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CKP > SEC Filings for CKP > Form 10-Q on 8-Nov-2013All Recent SEC Filings

Show all filings for CHECKPOINT SYSTEMS INC

Form 10-Q for CHECKPOINT SYSTEMS INC


8-Nov-2013

Quarterly Report


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. Statements in this Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this quarterly report on Form 10-Q which express that we "believe," "anticipate," "expect" or "plan to" as well as other statements which are not historical fact, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to the safe harbors created under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended. These forward-looking statements reflect our current views with respect to future events and financial performance, and are subject to certain risks and uncertainties which could cause actual results to differ materially from historical results or those anticipated. Any such forward-looking statements may involve risk and uncertainties that could cause actual results to differ materially from any future results encompassed within the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited, to the following: the impact upon operations of legal and tax compliance matters or internal controls review, improvement and remediation, including the detection of wrongdoing, improper activities, or circumvention of internal controls; our ability to successfully implement our strategic plan; the impact of our working capital improvement initiatives; our ability to manage growth effectively including our ability to integrate acquisitions and to achieve our financial and operational goals for our acquisitions; our ability to manage risks associated with business divestitures; changes in economic or international business conditions; foreign currency exchange rate and interest rate fluctuations; lower than anticipated demand by retailers and other customers for our products; slower commitments of retail customers to chain-wide installations and/or source tagging adoption or expansion; 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; our ability to provide and market innovative and cost-effective products; the development of new competitive technologies; our ability to maintain our intellectual property; competitive pricing pressures causing profit erosion; the availability and pricing of component parts and raw materials; possible increases in the payment time for receivables as a result of economic conditions or other market factors; our ability to comply with covenants and other requirements of our debt agreements; changes in regulations or standards applicable to our products; our ability to successfully implement global cost reductions in operating expenses including, field service, sales, and general and administrative expense, and our manufacturing and supply chain operations without significantly impacting revenue and profits; our ability to maintain effective internal control over financial reporting; and risks generally associated with information systems upgrades and our company-wide implementation of an enterprise resource planning (ERP) system. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Additional information about potential factors that could affect our business and financial results is included in our Annual Report on Form 10-K for the year ended December 30, 2012, and our other Securities and Exchange Commission filings.

Overview

We are a leading global manufacturer and provider of technology-driven, loss prevention, inventory management and labeling solutions to the retail and apparel industry. We provide integrated inventory management solutions to brand, track, and secure goods for retailers and consumer product manufacturers worldwide. We are a leading provider of, and earn revenues primarily from the sale of Merchandise Availability Solutions, Apparel Labeling Solutions, and Retail Merchandising Solutions. Merchandise Availability Solutions consists of electronic article surveillance (EAS) systems, EAS consumables, Alpha® solutions, store security system installations and monitoring solutions (CheckView®), and radio frequency identification (RFID) systems and software. Apparel Labeling Solutions includes our web-based data management service and network of service bureaus to manage the printing of variable information on price and promotional tickets, adhesive labels, fabric and woven tags and labels, apparel branding tags, and RFID labels. Retail Merchandising Solutions consists of hand-held labeling systems (HLS) and retail display systems (RDS). Applications of these products include primarily retail security, asset and merchandise visibility, automatic identification, and pricing and promotional labels and signage. Operating directly in 28 countries, we have a global network of subsidiaries and distributors, and provide customer service and technical support around the world.

Our results are heavily dependent upon sales to the retail market. Our customers are dependent upon retail sales, which are susceptible to economic cycles and seasonal fluctuations. Furthermore, as approximately two-thirds of our revenues and operations are located outside the U.S., fluctuations in foreign currency exchange rates have a significant impact on reported results.


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Historically, we have reported our results of operations in three segments:
Shrink Management Solutions (SMS), Apparel Labeling Solutions (ALS), and Retail Merchandising Solutions (RMS). During the third quarter of 2013, we adjusted the product allocation between our SMS and ALS segments, renamed the SMS segment Merchandise Availability Solutions (MAS) and began reporting our segments as:
Merchandise Availability Solutions, Apparel Labeling Solutions, and Retail Merchandising Solutions. Prior periods have been conformed to reflect the segment change.
ALS now includes the results of our radio frequency identification (RFID) labels business (previously reported in SMS), coupled with our data management platform and network of service bureaus that manage the printing of variable information on apparel labels and tags. This change aligns us with our refined ALS strategy to be a leading supplier of apparel labeling solutions, with expertise in intelligent apparel labels for item-level tracking and loss prevention. Our MAS segment, which is focused on loss prevention and Merchandise Visibility™ (RFID), includes EAS systems, EAS consumables, Alpha® high-theft solutions, RFID systems and software and non-U.S. and Canada-based CheckView®. There were no changes to the RMS Segment. The revenues and gross profit for each of the segments are included in Note 13 of the Consolidated Financial Statements. In 2012, we refined our business strategy to transition from a product protection business to a provider of inventory management solutions that give retailers ready insight into the on-shelf availability of merchandise in their stores. In support of this strategy, we continue to provide to retailers, manufacturers and distributors our EAS systems and consumables, Alpha® high-theft solutions, RFID products and services, and METO® hand-held labeling products. In apparel labeling, we are focusing on those products that support our refined strategy and leveraging our competitive advantage in the transfer and printing of variable data onto apparel labels. We have divested and will continue to consider divesting certain businesses and product lines that are not advantageous to our refined strategy.

