability arising therefrom
should not be material to the financial position of the Company, but could be
material to its results of operations in any quarter or annual period.
The following table sets forth the movements in the warranty reserve:
Quarter Nine Months
(13 weeks) Ended (39 weeks) Ended
-------------------- --------------------
Sept. 28, Sept. 29, Sept. 28, Sept. 29,
2003 2002 2003 2002
-------- -------- -------- --------
(Thousands)
Balance at the beginning
of the period $ 4,373 $ 3,613 $ 4,002 $ 3,303
Accruals for warranties
issued $ 396 $ 106 $ 892 $ 499
Accruals related to
pre-existing warranties,
including changes in
estimates (27) (2) (27) (88)
-------- -------- -------- --------
Total accruals $ 369 $ 104 $ 865 $ 411
Settlements made (271) (134) (656) (397)
Foreign currency
translation adjustment (15) (38) 245 228
-------- -------- -------- --------
Balance at the end of the
period $ 4,456 $ 3,545 $ 4,456 $ 3,545
======== ======== ======== ========
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
10. BUSINESS SEGMENTS
Quarter Nine Months
(13 weeks) Ended (39 weeks) Ended
-------------------- --------------------
Sept. 28, Sept. 29, Sept. 28, Sept. 29,
2003 2002 2003 2002
-------- -------- -------- --------
(Thousands)
Business segment net revenues:
Security $117,104 $102,805 $321,829 $281,089
Labeling Services 36,688 33,152 114,703 106,850
Retail Merchandising 23,437 22,843 72,834 75,239
-------- -------- -------- --------
Total $177,229 $158,800 $509,366 $463,178
======== ======== ======== ========
Business segment gross profit:
Security $ 52,640 $ 45,174 $144,204 $122,993
Labeling Services 9,985 10,147 33,032 32,685
Retail Merchandising 10,565 10,292 34,714 35,449
-------- -------- -------- --------
Total gross profit $ 73,190 $ 65,613 $211,950 $191,127
Operating expenses 56,118 52,433 167,638 156,232
Interest expense, net 2,325 3,392 7,572 10,150
Other gain/(loss) 271 (366) 810 (466)
-------- -------- -------- --------
Earnings before income taxes $ 15,018 $ 9,422 $ 37,550 $ 24,279
======== ======== ======== ========
11. STOCK OPTIONS
At September 28, 2003, the Company has one stock-based employee compensation
plan. Statement of Financial Accounting Standards No. 123 (SFAS 123),
"Accounting for Stock-Based Compensation", encourages, but does not require
companies to record compensation cost for stock-based employee compensation
plans at fair value. The Company continues to account for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to
Employees". Accordingly, compensation cost for stock options is measured as the
excess, if any, of the quoted market price of the Company's common stock at the
date of grant over the amount an employee must pay to acquire the stock. Since
all options were granted at market value, there is no compensation cost to be
recognized.
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Had compensation cost for the Company's stock option plans been determined based
upon the fair value at the grant date using the Black Scholes option pricing
model prescribed under SFAS 123, the Company's net earnings/(loss) and net
earnings/(loss) per share would approximate the pro-forma amounts as follows:
Quarter Nine Months
(13 weeks) Ended (39 weeks) Ended
-------------------- --------------------
Sept. 28, Sept. 29, Sept. 28, Sept. 29,
2003 2002 2003 2002
-------- -------- -------- --------
(Thousands)
Net earnings/(loss),
as reported $ 10,022 $ 6,374 $ 25,085 $(56,406)
Total stock-based
employee compensation
expense determined
under fair value
based method,
net of tax (556) (485) (2,228) (2,503)
-------- -------- -------- --------
Pro-forma net
earnings/(loss) $ 9,466 $ 5,889 $ 22,857 $(58,909)
======== ======== ======== ========
Net earnings/(loss)
per share:
Basic, as reported $ .31 $ .20 $ .77 $ (1.75)
======== ======== ======== ========
Basic, pro-forma $ .29 $ .18 $ .70 $ (1.83)
======== ======== ======== ========
Diluted, as reported $ .27 $ .19 $ .70 $ (1.36)
======== ======== ======== ========
Diluted, pro-forma $ .26 $ .17 $ .65 $ (1.43)
======== ======== ======== ========
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
12. NEW ACCOUNTING PRONOUNCEMENTS AND OTHER STANDARDS
In November 2002, the Emerging Issues Task Force (EITF) of the FASB reached
consensus on Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables".
