Item 1. BUSINESS
Checkpoint Systems, Inc. is a leading global manufacturer and provider of technology-driven end-to-end loss prevention, merchandising and labeling solutions to the retail and apparel industry. We enable retailers and their suppliers to reduce shrink, improve shelf availability and leverage real-time data to achieve operational excellence. Our solutions are built upon 40 years of RF technology expertise, diverse shrink management offerings, a broad portfolio of apparel labeling solutions, RFID applications, innovative high-theft solutions and our Check-Net® web-based data management platform. We provide solutions to brand, track and secure goods for retailers, apparel manufacturers and consumer product manufacturers worldwide.
Retailers and manufacturers are increasingly focused on identifying and protecting assets that are moving through the supply chain. On the sales floor, retailers need to make sure that the right merchandise is in stock to satisfy customers and boost sales. To address this market opportunity, we have built the necessary infrastructure to be a single global source for shrink management, merchandise tracking and visibility, and apparel labeling solutions.
We are a leading provider of electronic article surveillance (EAS) systems and tags using radio frequency (RF) and electromagnetic (EM) technology, source tagging security solutions, secure merchandising solutions using RF and acoustic-magnetic (AM) technology. In addition, we manufacture and sell worldwide a complete line of apparel tags and labels. In Europe, we are a leading provider of retail display systems (RDS) and hand-held labeling systems (HLS). In the U.S., we are also a leading provider and installer of physical and electronic security solutions in the form of fire and intrusion alarms, digital video surveillance solutions and 24/7 alarm monitoring for the retail and financial services environments.
Our retail labeling systems and services are designed to consolidate tag and label requirements to improve efficiency, reduce costs, and furnish value-added solutions for customers in many markets and industries. Applications for apparel customers include tickets, tags and labels containing brand identification, variable data, pricing and promotional information, automatic identification (auto-ID), EAS for theft protection, and RFID for item tracking and inventory management. We have achieved substantial international growth, primarily through acquisitions, and now operate directly in 31 countries. Products are principally developed and manufactured in-house and sold through direct distribution and reseller channels.
COMPANY HISTORY
Founded in 1969, we were incorporated in Pennsylvania as a wholly-owned subsidiary of Logistics Industries Corporation (Logistics). In 1977, Logistics, pursuant to the terms of its merger into Lydall, Inc., distributed our common stock to Logistics’ shareholders as a dividend.
Historically, we have expanded our business both domestically and internationally through acquisitions, internal growth using wholly-owned subsidiaries, and the utilization of independent distributors. In 1993 and 1995, we completed two key acquisitions that gave us direct access into Western Europe. We acquired ID Systems International BV and ID Systems Europe BV in 1993 and Actron Group Limited in 1995. These companies engaged in the manufacture, distribution, and sale of EAS systems throughout Europe.
In December 1999, we acquired Meto AG, a German multinational corporation and a leading provider of value-added labeling solutions for article identification and security. This acquisition doubled our revenues and provided us with an increased breadth of product offerings and global reach.
In January 2001, we acquired A.W. Printing Inc., a Houston, Texas-based printer of tags, labels, and packaging material for the apparel industry.
In January 2006, we completed the sale of our barcode systems business to SATO, a global leader in barcode printing, labeling, and Electronic Product Code (EPC)/Radio Frequency Identification (RFID) solutions.
In November 2006, we acquired ADS Worldwide (ADS). Based in Hull, England, ADS is an established supplier of tags, labels and trim to apparel manufacturers, retailers and brands around the world. This acquisition, which gave us new technological and production capabilities, was in line with our strategy to enhance our product offerings and solutions to apparel customers and to create increased value for our stockholders.
In November 2007, we acquired the Alpha S3 business from Alpha Security Products, Inc. Based in Charlotte, North Carolina, the Alpha S3 business offers a comprehensive line of security solutions designed to protect high-theft merchandise on open display in retail environments. The Alpha S3 product portfolio complements our EAS source tagging program, and is in line with our strategy to provide retailers a comprehensive line of shrink management solutions.
In November 2007, we also acquired SIDEP, an established supplier of EAS systems operating in France and China, and Shanghai Asialco Electronics Co. Ltd. (Asialco), a China-based manufacturer of RF-EAS labels. With facilities in Shanghai, China, Asialco significantly increased our label manufacturing capacity in Asia. These businesses are helping us to meet growing regional demand.
