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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 June 27, 2004
------------------------------------------------
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 July 30, 2004 there were 37,581,786 shares of the Registrant's 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
(Loss)/Income 6
Consolidated Statements of Cash Flows 7
Notes to Consolidated Financial Statements 8-19
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 28-30
Item 4. Submission of Matters to a Vote of
Security Holders 31
Item 6. Exhibits and Reports on Form 8-K 32
SIGNATURES 33
INDEX TO EXHIBITS 34
CHECKPOINT SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
June 27, Dec. 28,
2004 2003
-------- --------
(Unaudited)
ASSETS (Thousands)
CURRENT ASSETS
Cash and cash equivalents $ 68,452 $110,376
Accounts receivable, net of allowances
of $13,020 and $12,003 140,793 137,494
Inventories 91,636 80,986
Other current assets 31,960 32,170
Deferred income taxes 12,926 13,076
-------- --------
Total current assets 345,767 374,102
REVENUE EQUIPMENT ON OPERATING LEASE, net 4,073 4,002
PROPERTY, PLANT, AND EQUIPMENT, net 94,322 100,393
GOODWILL 209,296 212,206
OTHER INTANGIBLES, net 50,510 53,446
OTHER ASSETS 26,979 29,173
-------- --------
TOTAL ASSETS $730,947 $773,322
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Short-term borrowings and current
portion of long-term debt $ 23,141 $ 79,437
Accounts payable 44,745 62,833
Accrued compensation and related taxes 29,580 36,911
Other accrued expenses 32,214 31,653
Income taxes 22,858 28,120
Unearned revenues 24,661 27,813
Restructuring reserve 8,598 10,173
Other current liabilities 35,851 20,272
-------- --------
Total current liabilities 221,648 297,212
LONG-TERM DEBT, LESS CURRENT MATURITIES 33,102 42,601
CONVERTIBLE SUBORDINATED DEBENTURES 23,257 23,753
ACCRUED PENSIONS 64,734 65,871
OTHER LONG-TERM LIABILITIES 17,941 19,588
MINORITY INTEREST 1,040 1,007
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Preferred stock, no par value, authorized
500,000 shares, none issued
Common Stock, par value $.10 per share, 3,962 3,948
authorized 100,000,000 shares, issued
39,621,592 and 39,479,407
Additional capital 306,555 282,529
Retained earnings 92,409 93,422
Common stock in treasury, at cost,
2,043,856 shares and 4,640,631 shares (20,701) (47,003)
Accumulated other comprehensive loss (13,000) (9,606)
-------- --------
TOTAL SHAREHOLDERS' EQUITY 369,225 323,290
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $730,947 $773,322
======== ========
See accompanying notes to consolidated financial statements.
CHECKPOINT SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Quarter Six Months
(13 weeks) Ended (26 weeks) Ended
--------------------- ---------------------
June 27, June 29, June 27, June 29,
2004 2003 2004 2003
-------- -------- -------- --------
(Restated (Restated
see Note 14) see Note 14)
(Thousands, except per share data)
Net revenues $189,270 $175,720 $369,916 $332,137
Cost of revenues 112,220 100,109 221,659 193,377
-------- -------- -------- --------
Gross profit 77,050 75,611 148,257 138,760
Selling, general, and
administrative expenses 63,558 56,623 125,435 111,520
Other operating expense 19,950 - 19,950 -
-------- -------- -------- --------
Operating (loss)/income (6,458) 18,988 2,872 27,240
Interest income 332 385 785 724
Interest expense 1,473 2,928 3,653 5,971
Other (loss)/gain, net (169) (209) (113) 539
-------- -------- -------- --------
(Loss)/earnings before
income taxes (7,768) 16,236 (109) 22,532
Income taxes (1,350) 5,542 871 7,691
Minority interest 24 17 33 34
-------- -------- -------- --------
Net (loss)/earnings $ (6,442) $ 10,677 $ (1,013) $ 14,807
======== ======== ======== ========
Net (loss)/earnings per share:
Basic $ (.17) $ .33 $ (.03) $ .45
======== ======== ======== ========
Diluted $ (.17) $ .29 $ (.03) $ .42
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
CHECKPOINT SYSTEMS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(Unaudited)
Six Months (26 weeks) Ended June 27, 2004
-----------------------------------------------------
Accumu-
lated
Other
Addit- Compre-
Common ional Retained hensive Treasury
Stock Capital Earnings Loss Stock Total
------ ------- -------- ------- -------- -----
(Thousands)
Balance,
December 28, 2003 $3,948 $282,529 $ 93,422 $ (9,606) $(47,003) $323,290
(Common shares:
issued 39,479,407
reacquired 4,640,631)
Net (loss) (1,013) (1,013)
Exercise of stock
options 14 1,734 1,748
(142,185 shares)
Net gain on interest
rate swap 269 269
Subordinated debentures
conversion 22,292 26,302 48,594
Foreign currency
translation adjustment (3,663) (3,663)
------ -------- -------- -------- -------- --------
Balance,
June 27, 2004 $3,962 $306,555 $ 92,409 $(13,000) $(20,701) $369,225
====== ======== ======== ======== ======== ========
(Common shares:
issued 39,621,592
reacquired 2,043,856)
See accompanying notes to consolidated financial statements.
CHECKPOINT SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS)/INCOME
(Unaudited)
Quarter Six Months
(13 weeks) Ended (26 weeks) Ended
--------------------- --------------------
June 27, June 29, June 27, June 29,
2004 2003 2004 2003
------- ------- ------- -------
(Restated (Restated
see Note 14) see Note 14)
(Thousands)
Net (loss)/earnings $(6,442) $10,677 $(1,013) $14,807
Net gain/(loss) on interest
rate swap, net of tax 265 (19) 269 (64)
Foreign currency
translation adjustment (188) 11,479 (3,663) 16,268
------- ------- ------- -------
Comprehensive (loss)/income $(6,365) $22,137 $(4,407) $31,011
======= ======= ======= =======
See accompanying notes to consolidated financial statements.