The standard provides guidance on how to account for arrangements that involve
the delivery or performance of multiple products, services, and/or rights to use
assets. The provisions of EITF Issue No. 00-21 apply to revenue arrangements
entered into by the Company after June 29, 2003. The Company's adoption of EITF
Issue No. 00-21 has not significantly impacted its consolidated financial
statements.
In January 2003, the FASB issued interpretation No. 46 (FIN 46), "Consolidation
of Variable Interest Entities, an Interpretation of ARB No. 51". FIN 46 requires
certain variable interest entities to be consolidated by the primary beneficiary
of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. FIN 46 is effective for all
new variable interest entities created or acquired after January 31, 2003. For
variable interest entities created or acquired prior to February 1, 2003, the
provisions of FIN 46 must be applied to the Company's consolidated financial
statements for the fourth quarter of 2003. The Company does not expect the
adoption of FIN 46 to have a significant impact on its consolidated financial
statements.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Information relating to Forward-Looking Statements
This report includes forward-looking statements made pursuant to the safe harbor
provision of the Private Securities Litigation Reform Act of 1995. Except for
historical matters, the matters discussed are forward-looking statements, within
the meaning of Section 27A of the Securities Act of 1933, as amended, that
reflect the Company's current views with respect to future events and financial
performance. These forward-looking statements are subject to certain risks and
uncertainties which could cause actual results to differ materially from
historical results or those anticipated. Readers are cautioned not to place
undue reliance on these forward-looking statements, which speak only as of their
dates. The Company undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. The following risk factors, among other possible factors,
could cause actual results to differ materially from historical or anticipated
results: (1) changes in international business conditions; (2) foreign currency
exchange rate and interest rate fluctuations; (3) lower than anticipated demand
by retailers and other customers for the Company's products, particularly in the
current economic environment; (4) slower commitments of retail customers to
chain-wide installations and/or source tagging adoption or expansion; (5)
possible increases in per unit product manufacturing costs due to less than full
utilization of manufacturing capacity as a result of slowing economic conditions
or other factors; (6) the Company's ability to provide and market innovative and
cost-effective products; (7) the development of new competitive technologies;
(8) the Company's ability to maintain its intellectual property; (9) competitive
pricing pressures causing profit erosion; (10) the availability and pricing of
component parts and raw materials; (11) possible increases in the payment time
for receivables, as a result of economic conditions or other market factors;
(12) changes in regulations or standards applicable to the Company's products;
(13) unanticipated liabilities or expenses; (14) adverse determinations in the
ID Security Systems Canada Inc. litigation and any other pending litigation
affecting the Company; and (15) the impact of adverse determinations in the ID
Security Systems Canada Inc. litigation on liquidity and debt covenant
compliance. More information about potential factors that could affect the
Company's business and financial results is included in the Company's Annual
Report on Form 10-K for the year ended December 29, 2002, and the Company's
other Securities and Exchange Commission filings.
Critical Accounting Policies and Estimates
- ------------------------------------------
For a discussion of the Company's critical accounting policies and estimates,
see Item 7 "Management's Discussion And Analysis Of Financial Condition And
Results Of Operations" in the Company's Annual Report on Form 10-K filed for the
year ending December 29, 2002.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Third Quarter 2003 Compared to Third Quarter 2002
- ---------------------------------------------------
Net Revenues
Revenues for the third quarter 2003 compared to the third quarter 2002 increased
by $18.4 million or 11.6% from $158.8 million to $177.2 million. Foreign
currency translation had a positive impact on revenues of approximately $12.0
million or 7.6% in the third quarter of 2003 as compared to the third quarter of
2002.
Security revenues increased by $14.3 million or 13.9% in the third quarter of
2003 as compared to the third quarter of 2002. Foreign currency translation had
a positive impact of approximately $7.2 million. The remaining increase was
primarily due to growth in the closed-circuit television (CCTV) market in the
USA and the UK and in the electronic article surveillance (EAS) market in Asia
Pacific, partially offset by a decline in US EAS sales. Labeling services
revenues increased by $3.5 million. The increase was due to the positive impact
of foreign currency translation of approximately $2.5 million and increased
service bureau revenues in Europe and Asia Pacific partially offset by lower
barcode printer revenues. Retail merchandising revenues increased by
$0.6 million or 2.6%. The positive impact of foreign currency translation of
approximately $2.4 million was largely offset by decreases in hand-held labeling
systems (HLS) in Europe and the USA and retail display systems (RDS) in Europe.
The continuing transition from hand-held price labeling to automated barcoding
and scanning by retailers caused the decline in HLS. The RDS decrease was
primarily due to weaker economic conditions in Europe resulting in fewer new
store openings.