Our solutions help customers identify, track, and protect their assets. We believe that innovative new products and expanded product offerings will provide opportunities to enhance the value of legacy products while expanding the product base in existing customer accounts. We intend to maintain our leadership position in key hard goods markets (supermarkets, drug stores, mass merchandisers, and music and electronics retailers); to expand our market share in soft goods markets (specifically apparel), and to maximize our position in under-penetrated markets. We also intend to continue to capitalize on our installed base with large global retailers to promote source tagging. Furthermore, we plan to leverage our knowledge of RF and identification technologies to assist retailers and manufacturers in realizing the benefits of RFID.

Our Apparel Labeling business, which was assembled over the past few years through numerous acquisitions to support our penetration into the apparel industry and to support the growth of our RFID strategy, needed a more narrow focus. We are achieving this by right-sizing the Apparel Labeling footprint in order to profitably provide on-time, high quality products to our apparel customers so that retailers can effectively merchandise their products. Simultaneously, we are reducing our Apparel Labeling product offering to only those that are also necessary to support our RFID strategy.

Our operations and results depend significantly on global market worldwide economic conditions, which have experienced deterioration in recent years. In response to these market conditions, we continue to focus on providing customers with innovative products that will be valuable in addressing shrink, which is particularly important during a difficult economic environment. We have also implemented initiatives to reduce costs and improve working capital to mitigate the effects of the economy on our business.

During 2009, we initiated the SG&A Restructuring Plan focused on reducing our overall operating expenses by consolidating certain administrative functions to improve efficiencies. The first phase of this plan was implemented in the fourth quarter of 2009 with the remaining phases of the plan substantially completed by the end of the first quarter of 2012.

During September 2011, we initiated the Global Restructuring Plan focused on further reducing our overall operating expenses by including manufacturing and other cost reduction initiatives, such as consolidating certain manufacturing facilities and administrative functions to improve efficiencies. This plan was further expanded in the first quarter of 2012 and again during the second quarter of 2012 to include Project LEAN. The first phase of this plan was implemented in the third quarter of 2011 with the remaining phases of the plan expected to be substantially complete by the first quarter of 2014.


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The expanded Global Restructuring Plan including Project LEAN and the SG&A Restructuring Plan will impact approximately 2,500 employees. Total costs of the Global Restructuring Plan including Project LEAN and the SG&A Restructuring Plan are expected to approximate $71 million to $73 million by the end of 2013, with $53 million to $55 million in total anticipated costs for the Global Restructuring Plan including Project LEAN and approximately $18 million of costs incurred for the SG&A Restructuring Plan, which is substantially complete. Total annual savings of the two plans are expected to approximate $100 million to $105 million by the first quarter of 2014, with $81 million to $85 million in total anticipated savings for the Global Restructuring Plan including Project LEAN and $19 million to $20 million in total anticipated savings for the SG&A Restructuring Plan. Through our Global Restructuring Plan including Project LEAN, we continue to stabilize sales, actively manage margins, dramatically reduce operating expenses, more effectively manage working capital and improve global cash management control. We will continue to develop additional cost savings and margin enhancement initiatives over and above those in our current global restructuring initiatives.

In the third quarter of 2012, following an extensive strategic review, we developed a comprehensive plan to address operational performance in ALS. The business was fundamentally restructured, including consolidating certain manufacturing operations in order to provide quality merchandising products profitably and on time. We are also reducing our product capabilities to deliver those products that support our refined on-shelf availability strategy and we are rationalizing our customer base.

On February 17, 2012, we entered into amendments to our Senior Secured Credit Facility and Senior Secured Notes ("Debt Agreements") which increased the required leverage ratio covenant of adjusted EBITDA to total debt from 2.75 to 3.00, 3.35 and 3.25 for the periods ended March 25, 2012, June 24, 2012 and September 23, 2012. Had we not received these amendments, we would have been in violation of the leverage ratio covenant as of March 25, 2012.