CHECKPOINT SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months (26 weeks) Ended
---------------------------
June 27, June 29,
2004 2003
------- -------
(Restated
see Note 14)
(Thousands)
Cash flows from operating activities:
Net (loss)/earnings $ (1,013) $ 14,807
Adjustments to reconcile net earnings
to net cash provided by operating activities:
Depreciation and amortization 13,406 14,630
(Gain)/loss on disposal of fixed assets 161 (900)
(Increase)/decrease in current assets, net
of the effects of acquired companies:
Accounts receivable (2,818) 5,722
Inventories (12,700) (2,937)
Other current assets (1,544) (438)
Increase/(decrease) in current liabilities,
net of the effects of acquired companies:
Accounts payable (17,388) (4,193)
Income taxes (4,971) 1,413
Unearned revenues (2,791) (80)
Restructuring reserve (1,520) (1,319)
Other current and accrued liabilities 10,452 (3,076)
-------- --------
Net cash (used in)/provided by operating
activities $(20,726) $ 23,629
-------- --------
Cash flows from investing activities:
Acquisition of property, plant, and equipment (5,065) (7,801)
Acquisitions, net of cash acquired (155) -
Other investing activities 468 439
-------- --------
Net cash used in investing activities $ (4,752) $ (7,362)
-------- --------
Cash flows from financing activities:
Proceeds from stock issuances 1,525 914
Net change in short-term debt 2,820 998
Payment of long-term debt (19,213) (27,154)
-------- --------
Net cash used in financing activities $(14,868) $(25,242)
-------- --------
Effect of foreign currency rate fluctuations
on cash and cash equivalents (1,578) 2,484
-------- --------
Net decrease in cash and cash equivalents $(41,924) $ (6,491)
Cash and cash equivalents:
Beginning of period 110,376 54,670
-------- --------
End of period $ 68,452 $ 48,179
======== ========
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/A for
the fiscal year ended December 28, 2003 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 June 27, 2004 and December 28, 2003 and its results of
operations and changes in cash flows for the twenty-six week periods ended
June 27, 2004 and December 28, 2003.
Certain reclassifications have been made to the 2003 financial statements and
related footnotes to conform to the 2004 presentation.
Variable Interest Entity
- ------------------------
On February 3, 2004, the Company made a $2.5 million minority investment in
Goliath Solutions, a start-up developer of RFID-based technology for point-of-
purchase advertising and display compliance monitoring in the grocery,
chain-drug, mass merchandise, and convenience store channels of trade, which is
considered a variable interest entity (VIE). Management has determined that the
Company is the primary beneficiary and has therefore consolidated Goliath
Solutions' assets, liabilities, and results of operations in the Company's
consolidated financial statements. The creditors (or beneficial interest
holders) of Goliath Solutions have no recourse to the general credit of the
Company. As of June 27, 2004, the Company's investment in Goliath Solutions was
approximately $2.5 million, representing the Company's maximum exposure to loss.
Stock Options
- -------------
At June 27, 2004, the Company had 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 and net earnings per
share would approximate the pro-forma amounts as follows:
Quarter Six Months
(13 weeks) Ended (26 weeks) Ended
------------------- -------------------
June 27, June 29, June 27, June 29,
2004 2003 2004 2003
------- ------- ------- -------
(Restated (Restated
see Note 14) see Note 14)
(Thousands)
Net (loss)/earnings,
as reported $(6,442) $10,677 $(1,013) $14,807
Total stock-based
employee compensation
expense determined
under fair value
based method,
net of tax (255) (806) (723) (1,672)
------- ------- ------- -------
Pro-forma net
(loss)/earnings $(6,697) $ 9,871 $(1,736) $13,135
======= ======= ======= =======
Net (loss)/earnings
per share:
Basic, as reported $ (.17) $ .33 $ (.03) $ .45
======= ======= ======= =======
Basic, pro-forma $ (.18) $ .30 $ (.05) $ .40
======= ======= ======= =======
Diluted, as reported $ (.17) $ .29 $ (.03) $ .42
======= ======= ======= =======
Diluted, pro-forma $ (.17) $ .27 $ (.05) $ .38
======= ======= ======= =======
2. INVENTORIES
June 27, December 28,
2004 2003
------- -----------
(Thousands)
Raw materials $11,775 $ 8,285
Work in process 4,159 3,547
Finished goods 75,702 69,154
------- -------
$91,636 $80,986
======= =======
Inventories are stated at the lower of cost (first-in, first-out method)
or market.
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
3. GOODWILL AND OTHER INTANGIBLE ASSETS
The Company had intangible assets with a net book value of $50.5 million and
$53.4 million as of June 27, 2004 and December 28, 2003,
respectively.
The following table reflects the components of intangible assets as of
June 27, 2004 and December 28, 2003:
June 27, 2004 December 28, 2003
---------------------- ----------------------
Amortizable Gross Gross
Life Carrying Accumulated Carrying Accumulated
(years) Amount Amortization Amount Amortization
----------- -------- ------------ -------- ------------
(Thousands)
Customer lists 20 $30,299 $13,731 $31,020 $14,584
Trade name 30 27,699 4,540 28,226 3,763
Patents, license
agreements 5 to 14 36,776 26,649 37,362 25,439
Other 3 to 6 936 280 952 328
------- ------- ------- -------
$95,710 $45,200 $97,560 $44,114
======= ======= ======= =======
Estimated amortization expense for 2004 and each of the five succeeding years
is:
(Thousands)
2004 $3,948
2005 $3,885
2006 $3,652
2007 $3,600
2008 $3,578
2009 $3,571
The changes in the carrying amount of goodwill for the six months ended
June 27, 2004, are as follows:
Labeling Retail
Security Services Merchandising Total
-------- -------- ------------- -------
(Thousands)
Balance as of
beginning of
fiscal year 2004
(December 29, 2003) $106,095 $38,433 $67,678 $212,206
Goodwill acquired
during year 593 - - 593
Exchange rate changes (1,882) (209) (1,412) (3,503)
------- ------- ------- --------
Balance as of
June 27, 2004 $104,806 $38,224 $66,266 $209,296
======== ======= ======= ========
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
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.