Gross Profit
Gross profit for the third quarter 2003 was $73.2 million, or 41.3% of revenues,
compared to $65.6 million, or 41.3% of revenues, for the third quarter 2002. The
benefit of foreign currency translation on gross profit was approximately $4.8
million in the third quarter of 2003 as compared to the third quarter of 2002.
Security gross profit, as a percentage of sales, increased from 43.9% in the
third quarter of 2002 to 45.0% in the third quarter of 2003, primarily as a
result of improved margins in CCTV due to increased volume and higher EAS
product margins due to increased volume, improvements in manufacturing
efficiencies, and the benefits of the weakening US dollar on products sourced
in US dollars but sold in a different currency. The improvement in EAS product
margins more than offset an increase in EAS technology spending. Gross profit,
as a percentage of net revenues, for labeling services declined to 27.2% in the
third quarter of 2003 from 30.6% in the third quarter of 2002. Competitive
pricing pressures primarily caused the decline. The retail merchandising gross
profit percentage remained constant at 45.1%.
Field service and installation costs for the third quarter of 2003 and 2002 were
9.3% and 8.3% of net revenues, respectively. The increase as a percentage of net
revenues resulted from an increase in CCTV and EAS installations relative to
total net revenues.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Selling, General, and Administrative Expenses
SG&A expenses increased $2.8 million over the third quarter of 2002. As a
percentage of net revenues, SG&A expenses decreased to 31.7% from 33.6%. Foreign
currency translation increased SG&A expenses in the third quarter of 2003 by
approximately $3.9 million over the comparable quarter in 2002. The third
quarter of 2002 included $2.7 million of compensation costs associated with
executive management changes and legal fees for the ID Security Systems Canada
Inc. litigation.
Other Operating Income
Due to changes in management in 2002, the Company reviewed and modified the 2001
restructuring plans in order to reduce the future cash outlays necessary to
execute these plans. The principal modification was to move a manufacturing
facility to a location closer than originally planned. This, and other
modifications, resulted in the retention of certain employees included in the
original plan. These changes in estimates resulted in the reversal of $2.4
million of the restructuring accrual in the third quarter of 2002. Of this
amount, $1.5 million was credited to cost of revenues and $0.9 million to other
operating income.
Interest Expense and Interest Income
Interest expense for the third quarter of 2003 decreased $1.2 million from the
comparable quarter in 2002 (from $3.8 million to $2.6 million) due to debt
repayment over the last twelve months. Interest income for the third quarter of
2003 decreased by $0.1 million from the comparable quarter in 2002 (from $0.4
million to $0.3 million) as a result of lower interest rates on cash
investments.
Other Gain/(Loss), net
Other gain/(loss), net represented a net foreign exchange gain of $0.3 million
and a net foreign exchange loss of $0.4 million for the third quarter of 2003
and 2002, respectively.
Income Taxes
The effective tax rate for the third quarter of 2003 was 33.0%. The effective
tax rate for the third quarter of 2002 was 32.0%. The higher tax rate results
primarily from foreign income tax rate differentials.
Net Earnings/(Loss)
The Company's third quarter 2003 net earnings were $10.0 million, or $0.27 per
diluted share, compared to $6.4 million, or $0.19 per diluted share, in the
third quarter 2002.
Exposure to International Operations
Approximately 64% of the Company's sales are made in currencies other than U.S.
dollars. Sales denominated in currencies other than U.S. dollars increase the
Company's potential exposure to currency fluctuations, which can affect results.
Management cannot predict, with any degree of certainty, changes in currency
exchange rates and, therefore, the future impact that such changes may have on
its operations.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Restructuring
The changes in the provision for restructuring are covered in Note 8 of the
Consolidated Financial Statements.
First Nine Months 2003 Compared to First Nine Months 2002
- ---------------------------------------------------------
Net Revenues
Revenues for the nine months of 2003 compared to the same period in the prior
year increased by $46.2 million or 10.0% from $463.2 million to $509.4 million.
Foreign currency translation had a positive impact on revenues of approximately
$45.5 million or 9.8% in the first nine months of 2003 over the comparable
period for 2002.
Security revenues increased by $40.7 million or 14.5% in the nine months of 2003
as compared to the nine months of 2002. Foreign currency translation had a
positive impact of approximately $25.4 million. The remaining increase was
primarily due to growth in the US CCTV market as well as growth in the European
and Asia Pacific EAS markets, partially offset by a decline in US EAS
sales. Labeling services revenues increased by $7.9 million, from $106.8 million
to $114.7 million. The increase was due to the positive impact of foreign
currency translation of approximately $10.0 million and a $2.2 million increase
in RFID library system revenues in the USA, which was partially offset by lower
barcode systems revenues in the USA and Europe. Retail merchandising revenues
decreased by $2.4 million or 3.2%, despite the positive impact of foreign
currency translation of $10.1 million. The lower revenues primarily resulted
from the decline of HLS in Europe, due to the continuing transition from hand-
held price labeling to automated barcoding and scanning by retailers, combined
with a decrease in RDS revenues caused by weaker economic conditions in Europe.