On July 31, 2012, we entered into additional amendments to our Debt Agreements ("July 2012 Amendments"), which contained several modifications. The July 2012 Amendments reduced the total commitment of the Senior Secured Credit Facility from $125.0 million to $75.0 million. The July 2012 Amendments reduced the sublimit for the issuance of letters of credit of the Senior Secured Credit Facility from $25.0 million to $5.0 million. The July 2012 Amendments reduced the sublimit for swingline loans of the Senior Secured Credit Facility from $25.0 million to $5.0 million. The July 2012 Amendments increased the required leverage ratio covenant of adjusted EBITDA to total debt to 5.25, 6.50, 5.50, 3.50, and 2.75 for the periods ended June 24, 2012, September 23, 2012, December 30, 2012, March 31, 2013, and June 30, 2013 and thereafter. Cash restructuring of up to $25.0 million is excluded from the calculation of EBITDA beginning in the fiscal quarter ending June 24, 2012. The July 2012 Amendments waived the fixed charge covenant from June 24, 2012 through September 23, 2012 (the "Waiver Period"), decreased it to 1.00 for the period ended December 30, 2012, and returns to 1.25 for periods thereafter. In addition, the July 2012 Amendments permit divestitures, acquisitions and transfers of assets to non-credit parties, under certain conditions. The July 2012 Amendments also contain a provision whereby if our cash balance exceeds $65 million as of weekly measurement dates, we must prepay any additional borrowings made subsequent to the July 2012 Amendments. This provision is effective until we are in compliance with our original covenant requirements for two consecutive quarters.

Absent the waiver and additional July 2012 Amendments, we would have been in violation of the June 24, 2012 leverage ratio and fixed charge coverage covenants. We were in compliance with the amended leverage ratio for the periods ended June 24, 2012, September 23, 2012, December 30, 2012, March 31, 2013, and June 30, 2013. We are in compliance with the original leverage ratio for the period ended September 29, 2013. Absent the waiver, we would have been in violation of the fixed charge covenant for the periods ended June 24, 2012 and September 23, 2012. We were in compliance with the amended fixed charge covenant for the periods ended December 30, 2012 and March 31, 2013. We were in compliance with the original fixed charge covenant for the periods ended June 30, 2013, and September 29, 2013. Although we cannot provide full assurance, we expect to be in compliance with all of our covenants for the next twelve months.

During the Waiver Period, the interest rate spread on the Senior Secured Credit Facility increases to a maximum of 4.25% over the Base Rate or 5.25% over the LIBOR rate. The "Base Rate" is the highest of (a) our lender's prime rate, (b) the Federal Funds rate, plus 0.50%, and (c) a daily rate equal to the one-month LIBOR rate, plus 1.00%. The unused line fee will increase to a maximum of 1.00% per annum. The maximum is based in accordance with changes in our leverage ratio.

During the Waiver Period, and until such time as the financial covenants return to the original covenants for two consecutive quarters, the coupon rate on the Senior Secured Notes will increase to 5.75%, 6.13%, and 6.50% for the Series A Senior Secured Notes, Series B Senior Secured Notes, and Series C Senior Secured Notes, respectively.

In October 2012, we completed the sale of the Banking Security Systems Integration business unit, which was focused on the financial services sector and previously was part of our CheckView® business. In April 2013, we completed the sale of our U.S. and Canada based CheckView® business. In June 2013, we completed the sale of our interest in the non-strategic Sri Lanka subsidiary.


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Future financial results will be dependent upon our ability to successfully implement our redefined strategic focus, expand the functionality of our existing product lines, develop or acquire new products for sale through our global distribution channels, convert new large chain retailers to our solutions for shrink management, merchandise visibility and apparel labeling, manage foreign currency exposures and reduce the cost of our products and infrastructure to respond to competitive pricing pressures.

We believe that our base of recurring revenue (revenues from the sale of consumables into the installed base of security systems, apparel tags and labels, and hand-held labeling tools and services from monitoring and maintenance), repeat customer business, the anticipated effect of our restructuring activities, and our borrowing capacity should provide us with adequate cash flow and liquidity to execute our business plan.

Critical Accounting Policies and Estimates

We have presented our Critical Accounting Policies and Estimates in Part II - Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended December 30, 2012. There have been no material changes to our Critical Accounting Policies and Estimates set forth in our Annual Report on Form 10-K for the fiscal year ended December 30, 2012.

Results of Operations

All comparisons are with the prior year period, unless otherwise stated.

Net Revenues

Our unit volume is driven by product offerings, number of direct sales personnel, recurring sales and, to some extent, pricing. Our base of installed systems provides a source of recurring revenues from the sale of disposable tags, labels, and service revenues.

Our customers are substantially dependent on retail sales, which are seasonal, subject to significant fluctuations, and difficult to predict. In addition, current economic trends have particularly affected our customers, and consequently our net revenues have been, and may continue to be impacted in the future. Historically, we have experienced lower sales in the first half of each year.


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