4. LONG-TERM DEBT
Long-term debt at June 27, 2004 and December 28, 2003 consisted of the
following:
June 27, December 28,
2004 2003
------- -----------
(Thousands)
EUR 244 million variable interest
rate term loan maturing in 2006 $37,942 $45,863
$100 million multi-currency variable
interest rate revolving credit
facility maturing in 2006 2,784 2,791
EUR 9.5 million capital lease
maturing in 2021 10,341 10,733
EUR 2.7 million capital lease
maturing in 2007 1,462 1,693
Other capital lease maturing
in 2004 - 27
------- -------
Total 52,529 61,107
Less current portion 19,427 18,506
------- -------
Total long-term portion (excluding
convertible subordinated debentures) 33,102 42,601
Convertible subordinated debentures 23,257 83,753
Less called portion of convertible
subordinated debentures - 60,000
------- -------
Total long-term portion $56,359 $66,354
======= =======
At June 27, 2004, EUR 31.2 million (approximately $37.9 million) was outstanding
under the multi-currency term loan. The outstanding borrowings under the
revolving credit facility were JPY 300 million (approximately $2.8 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 the ID Security Systems
Canada Inc. litigation.
On February 18, 2004, the Company called $60.0 million of the convertible
subordinated debentures for redemption on April 13, 2004. The debentures were
convertible into common stock at a conversion price of $18.375 per share. Of
the called debentures, $47.2 million were converted into 2.570 million shares
of the Company's common stock and $12.8 million were redeemed for cash.
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
5. INCOME TAXES
Income taxes are provided on an interim basis at an estimated effective annual
tax rate. The Company's earnings generated by the operations of its Puerto Rico
subsidiary are partially 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. 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 Six Months
(13 weeks) Ended (26 weeks) Ended
------------------- --------------------
June 27, June 29, June 27, June 29,
2004 2003 2004 2003
------- ------- ------- -------
(Restated (Restated
see Note 14) see Note 14)
(Thousands, except per share amounts)
Basic (loss)/earnings
per share:
Net (loss)/earnings $(6,442) $10,677 $(1,013) $14,807
======= ======= ======= =======
Weighted average common
stock outstanding 37,576 32,762 36,271 32,743
======= ======= ======= =======
Basic (loss)/earnings
per share $ (.17) $ .33 $ (.03) $ .45
======= ======= ======= =======
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Diluted (loss)/earnings
per share:
Net (loss)/earnings $(6,442) $10,677 $(1,013) $14,807
Interest on subordinated
debentures, net of tax (1) - 961 - 1,921
------- ------- ------- -------
Net (loss)/earnings available
for dilutive securities $(6,442) $11,638 $(1,013) $16,728
======= ======= ======= =======
Weighted average common
stock outstanding 37,576 32,762 36,271 32,743
Additional common shares
resulting from stock
options (2) 837 501 951 296
Additional common shares
resulting from subordinated
debentures (1) - 6,528 - 6,528
------- ------- ------- -------
Weighted average common
stock and dilutive stock
outstanding 38,413 39,791 37,222 39,567
======= ======= ======= =======
Diluted (loss)/earnings
per share $ (.17) $ .29 $ (.03) $ .42
======= ======= ======= =======
(1) The conversion of 1,266 and 2,902 common shares for the second quarter
and the first six months of 2004, respectively, from the subordinated
debentures is not included as it is anti-dilutive.
(2) Excludes approximately 1,258, 1,179, 1,023 and 1,816 anti-dilutive
outstanding stock options for the second quarters of 2004 and 2003, and
the first six months of 2004 and 2003, respectively.
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 twenty-six week
periods ended June 27, 2004 and June 29, 2003 were as follows:
Quarter Six Months
(13 weeks) Ended (26 weeks) Ended
-------------------- --------------------
June 27, June 29, June 27, June 29,
2004 2003 2004 2003
------- ------- ------- -------
(Thousands)
Interest $1,940 $4,514 $3,010 $5,988
Income tax payments, net $2,078 $4,153 $2,328 $3,107
During the first six months of 2004, $47.7 million of convertible
subordinated debentures were converted into 2.597 million shares of the
Company's common stock.
8. PROVISION FOR RESTRUCTURING
Accrual Cash Accrual
at Payments at
Beginning (and Exchange March 28,
of 2004 Rate Changes) 2004
--------- ------------ --------
(Thousands)
Severance and other employee-
related charges $ 8,878 $ (679) $ 8,199
Lease termination costs 1,295 (74) 1,221
------- ------- -------
$10,173 $ (753) $ 9,420
======= ======= =======
Accrual Cash Accrual
at Payments at
March 28, (and Exchange June 27,
2004 Rate Changes) 2004
-------- ------------ -------
(Thousands)
Severance and other employee-
related charges $ 8,199 $ (764) $ 7,435
Lease termination costs 1,221 (58) 1,163
------- ------- -------
$ 9,420 $ (822) $ 8,598
======= ======= =======
At the end of the second quarter 2004, 395 of the 512 planned employee
terminations, related to the 2003 restructuring, had occurred. The Company
expects the terminations and restructuring actions to be completed by the end
of 2005. Termination benefits are being paid out over a period of
1 to 24 months after termination.