The Company experienced an unusual increase in European HLS revenues in the
first quarter of 2002 as a result of the conversion to the Euro currency.
Gross Profit
Gross profit for the first nine months of 2003 was $212.0 million, or 41.6% of
revenues, compared to $191.1 million, or 41.3% of revenues, for the first nine
months of 2002. The benefit of foreign currency translation on gross profit was
approximately $19.1 million in the nine months of 2003 as compared to the nine
months of 2002.
Security gross profit, as a percentage of sales, increased from 43.8% in the
nine months of 2002 to 44.8% in the comparable period of 2003, primarily as a
result of improvements in manufacturing efficiencies and the benefits of the
weakening US dollar on products sourced in US dollars but sold in a different
currency. Gross profit, as a percentage of net revenues, for labeling services
decreased from 30.6% for the nine months of 2002 to 28.8% for the nine months of
2003. The decrease in gross profit percentage was principally due to competitive
pricing pressure in the first nine months of 2003. The retail merchandising
gross profit percentage increased 0.6% (from 47.1% to 47.7%) in the nine months
of 2003 compared to the nine months of 2002. The increase was principally due to
an improvement in RDS gross profit in Europe.
For the first nine months of 2003 and 2002, field service and installation costs
were 9.0% and 8.4% of net revenues, respectively.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Selling, General, and Administrative Expenses
SG&A expenses increased $10.5 million over the nine months of 2002 (from $157.1
million to $167.6 million). As a percentage of net revenues, SG&A expenses
decreased from 33.9% to 32.9%. Foreign currency translation increased SG&A
expenses in the first nine months of 2003 by approximately $15.1 million over
the comparable period in 2002. The second and third quarters of 2002 included
$5.5 million of compensation costs associated with executive management changes
and legal fees for the ID Security Systems Canada Inc. litigation.
Other Operating Income
Due to changes in management in 2002, the Company reviewed and modified the 2001
restructuring plans in order to reduce the future cash outlays necessary to
execute these plans. The principal modification was to move a manufacturing
facility to a location closer than originally planned. This, and other
modifications, resulted in the retention of certain employees included in the
original plan. These changes in estimates resulted in the reversal of $2.4
million of the restructuring accrual in the third quarter of 2002. Of this
amount, $1.5 million was credited to cost of revenues and $0.9 million to other
operating income.
Other Gain/(Loss), net
Other gain/(loss), net represented a net foreign exchange gain of $0.8 million
and a net foreign exchange loss of $0.5 million for the nine months of 2003 and
2002, respectively.
Interest Expense and Interest Income
Interest expense for the nine months of 2003 decreased $2.9 million from the
comparable period in 2002 (from $11.5 million to $8.6 million) due to debt
repayment in the last twelve months. Interest income for the nine months of 2003
decreased by $0.3 million from the comparable half in 2002 (from $1.3 million to
$1.0 million) as a result of lower interest rates on cash investments.
Income Taxes
The effective tax rate for the first six months of 2003 was 33.0%. The effective
tax rate for the nine months of 2002 was 32.0%. The higher tax rate results
primarily from foreign income tax rate differentials.
Net Earnings/(Loss)
The Company's net earnings for the nine months of 2003 were $25.1 million, or
$0.70 per diluted share, compared to a net loss of $56.4 million, or $1.36 per
diluted share, in the nine months of 2002. Included in the net loss for the
first nine months of 2002 is the cumulative effect of the change in accounting
principle of $72.9 million, which resulted from the Company's adoption of
Statement of Financial Accounting Standards No. 142 (SFAS 142) "Goodwill and
Other Intangible Assets." The earnings before cumulative effect of change in
accounting principle for the nine months of 2002 was $16.5 million, or $0.49 per
diluted share.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Exposure to International Operations
Approximately 66% of the Company's sales are made in currencies other than U.S.
dollars. Sales denominated in currencies other than U.S. dollars increase the
Company's potential exposure to currency fluctuations, which can affect results.
Management cannot predict, with any degree of certainty, changes in currency
exchange rates and therefore, the future impact that such changes may have on
its operations.