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
9. OTHER OPERATING EXPENSE
On August 1, 2004, the Company and ID Security Systems Canada Inc. entered
into a settlement agreement effective July 30, 2004, pursuant to which the
Company agreed to pay $19.95 million, in full and final settlement of the
claims covered by the litigation between the two companies (see Note 11).
Payment in full was made on August 5, 2004.
10. PENSION BENEFITS
The components of net periodic benefit cost for the thirteen and twenty-six
week periods ended June 27, 2004 and June 29, 2003 were as follows:
Quarter Six Months
(13 weeks) Ended (26 weeks) Ended
-------------------- --------------------
June 27, June 29, June 27, June 29,
2004 2003 2004 2003
------- ------- ------- -------
Service cost $ 329 $ 336 $ 681 $ 638
Interest cost 927 824 1,860 1,617
Expected return on plan
assets 1 1 2 2
Amortization of prior
service cost 1 - 2 1
Amortization of net
loss 28 26 57 51
------- ------- ------- -------
Net benefit cost $ 1,284 $ 1,185 $ 2,598 $ 2,305
======= ======= ======= =======
The Company expects the cash requirements for funding the pension benefits to be
approximately $3.4 million during fiscal 2004, including $0.7 million which was
funded during the quarter ended June 27, 2004.
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
11. 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.
ID Security Systems Canada Inc. versus Checkpoint Systems, Inc.
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. On
May 20, 2003, the Court further reduced the judgment from $13 million to
$10.9 million. On the same date, the Court stayed execution of the judgment upon
the posting of a bond in the amount of $11.3 million by the Company.
Both ID Security Systems Canada Inc. and the Company filed appeals to the Third
Circuit Court of Appeals related to the various decisions of the Court. Oral
arguments for these appeals were heard on March 30, 2004. On August 1, 2004, the
Company and ID Security Systems Canada Inc. entered into a settlement agreement
effective July 30, 2004, pursuant to which the Company agreed to pay
$19.95 million, in full and final settlement of the claims covered by the
litigation. Payment in full was made on August 5, 2004. The Company
does not admit or acknowledge any wrongdoing or liability regarding the
litigation. In connection with the settlement, the parties have mutually
released each other from all other claims, except for any claims relating to
existing contracts between the parties. A release in favor of the Company was
also provided by various affiliates and associates of ID Security Systems
Canada Inc. Management believes that the settlement is in the best interest of
the Company to avoid the risks, burden, and expenses of continued litigation.
Matters related to ID Security Systems Canada Inc. versus Checkpoint Systems,
Inc.
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.
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
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. As a result of the settlement of the litigation with
ID Security Systems Canada Inc. described above, an application can be made to
the Court to dissolve the Stay Order at this time.
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.
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
The following table set forth the movement in the warranty reserve:
Quarter Six Months
(13 weeks) Ended (26 weeks) Ended
-------------------- --------------------
June 27, June 29, June 27, June 29,
2004 2003 2004 2003
------- ------- ------- -------
(Thousands)
Balance at the beginning
of the period $ 4,636 $ 4,111 $ 4,591 $ 4,002
Accruals for warranties
issued $ 489 $ 280 $ 795 $ 496
Accruals related to
pre-existing warranties,
including changes
in estimate 15 - 15 -
------- ------- ------- -------
Total accruals $ 504 $ 280 $ 810 $ 496
Settlement made (423) (204) (627) (385)
Foreign currency
translation adjustment 36 186 (21) 260
------- ------- ------- -------
Balance at the end of period $ 4,753 $ 4,373 $ 4,753 $ 4,373
======= ======= ======= =======
12. BUSINESS SEGMENTS
Quarter Six Months
(13 weeks) Ended (26 weeks) Ended
-------------------- --------------------
June 27, June 29, June 27, June 29,
2004 2003 2004 2003
-------- -------- -------- --------
(Thousands)
Business segment net revenues:
Security $120,666 $111,962 $233,195 $204,726
Labeling Services 41,446 39,392 82,486 78,015
Retail Merchandising 27,158 24,366 54,235 49,396
-------- -------- -------- --------
Total $189,270 $175,720 $369,916 $332,137
======== ======== ======== ========
Business segment gross profit:
Security $ 55,847 $ 51,921 $103,864 $ 91,563
Labeling Services 11,985 11,724 22,642 23,047
Retail Merchandising 9,218 11,966 21,751 24,150
-------- -------- -------- --------
Total gross profit $ 77,050 $ 75,611 $148,257 $138,760
Operating expenses 83,508 56,623 145,385 111,520
Interest expense, net 1,141 2,543 2,868 5,247
Other (loss)/gain, net (169) (209) (113) 539
-------- -------- -------- --------
(Loss)/earnings before
income taxes $ (7,768) $ 16,236 $ (109) $ 22,532
======== ======== ======== ========
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
13. NEW ACCOUNTING PRONOUNCEMENTS AND OTHER STANDARDS
No new accounting pronouncements and other standards material to the Company
were issued in the first six months of 2004.
14. RESTATEMENT
On May 21, 2004 the Company filed Amendment No. 1 to the Annual Report on
Form 10-K for the fiscal year ended December 28, 2003 (Form 10-K/A) to restate
the Company's financial results for the fiscal years 2002 and 2003 following the
Company's discovery of errors in the computation of its income tax expense
relating to tax credits on the income from the Company's Puerto Rico operations
as well as certain foreign income inclusions for U.S. tax purposes for fiscal
years 2002 and 2003. The effect of the adjustments was to increase income tax
expense and decrease net earnings by $3.6 million in fiscal year 2002 and
$0.7 million in fiscal year 2003.
The Company has also restated its consolidated balance sheet at
December 28, 2003 and its consolidated statements of operations for the quarter
and six months ended June 29, 2003 that are included in this quarterly report
on Form 10-Q.
In 1996, Congress revised the Section 936 credit for U.S. manufacturers doing
business in Puerto Rico. The tax credits expire for fiscal years beginning after
December 31, 2005. The U.S. Internal Revenue Code provides limitations on the
use of the tax credits during a phase-out period for years 2002-2005. The
Company made an error in computing the limitation during the phase-out period.
The effects of the adjustments are summarized as follows:
Previously As
reported restated
---------- --------
Consolidated Statement of Operations
for the Quarter ended June 29, 2003
Income taxes $ 5,357 $ 5,542
Net earnings $ 10,862 $ 10,677
Consolidated Statement of Operations
for the six months ended June 29, 2003
Income taxes $ 7,435 $ 7,691
Net earnings $ 15,063 $ 14,807
The restatement reduced the diluted earnings per share for the quarter ended
June 29, 2003 from $.30 to $.29 and for the six months ended June 29, 2003
from $.43 to $.42, but had no effect on cash flows.
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 Companys 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 pending litigation affecting the Company; and (15) the impact
of adverse determinations in pending 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/A for the year ended December 2003, 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/A filed for
the year ended December 28, 2003.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Management's discussion and analysis of financial condition and results of
operations reflects the restatement of the Company's financial statements for
the fiscal years 2002 and 2003 following the Company's discovery of errors in
the computation of its income tax expense relating to tax credits on the income
from the Company's Puerto Rico operations as well as certain foreign income
inclusions for U.S. tax purposes for fiscal years 2002 and 2003. See Note 14 to
the Consolidated Financial Statements.
Second Quarter 2004 Compared to Second Quarter 2003
- ---------------------------------------------------
Net Revenues
Revenues for the second quarter 2004 compared to the second quarter 2003
increased by $13.6 million or 7.7% from $175.7 million to $189.3 million.
Foreign currency translation had a positive impact on revenues of approximately
$7.6 million or 4.3% in the second quarter of 2004 as compared to the second
quarter of 2003.
Security revenues increased by $8.7 million or 7.8% in the second quarter of
2004 as compared to the second quarter of 2003. Foreign currency translation had
positive impact of approximately $4.5 million. The remaining increase was
primarily due to growth in the closed-circuit television (CCTV) market in the
USA, Japan, and Canada, partially offset by a decline in European electronic
article surveillance (EAS) sales of $2.4 million. The growth in the US CCTV
revenues of $4.8 million can be primarily attributed to enhanced products and
applications, as well as a focus on customer service. Labeling services revenues
increased by $2.1 million or 5.2% of which approximately $1.7 million was due to
the positive impact of foreign currency translation. Increases in barcode
labeling systems (BCS) revenues in the USA ($0.8 million), Check-Net revenues
in Europe ($0.7 million) and Asia Pacific ($0.7 million), and radio frequency
identification (RFID) library system revenues outside the USA ($0.6 million)
were largely offset by lower BCS revenues in Europe ($2.4 million) caused by
weak retail trading and price competition. Retail merchandising revenues
increased by $2.8 million or 11.4%. The positive impact of foreign currency
translation was approximately $1.4 million. The remaining increase was primarily
due to an increase of $1.5 million in retail display system revenues in Europe
partially offset by continued decreases in hand-held labeling systems (HLS) in
Europe and the USA. The continuing transition from hand-held price labeling to
automated barcoding and scanning by retailers caused the decline in HLS.
Gross Profit
Gross profit for the second quarter 2004 was $77.1 million, or 40.7% of
revenues, compared to $75.6 million, or 43.0% of revenues, for the second
quarter 2003. The benefit of foreign currency translation on gross profit was
approximately $3.0 million in the second quarter of 2004 as compared to the
second quarter of 2003. Included in gross profit are research and development
costs, which increased from $3.0 million, or 1.7% of revenues, in the second
quarter of 2003 to $6.9 million, or 3.6% of revenues, in the second
quarter of 2004.
Security gross profit, as a percentage of sales, decreased from 46.4% in the
second quarter of 2003 to 46.3% in the second quarter of 2004. Improvements in
manufacturing efficiencies and the benefits of a weaker U.S. dollar on
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
products sourced in U.S. dollars but sold in a different currency were offset by
increases in field service costs due to large roll-outs. The increase in CCTV
revenues as a percentage of security revenues also impacted the security gross
profit percentage negatively. Gross profit, as a percentage of net revenues, for
labeling services declined from 29.8% in the second quarter of 2003 to
28.9% in the second quarter of 2004. Increased technology spending on RFID
library products primarily caused the decline. The retail merchandising gross
profit, as a percentage of net revenues, declined from 49.1% in the second
quarter of 2003 to 33.9% in the second quarter 2004. The decrease in gross
profit as a percentage of net revenues resulted from an increase of $3.7 million
in RFID technology spending to support the development of supply chain and
in-store merchandising solutions for US and European retailers.
Field service and installation costs for the second quarter of 2004 and 2003
were 9.2% and 8.7% of net revenues, respectively. The increase, as a percentage
of net revenues, resulted from an increase in CCTV installations relative to
total net revenues.
Selling, General, and Administrative Expenses
SG&A expenses increased $6.9 million over the second quarter of 2003. Foreign
currency translation increased SG&A expenses by approximately $2.5 million. As
a percentage of net revenues, SG&A expenses increased from 32.2% to 33.5% due
primarily to the Company's ongoing commitment to invest in selling and
marketing.