Restructuring
The changes in the provision for restructuring are covered in Note 8 of the
consolidated financial statements.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
FINANCIAL CONDITION
- -------------------
Liquidity and Capital Resources
The Company's liquidity needs have related to, and are expected to continue to
relate to, capital investments, acquisitions, and working capital requirements.
The Company has met its liquidity needs over the last three years primarily
through funds provided by long-term borrowings and more recently through cash
generated from operations. Management believes that its anticipated cash needs
for the foreseeable future can be funded from cash and cash equivalents on hand,
the availability under the $100 million revolving credit facility, and cash
generated from future operations.
The Company's operating activities generated approximately $28.5 million during
the first nine months of 2003 compared to $58.8 million in the same period in
2002. This change from the prior year was primarily attributable to refundable
tax payments made in the third quarter of 2003 and a lower reduction in working
capital for the first nine months of 2003 compared to the same period in 2002,
particularly in accounts receivable, inventories.
During the third quarter 2003, an unscheduled repayment of $2.0 million was made
on the $25 million collateralized term loan to fully satisfy the outstanding
balance. At September 28, 2003, EUR 40.3 million (approximately $46.1 million)
was outstanding under the multi-currency term loan. The outstanding borrowings
under the revolving credit facility were JPY 300 million (approximately $2.7
million). The availability under the $100 million multi-currency revolving
credit facility has been reduced by letters of credit totaling $12.3 million,
primarily related to the surety bond posted in connection with ID Security
Systems Canada Inc. litigation.
The Company has called $35.0 million of the convertible subordinated debentures
for redemption on November 8, 2003. The called debentures are convertible at any
time prior to the close of business on November 3, 2003. Each Note in the
denomination of $1,000 is convertible, at the holder's option, into 54.4218
shares of the Company's common stock, which is equivalent to a conversion price
of $18.375 per share.
The Company does not anticipate paying any cash dividend in the near future and
is limited by existing covenants in the Company's debt instruments with regard
to paying dividends.
On May 24, 2002, the jury in the Civil Action No. 99-CV-577 in the United States
District Court for the Eastern District of Pennsylvania, filed by plaintiff ID
Security Systems Canada Inc. against Checkpoint Systems, Inc., held in favor of
the Company on the plaintiff's claim for Monopolization of Commerce, but against
the Company on claims of Attempted Monopolization and Conspiracy to Monopolize.
In addition, the jury held against the Company on two tort claims related to
tortious interference and unfair competition. Judgment was entered on the
verdict in favor of the plaintiff, after trebling, in the amount of $79.2
million plus attorneys' fees and costs to be determined by the Court.
On March 28, 2003, the Court issued an order which vacated the jury verdict on
the antitrust claims and reduced the damages award related to tortious
interference and unfair competition from $19 million to $13 million. The Company
subsequently filed an additional motion to further reduce the
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
$13 million by $2.1 million based on a prior agreement between the parties and a
previous Order by the Court. The Court granted the Company's motion, and on May
20, 2003 further reduced the judgment from $13 million to $10.9 million. On the
same date, the Court (1) authorized the release to the Company of the $26.4
million bond and escrowed treasury shares previously posted as security by the
Company, (2) directed the Company to post a replacement bond in the reduced
amount of $11.3 million, which amount was subsequently amended to $11.4 million,
and (3) stayed execution of the judgment upon the posting of said bond by the
Company. The Company promptly posted the requisite bond and execution on the
judgment in the amount of $10.9 million is now stayed. Both ID Security Systems
Canada Inc. and the Company have filed appeals to the Third Circuit Court of
Appeals related to the various decisions of the Court. ID Security Systems
Canada Inc.'s brief is due by November 17, 2003 and the Company's brief is due
30 days after ID Security Systems Canada Inc.'s brief is filed. (See Note 9 of
the Consolidated Financial Statements.)
Although management expects to be successful upon appeal, should the appeal be
unsuccessful, management anticipates that the final judgment would not be paid
prior to the end of 2004 and is of the opinion that the Company will have
sufficient financial resources in the form of cash and borrowing capacity, due
to the cash flow generated during the intervening period, to satisfy any
judgment. The recording of a liability or a final judgment could cause the
Company to be in default of certain bank covenants. In this event, management
would pursue various alternatives, which may include, among other things, debt
covenant waivers, debt covenant amendments, or refinancing of debt. While
management believes it would be successful in pursuing these alternatives, there
can be no assurance of success.
Capital Expenditures
The Company's capital expenditures during the first nine months of fiscal 2003
totaled $10.0 million compared to $4.6 million during the first nine months of
fiscal 2002. The increase in 2003 principally resulted from additional
manufacturing-related investments. The Company anticipates its capital
expenditures to approximate $14 million in 2003.