Other Operating Expense
On August 1, 2004, the Company and ID Security Systems Canada Inc. (ID Systems)
entered into a settlement agreement effective July 30, 2004, pursuant to which
the Company agreed to pay $19.95 million, in full and final settlement of the
claims covered by the litigation between the two companies (see Note 11 of the
Consolidated Financial Statements). Payment in full was made on August 5, 2004.
Interest Expense and Interest Income
Interest expense for the second quarter of 2004 decreased $1.5 million from the
comparable quarter in 2003 due to debt repayment and the conversion of
subordinated debentures into shares of the Company's common stock. Interest
income for the second quarter of 2004 decreased by $0.1 million from the
comparable quarter in 2003 (from $0.4 million to $0.3 million) as a result of
lower interest rates in the second quarter of 2004.
Other (Loss)/Gain, net
Other (loss)/gain, net resulted from net foreign currency transaction losses of
$(0.2) million for the second quarters of 2004 and 2003.
Income Taxes
Excluding the tax impact of the ID Systems settlement, the effective tax rate
for the second quarter 2004 was 30.6%. For the second quarter 2003, the
effective tax rate was 34.1%. The 2003 effective tax rate included an increase
in tax related to a change in valuation allowance and an increase in deferred
foreign withholding taxes. These items are not reflected in the 2004 effective
tax rate. The Company recorded a tax benefit on the ID Systems settlement at
the US statutory rate. However, as the ID Systems settlement created a taxable
loss in the US, the Company recorded a valuation allowance of $1.9 million on
US deferred tax assets related to foreign tax credit carryforwards.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Net (Loss)/Earnings
Net (loss)/earnings were $(6.4) million, or $(0.17) per diluted share, in the
second quarter 2004 compared to $10.7 million, or $0.29 per diluted share, in
the second quarter 2003. The ID Systems settlement resulted in a reduction of
net earnings of $14.9 million, or approximately $0.39 per diluted share. The
weighted average number of shares used in the diluted earnings per share
computation were 38.4 million and 39.8 million for the second quarters of 2004
and 2003, respectively.
First Half 2004 Compared to First Half 2003
- -------------------------------------------
Net Revenues
Revenues for the first six months of 2004 compared to the same period in 2003
increased by $37.8 million or 11.4% from $332.1 million to $369.9 million.
Foreign currency translation had a positive impact on revenues of approximately
$23.1 million or 7.0% in the first half of 2004 as compared to the second half
of 2003.
Security revenues increased by $28.5 million or 13.9% in the first six months of
2004 as compared to the first six months of 2003. Foreign currency translation
had a positive impact of approximately $13.3 million. The remaining increase was
primarily due to growth in the closed-circuit television (CCTV) market in the
USA, Japan, and the UK and in the electronic article surveillance (EAS) market
in Asia Pacific, partially offset by a $3.6 million decline in European EAS
sales. The growth in the US CCTV revenues can be primarily attributed to
enhanced products and applications, as well as a focus on customer service.
Labeling services revenues increased by $4.5 million or 5.7% due to the
positive impact of foreign currency translation of approximately $5.0 million.
The remaining decrease was primarily due to lower barcode labeling systems (BCS)
revenues in Europe ($4.1 million) caused by weak retail trading and price
competition and a decrease in radio frequency identification (RFID) library
system revenues in the USA ($2.0 million) resulting from the timing of several
large orders that were recognized in the first quarter of 2003. This was largely
offset by increases in BCS revenues in the USA ($2.3 million) and Check-Net
revenues in Europe ($1.6 million) and Asia Pacific ($1.1 million). Retail
merchandising revenues increased by $4.8 million or 9.8%. The positive impact of
foreign currency translation was approximately $4.8 million. Increased retail
display system revenues in Europe of $1.7 million were offset by decreased
hand-held labeling system (HLS) revenues in Europe and the USA. The continuing
transition from hand-held price labeling to automated barcoding and scanning by
retailers caused the decline in HLS.
Gross Profit
Gross profit for the first half of 2004 was $148.3 million, or 40.1% of
revenues, compared to $138.8 million, or 41.8% of revenues, for the first half
of 2003. The benefit of foreign currency translation on gross profit was
approximately $9.4 million in the first six months of 2004 as compared to the
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
same period in 2003. Included in gross profit are research and development
costs, which increased from $5.4 million, or 1.6% of revenues, in the first half
of 2003 to $12.4 million, or 3.4% of revenues, in the first half of 2004.
Security gross profit, as a percentage of sales, decreased from 44.7% in the
first six months of 2003 to 44.5% in the first six months of 2004. Improvements
in manufacturing efficiencies and the benefits of a weaker U.S. dollar on
products sourced in U.S. dollars but sold in a different currency were more
than offset by increases in field service costs due to large roll-outs and a
$1.6 million increase in technology spending. The increase in CCTV revenues as a
percentage of security revenues also impacted the security gross profit
percentage negatively. Gross profit, as a percentage of net revenues, for
labeling services declined from 29.5% in the first half of 2003 to 27.4% in the
first half of 2004. Increased technology spending of $1.1 million on RFID
library products and competitive pricing pressures primarily caused the decline.
The retail merchandising gross profit, as a percentage of net revenues,
declined from 49.1% in the first six months of 2003 to 40.1% in the comparable
period of 2004. The decrease resulted primarily from a $4.3 million increase in
RFID technology spending to support the development of supply chain and in-store
merchandising solutions for US and European retailers.
Field service and installation costs for the first half of 2004 and 2003 were
9.4% and 8.8% of net revenues, respectively. The increase, as a percentage of
net revenues, resulted from an increase in CCTV installations relative to total
net revenues.
Selling, General, and Administrative Expenses
SG&A expenses increased $13.9 million over the first six months of 2003. Foreign
currency translation increased SG&A expenses by approximately $7.8 million. As a
percentage of net revenues, SG&A expenses increased from 33.6% to 33.9% due to
the Company's increased investment in selling and marketing.
Other Operating Expense
On August 1, 2004, the Company and ID Security Systems Canada Inc. entered into
a settlement agreement effective July 30, 2004, pursuant to which the Company
agreed to pay $19.95 million, in full and final settlement of the claims covered
by the litigation between the two companies (see Note 11 of the Consolidated
Financial Statements). Payment in full was made on August 5, 2004.
Interest Expense and Interest Income
Interest expense for the first six months of 2004 decreased $2.3 million from
the comparable quarter in 2003 due to debt repayment and the conversion of
subordinated debentures into shares of the Company's common stock. Interest
income for the first half of fiscal 2004 increased by $0.1 million from the
comparable quarter in 2003 (from $0.7 million to $0.8 million). Higher cash
balances in the first six months of 2004 were largely offset by lower interest
rates during the same period.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Other (Loss)/Gain, net
Other (loss)/gain, net resulted from net foreign currency transaction losses of
$(0.1) million in the first half of fiscal 2004 and gains of $0.5 million in
the first half of fiscal 2003.
Income Taxes
Excluding the tax impact of the ID Systems settlement, the effective tax rate
for the first six months of 2004 was 30.0%. For the same period in 2003, the
effective tax rate was 34.1%. The 2003 effective tax rate included an increase
in tax related to a change in valuation allowance and an increase in deferred
foreign withholding taxes. These items are not reflected in the 2004 effective
tax rate. The Company recorded a tax benefit on the ID Systems settlement at
the US statutory tax rate. However, as the ID Systems settlement created a
taxable loss in the US, the Company recorded a valuation allowance of
$1.9 million on US deferred tax assets related to foreign tax credit
carryforwards.
Net (Loss)/Earnings
The Company's net (loss)/earnings were $(1.0) million, or $(0.03) per diluted
share, for the first six months of 2004 compared to $14.8 million, or $0.42 per
diluted share, in the same period of 2003. The ID Systems settlement resulted
in a reduction of net earnings of $14.9 million, or approximately $0.39 per
diluted share. The weighted average number of shares used in the diluted
earnings per share computation were 37.2 million and 39.6 million for the first
six months of 2004 and 2003, respectively.
Exposure to International Operations
Approximately 65.4% 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.
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.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
The Company's operating activities utilized approximately $20.7 million during
the first six months of 2004 compared to $23.6 million generated in the same
period of 2003. This change from the prior year was primarily attributable to a
reduction in accounts payable and accrued compensation of $24.2 million and
increases of $12.7 million in inventories and $2.8 million in accounts
receivable due to increased revenues. The ID Systems settlement was not paid
until the third quarter 2004 and is included in other current liabilities.
At June 27, 2004, EUR 31.2 million (approximately $37.9 million) was
outstanding under the multi-currency term loan. The outstanding borrowings under
the revolving credit facility were JPY 300 million (approximately $2.8 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 the ID Security Systems
Canada Inc. litigation.
At June 27, 2004, the Company was in compliance with its debt covenants.
On February 18, 2004, the Company called $60.0 million of its convertible
subordinated debentures for redemption on April 13, 2004. The debentures
were convertible into common stock at a conversion price of $18.375 per share.
Of the called debentures, $47.2 million were converted into 2.570 million
shares of the Company's common stock and $12.8 million were redeemed for cash.
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.
On May 20, 2003, the Court further reduced the judgment from $13 million to
$10.9 million. On the same date, the Court stayed execution of the judgment upon
the posting of a bond in the amount of $11.3 million by the Company.
Both ID Security Systems Canada Inc. and the Company filed appeals to the
Third Circuit Court of Appeals related to the various decisions of the Court.
Oral arguments for these appeals were heard on March 30, 2004. On
August 1, 2004, the Company and ID Security Systems Canada Inc. entered into a
settlement agreement effective July 30, 2004, pursuant to which the Company
agreed to pay $19.95 million, in full and final settlement of the claims
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
covered by the litigation. Payment in full was made on August 5, 2004 from cash
on hand and borrowing capacity. Subsequent to the payment, management continues
to believe 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.
Capital Expenditures
The Company's capital expenditures during the first half of fiscal 2004 totaled
$5.1 million compared to $7.8 million during the first half of fiscal 2003.
The decrease in 2004 principally resulted from lower manufacturing-related
investments. The Company anticipates capital expenditures to primarily upgrade
technology and improve its production capabilities to total approximately
$14 million in 2004.
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 on the
inter-company receivables and payables. Additionally, the sourcing of product in
one currency and the sales of product in a different currency can cause gross
margin fluctuations due to changes in currency exchange rates.
The Company selectively purchases currency forward exchange contracts to reduce
the risks of currency fluctuations on short-term inter-company receivables and
payables. These contracts lock in 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 June 27, 2004, the Company had currency forward exchange contracts
totaling approximately $33.8 million. The contracts are in the various local
currencies covering primarily the Company's Western European, Canadian, and
Australian operations. Historically, the Company has not purchased currency
forward exchange 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. The Company has used third party
borrowings in foreign currencies to hedge a portion of its net investments in
and cash flows derived from its foreign subsidiaries. As the Company reduces its
third party foreign currency borrowings, the effect of foreign currency
fluctuations on its net investments in and cash flows derived from its
foreign subsidiaries increases.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
OTHER MATTERS
- -------------
New Accounting Pronouncements and Other Standards
No new accounting pronouncements and other standards material to the Company
were issued in the second quarter of 2004.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no significant changes to the market risks as disclosed in
Item 7a. "Quantitative And Qualitative Disclosures About Market Risk" of the
Company's Annual Report on Form 10-K/A filed for the year ended
December 28, 2003.