Exposure to International Operations
The Company manufactures products in the USA, the Caribbean, Europe, and the
Asia Pacific region for both the local marketplace as well as for export to its
foreign subsidiaries. The subsidiaries, in turn, sell these products to
customers in their respective geographic areas of operation, generally in local
currencies. This method of sale and resale gives rise to the risk of gains or
losses as a result of currency exchange rate fluctuations.
The Company has been selectively purchasing currency exchange forward contracts
on a regular basis to reduce the risks of currency fluctuations on short-term
receivables. These contracts guarantee a predetermined exchange rate at the time
the contract is purchased. This allows the Company to shift the risk, whether
positive or negative, of currency fluctuations from the date of the contract to
a third party.
As of September 28, 2003, the Company had currency exchange forward contracts
totaling approximately $22.6 million. The contracts are in the various local
currencies covering primarily the Company's Western European operations along
with the Company's Canadian and Australian operations. Historically, the Company
has not purchased currency exchange forward contracts where it is not
economically efficient, specifically for its operations in South America and
Asia.
The Company has historically not used financial instruments to minimize its
exposure to currency fluctuations on its net investments in and cash flows
derived from its foreign subsidiaries.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
OTHER MATTERS
- -------------
New Accounting Pronouncements and Other Standards
In November 2002, the Emerging Issues Task Force (EITF) of the FASB reached
consensus on Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables".
The standard provides guidance on how to account for arrangements that involve
the delivery or performance of multiple products, services, and/or rights to use
assets. The provisions of EITF Issue No. 00-21 apply to revenue arrangements
entered into by the Company after June 29, 2003. The Company's adoption of EITF
Issue No. 00-21 has not significantly impacted its consolidated financial
statements.
In January 2003, the FASB issued interpretation No. 46 (FIN 46), "Consolidation
of Variable Interest Entities, an Interpretation of ARB No. 51". FIN 46 requires
certain variable interest entities to be consolidated by the primary beneficiary
of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. FIN 46 is effective for all
new variable interest entities created or acquired after January 31, 2003. For
variable interest entities created or acquired prior to February 1, 2003, the
provisions of FIN 46 must be applied to the Company's consolidated financial
statements for the fourth quarter of 2003. The Company does not expect the
adoption of FIN 46 to have a significant impact on its consolidated financial
statements.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no significant changes to the market risks as disclosed in item
7a of the Company's Annual Report on Form 10-K filed for the year ending
December 29, 2002.
Item 4. DISCLOSURE CONTROLS AND PROCEDURES
The Company carried out an evaluation, under the supervision and with the
participation of the Company's principal executive officer and principal
financial officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures as of the end of the period covered
by this report. Based on this evaluation, the Company's principal executive
officer and principal financial officer concluded that the Company's disclosure
controls and procedures are effective in alerting them, on a timely basis, to
material information required to be included in the Company's periodic SEC
reports. It should be noted that the design of any system of controls is based
in part upon certain assumptions about the likelihood of future events, and
there can be no assurance that any design will succeed in achieving its stated
goals under all potential future conditions, regardless of how remote.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
The Company is involved in certain legal and regulatory actions, all of which
have arisen in the ordinary course of business, except for the matters described
in the following paragraphs. Management believes it is remotely possible that
the ultimate resolution of such matters will have a material adverse effect on
the Company's consolidated results of operations and/or financial condition,
except as described below.
On May 24, 2002, the jury in the Civil Action No. 99-CV-577 in the United States
District Court for the Eastern District of Pennsylvania, filed by plaintiff ID
Security Systems Canada Inc. against Checkpoint Systems, Inc., held in favor of
the Company on the plaintiff's claim for Monopolization of Commerce, but against
the Company on claims of Attempted Monopolization and Conspiracy to Monopolize.
In addition, the jury held against the Company on two tort claims related to
tortious interference and unfair competition. Judgment was entered on the
verdict in favor of the plaintiff, after trebling, in the amount of $79.2
million plus attorneys' fees and costs to be determined by the Court.
On June 14, 2002, in response to Motions filed by the Company, the Court stayed
the execution of the judgments pending disposition of the Company's Motion for
Post-Trial Relief and ordered the Company to post a bond in the amount of $26.4
million and to place into escrow 3,179,600 shares of the Company's treasury
stock. The Company complied with the Court's order.