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.
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.
ID Security Systems Canada Inc. versus Checkpoint Systems, Inc.
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 tortuous
interference and unfair competition from $19 million to $13 million. On
May 20, 2003, the Court further reduced the judgment from $13 million to
$10.9 million. On the same date, the Court stayed execution of the judgment upon
the posting of a bond in the amount of $11.3 million by the Company.
Both ID Security Systems Canada Inc. and the Company filed appeals to the Third
Circuit Court of Appeals related to the various decisions of the Court. Oral
arguments for these appeals were heard on March 30, 2004. On August 1, 2004, the
Company and ID Security Systems Canada Inc. entered into a settlement agreement
effective July 30, 2004, pursuant to which the Company agreed to pay $19.95
million, in full and final settlement of the claims covered by the litigation.
Payment in full was made on August 5, 2004. The Company does not admit
or acknowledge any wrongdoing or liability regarding the litigation. In
connection with the settlement, the parties have mutually released each other
from all other claims, except for any claims relating to existing contracts
between the parties. A release in favor of the Company was also provided by
various affiliates and associates of ID Security Systems Canada Inc. Management
believes that the settlement is in the best interest of the Company to avoid the
risks, burden, and expenses of continued litigation.
Matters related to ID Security Systems Canada Inc. versus Checkpoint
Systems, Inc.
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. As a result of the settlement of the litigation with ID
Security Systems Canada Inc. described above, an application can be made to the
Court to dissolve the Stay Order at this time.
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.
All-Tag Security S.A., et al.
On April 22, 2004 the United States District Court For The Eastern District Of
Pennsylvania issued an opinion granting All-Tag Security S.A. and All-Tag
Security Americas, Inc.'s (jointly "All-Tag") and Sensormatic Electronics
Corporation's motion for summary judgment, which was filed on February 15, 2002,
and ordered the case closed. The Company originally filed suit on May 1, 2001,
alleging that the disposable, deactivatable radio frequency security tag
manufactured by All-Tag S.A. and sold by Sensormatic infringed on a patent owned
by the Company. The Court determined that the US patent is invalid because the
original application failed to identify a co-inventor. The original US
application was filed in March 1988 and was scheduled to expire on
March 15, 2008. The Company acquired the patent in 1995 when it acquired
Actron AG. On May 24, 2004, the Company filed a Notice of Appeal to the
District Court's decision. The Company's appeal is currently pending before the
United States Court of Appeals for the Federal Circuit.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) An annual meeting of shareholders was held on April 29, 2004.
(b) Directors elected at the meeting were: William S. Antle, III,
W. Craig Burns, John E. Davies, Jr., and R. Keith Elliott. Directors whose
term of office as a director continued after the meeting are:
Robert O. Aders, David W. Clark, Jr., Alan R. Hirsig, George W. Off,
Jack W. Partridge and Sally Pearson
(c) Shareholders voted upon the election and approved the following three
matters:
(1) The election of William S. Antle, III, W. Craig Burns, John E. Davies,
Jr., and R. Keith Elliott as the Company's Class I directors to hold
office until the 2007 Annual Shareholders Meeting. Shareholders voted
as follows:
William S. Antle, III W. Craig Burns John E. Davies Jr. R. Keith Elliott
--------------------- -------------- ------------------ ----------------
For 30,805,001 31,006,693 31,021,220 30,365,773
Against 836,861 635,169 620,642 1,276,089
---------- ---------- ---------- ----------
31,641,862 31,641,862 31,641,862 31,641,862
========== ========== ========== ==========
(2) To approve the Checkpoint Systems, Inc. 2004 Omnibus Incentive
Compensation Plan.
For Against Abstained Unvoted
---------- --------- ----------- ---------
18,924,082 5,169,525 75,759 7,472,496
(3) To approve the Checkpoint Systems, Inc. 423 Employee Stock Purchase
Plan:
For Against Abstained Unvoted
---------- --------- ----------- ---------
23,084,763 1,026,357 58,247 7,472,495
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
31.1 Rule 13a-14(a)/15d-14(a) Certification of George W. Off,
Chairman of the Board, President and Chief Executive Officer.
31.2 Rule 13a-a4(a)/15d-14(a) Certification of W. Craig Burns,
Executive Vice President, Chief Financial Officer and Treasurer.
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 April 14, 2004, the Company filed a Current Report on Form 8-K
attaching a press release dated April 14, 2004 announcing that the holders of
$47.2 million of the $60.0 million of aggregate principal amount of its existing
5-1/4% Convertible Subordinated Debentures due 2005 ("the Notes") called for
redemption on April 13, 2004, elected to convert their Notes into 2,569,797
shares of the Company's common stock at a conversion price of $18.375 per share.
The shares of Company common stock issuable as a result of the conversion are
freely-tradable, unrestricted shares.
On May 13, 2004 the Company filed a Current Report on Form 8-K attaching
a press release dated May 12, 2004 announcing that it intended to restate its
financial results for 2002 and 2003.
SIGNATURES
----------
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 August 5, 2004
- ----------------------------
W. Craig Burns
Executive Vice President,
Chief Financial Officer and Treasurer
/s/Arthur W. Todd August 5, 2004
- ----------------------------
Arthur W. Todd
Vice President, Corporate Controller
and Chief Accounting Officer
INDEX TO EXHIBITS
-----------------
Exhibit Description
- ---------- -----------
31.1 Rule 13a-14(a)/15d-14(a) Certification of George W.
Off, Chairman of the Board, President and Chief
Executive Officer
31.2 Rule 13a-4(a)/15d=14(a) Certification of W. Craig
Burns, Executive Vice President, Chief Financial
Officer and Treasurer
32.1 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 936 of the Sarbanes-Oxley
Act of 2002.