On March 28, 2003, in response to the Company's Motion for Post-Trial Relief,
the Court issued an order which vacated the jury verdict on the antitrust claims
and reduced the damages award related to tortious interference and unfair
competition from $19 million to $13 million. The Company subsequently filed an
additional motion to further reduce the $13 million by $2.1 million based on a
prior agreement between the parties and a previous Order by the Court. The Court
granted the Company's motion, and on May 20, 2003 further reduced the judgment
from $13 million to $10.9 million. On the same date, the Court (1) authorized
the release to the Company of the $26.4 million bond and escrowed treasury
shares previously posted as security by the Company, (2) directed the Company to
post a replacement bond in the reduced amount of $11.3 million, which amount was
subsequently amended to $11.4 million, and (3) stayed execution of the judgment
upon the posting of said bond by the Company. The Company promptly posted the
requisite bond and execution on the judgment in the amount of $10.9 million is
now stayed.
Both ID Security Systems Canada Inc. and the Company have filed appeals to the
Third Circuit Court of Appeals related to the various decisions of the Court. ID
Security Systems Canada Inc.'s brief is due by November 17, 2003 and the
Company's brief is due 30 days after ID Security Systems Canada Inc.'s brief is
filed. Based on input from outside legal counsel, management is of the opinion
that the Judge's Order is consistent with the law as it relates to the antitrust
issues, and is not consistent with the law as it relates to the tortious
interference and unfair competition aspects of the case. Accordingly, no
liability has been recorded for this litigation, as management believes that, at
this time, it is not probable the remaining judgment will be upheld and that the
reasonably possible range of the contingent liability is between zero and $11
million. Management believes it is remotely possible that the Court of Appeals
could reverse the decision of the lower Court as it relates to the antitrust
claims and reinstate the original judgment of $79.2 million plus attorneys' fees
and costs. If the final outcome of this litigation, after all appeals have been
exhausted, results in certain of the plaintiff's claims being upheld, the
potential damages could be material to the Company's consolidated results of
operations and/or financial condition and could cause the Company to be in
default of certain bank covenants. Although management expects to be successful
in the appeal process, should the appeal be unsuccessful, management anticipates
that any final judgment would not be paid prior to the end of 2004 and is of the
opinion that the Company will have sufficient financial resources in the form of
cash and borrowing capacity, due to the cash flow generated during the
intervening period, to satisfy any judgment.
A certain number of follow-on purported class action suits have arisen in
connection with the jury decision in the ID Security Systems Canada Inc.
litigation. The purported class action complaints generally allege a claim of
monopolization and are substantially based upon the same allegations as
contained in the ID Security Systems Canada Inc. case (Civil Action No.
99-CV-577) as discussed below.
On August 1, 2002, a civil action was filed in United States District Court for
the Eastern District of Pennsylvania, designated as Civil Action No. 02-6379(ER)
by plaintiff Diane Furs, Inc. t/a Diane Furs against Checkpoint Systems, Inc.
and served on August 21, 2002. On August 21, 2002, a Notice of Substitution of
Plaintiff and Filing of Amended Complaint was filed by the plaintiff, and the
named plaintiff was changed to Medi-Care Pharmacy, Inc.
On August 2, 2002, a civil action was filed in the United States District Court,
District of New Jersey (Camden) designated as Docket No. 02-CV-3730(JEI) by
plaintiff Club Sports International, Inc., d/b/a Soccer CSI against Checkpoint
Systems, Inc. and served on August 26, 2002.
On October 2, 2002, a civil action was filed in the United States District
Court, District of New Jersey (Camden) designated as Docket No. 02-CV-4777 (JBS)
by plaintiff Baby Mika, Inc. against Checkpoint Systems, Inc. and served on
October 7, 2002.
On October 23, 2002, a civil action was filed in the United States District
Court, District of New Jersey (Camden) designated as Docket No. 02-CV-5001 (JEI)
by plaintiff Washington Square Pharmacy, Inc. against Checkpoint Systems, Inc.
and served on November 1, 2002.
On October 18, 2002, The United States District, District of New Jersey (Camden)
entered an Order staying the proceedings in the Club Sports International, Inc.
and Baby Mika, Inc. cases referred to above. In accordance with the Order, the
Stay will also apply to the Washington Square Pharmacy, Inc. case referred to
above. In addition, the Medi-Care Pharmacy, Inc. case, referred to above, will
be voluntarily dismissed, and it has been re-filed in New Jersey and is included
in the Stay Order. The Stay is expected to remain in place until such time as
the ID Security Systems case, referred to above, is either terminated or any
appeals have been exhausted in the Third Circuit Court of Appeals.
On November 13, 2002, a civil action was filed in the United States District
Court, District of New Jersey (Camden) designated as Docket No. 02-CV-5319 (JEI)
by plaintiff 1700 Pharmacy, Inc. against Checkpoint Systems, Inc. and served on
November 15, 2002.
On December 30, 2002, a civil action was filed in the United States District
Court, District of New Jersey (Camden) designated as Docket No. 02-CV-6131 (JEI)
by plaintiff Medi-Care Pharmacy, Inc. against Checkpoint Systems, Inc. and
served on January 3, 2003.
Both the 1700 Pharmacy, Inc. case and the Medi-Care Pharmacy, Inc. case were
consolidated with the previously mentioned cases and are included in the October
18, 2002 Stay Order referred to above. No liability has been recorded for any of
the purported class action suits as management believes that, based on input
from outside legal counsel, it is remotely possible that the Court of Appeals
could reverse the decision of the lower Court in the ID Security Systems Canada
Inc. litigation as it relates to the antitrust claims.
On February 28, 2003 a civil action was filed in the Superior Court of New
Jersey, Bergen County, by Franklin Graphics, Inc. against Checkpoint Systems,
Inc. and Christopher Clarke, (Docket No. BER-L-1575-03) seeking compensatory
damages in excess of $1 million, treble damages, punitive damages, and
attorneys' fees. The plaintiff alleges tortious interference with a contractual
relationship and prospective economic relations, unfair competition, violation
of duty loyalty, breach of contract and consumer fraud.
The factual basis for the suit may be summarized as follows. The Company
performed clothing label tag printing services as a subcontractor to the
plaintiff for a number of apparel manufacturers who were customers of the
plaintiff. Co-defendant Clarke was an employee of the plaintiff who had
responsibility for interfacing with apparel manufacturers and the Company.
Co-defendant Clarke left the plaintiff's employment early in 2002, establishing
his own business. Subsequently, co-defendant Clarke joined the Company as an
employee. Certain of the plaintiff's customers ceased doing business with the
plaintiff and engaged Checkpoint directly to perform the clothing label tag
printing services.
The Company disputes any liability to the plaintiff and intends to defend this
matter vigorously. The Company filed a motion to dismiss the consumer
fraud/treble damage claim, and the Court denied that motion in August 2003. The
Company has since filed an answer denying liability, a counterclaim for
approximately $0.1 million for goods and services provided, and its own
counterclaim under the consumer fraud statute. Management is unable to predict
the outcome of this proceeding, but does not believe that the ultimate
resolution will have a material adverse affect on the consolidated financial
position or results of operations of the Company, however, if such matter were
determined adversely to the Company, the ultimate liability arising therefrom
should not be material to the financial position of the Company, but could be
material to its results of operations in any quarter or annual period.
The Company is a plaintiff in a number of patent infringement suits around the
world against various defendants in an effort to enforce certain of the
Company's intellectual property rights. In each of these proceedings, the
defendants have challenged the validity of the Company's patents. In the event
the relevant patent were to be modified or invalidated, such action could
diminish or eliminate the value to the Company of the relevant patent.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
99.1 Exhibit 31.1
Rule 13a-14(a)/15d-14(a) Certification of George W. Off, Chairman
of the Board, President and Chief Executive Officer.
99.2 Exhibit 31.2
Rule 13a-14(a)/15d-14(a) Certification of W. Craig Burns,
Executive Vice President, Chief Financial Officer and Treasurer.
99.3 Exhibit 32.1
Certification pursuant to 18 U.S. C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
On September 24, 2003, the Company filed a Current Report on Form 8-K
attaching a press release dated September 23, 2003, announcing that it
would redeem $35 million of the aggregate principal amount of its existing
5-1/4% Convertible Subordinated Debentures due 2005.
On October 24, 2003, the Company filed a Current Report on Form 8-K
attaching a press release dated October 23, 2003, announcing its financial
results for the third quarter of 2003.
SIGNATURES
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Pursuant to the requirements 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.
CHECKPOINT SYSTEMS, INC.
/s/W. Craig Burns October 31, 2003
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W. Craig Burns
Executive Vice President,
Chief Financial Officer and Treasurer
/s/Arthur W. Todd October 31, 2003
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Arthur W. Todd
Vice President, Corporate Controller
and Chief Accounting Officer
INDEX TO EXHIBITS
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Exhibit Description
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99.1 Exhibit 31.1
Rule 13a-14(a)/15d-14(a) Certification of George W. Off, Chairman
of the Board, President and Chief Executive Officer.
99.2 Exhibit 31.2
Rule 13a-14(a)/15d-14(a) Certification of W. Craig Burns,
Executive Vice President, Chief Financial Officer and Treasurer.
99.3 Exhibit 32.1
Certification pursuant to 18 U.S. C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.