In January 2008, we purchased the business of Security Corporation, Inc., a privately held company that provides technology and physical security solutions to the financial services sector.
In June 2008, we acquired OATSystems, Inc., a recognized leader in RFID-based application software. The addition of OATSystems, Inc. has enhanced our strategy to help retailers and suppliers with our EVOLVE™ EAS platform to more easily migrate to EPC RFID, as our industry moves to a common EPC standard. In addition, as closed-loop apparel retailers and department stores increasingly see the value of using item-level RFID for tracking and managing inventory through the supply chain and in stores. Our complete end-to-end solution of RFID hardware and software, tags and labels, service and support, is uniquely available from one fully integrated source. With Checkpoint’s merchandise visibility solutions, retailers and their suppliers gain deeper visibility of assets and merchandise, enabling them to reduce out-of-stock products, reduce working capital requirements, and increase sales.
In August 2009, we acquired Brilliant Label Manufacturing Ltd., a China-based manufacturer of paper, fabric and woven tags and labels. Brilliant Label, through its facilities in Hong Kong and China, adds significant capacity to Checkpoint’s world-class apparel labeling business. This acquisition enables us to meet greater demand for fabric and woven tags and labels and expands our global manufacturing footprint. Additionally, our apparel labeling business extends the use of paper, fabric and woven labels beyond carriers of branding, variable data and garment care information to the discreet integration of RF-EAS and RFID. These capabilities enable apparel retailers and vendors to brand, track and secure their products at the point of manufacture using a single solution.
In October 2010, we acquired a software programming and development business based in the Philippines from Napar Contracting and Allied Services, Inc.
Products and Offerings
Historically, we have reported our results of operations into three segments: Shrink Management Solutions, Intelligent Labels, and Retail Merchandising. During the first quarter of 2009, resulting from a change in our management structure, we began reporting our segments into three new segments: Shrink Management Solutions, Apparel Labeling Solutions, and Retail Merchandising Solutions. Fiscal year 2008 has been conformed to reflect the segment change. Shrink Management Solutions now includes results of our EAS labels and library business. Apparel Labeling Solutions, formerly referred to as Check-Net®, includes tag and label solutions sold to apparel manufacturers, retailers and brand owners. This segment leverages our graphic and design expertise for apparel tags and labels, strategically located service bureaus, and our Check-Net® web-based data management platform. These services coupled with our EAS and RFID capabilities provide a combination of apparel branding and identification with loss prevention and supply chain visibility. There were no changes to the Retail Merchandising Segment. The margins for each of the segments and the identifiable assets attributable to each reporting segment are set forth in Note 18 “Business Segments and Geographic Information” to the consolidated financial statements.
Historically, we have reported RF and EM Hard Tags as part of the SMS EAS Systems product line. During the first quarter of 2010, we began reporting our RF and EM Hard Tags as part of the Alpha product line. This change results in all hard tags for in-store application being recorded in the same product line as the Alpha hard tags. Because both product lines are reported within the Shrink Management Solutions segment, the change in classification does not impact segment reporting. The years ended 2009 and 2008 have been conformed to reflect the product line change within the SMS segment. We have adjusted all prior year comparative amounts and explanations within Management’s Discussion and Analysis to reflect this change in classification to be consistent for all periods presented.
Each of these segments offer an assortment of products and services that in combination are designed to provide a comprehensive, single source solution to help retailers, manufacturers, and distributors identify, track, and protect their assets throughout the entire supply chain. Each segment and its respective products and services are described below.
SHRINK MANAGEMENT SOLUTIONS
Our largest segment is providing shrink management and merchandise visibility solutions to retailers. Our diversified line of security products is designed to help retailers prevent inventory losses caused by impulse theft, organized retail theft, and employee theft, reduce selling costs through lower staff requirements, improve inventory management and boost sales by having the right goods available when customers are ready to buy. Our products facilitate the open display of merchandise, which allows retailers to maximize sales opportunities. We believe that we hold a significant share of worldwide EAS systems installations through the deployment of our own proprietary RF-EAS and EM-EAS technologies. EAS systems revenues accounted for 22%, 26%, and 32% of our 2010, 2009, and 2008 total revenues, respectively.
We offer a wide variety of EAS-RF and EAS-EM labels which provide security solutions matched to specific retail requirements. Under our source tagging program, labels and tags can be attached or embedded in products or packaging at the point of manufacture. In 2009, we introduced Hard Tag @ Source for apparel customers who prefer hard tags for garment security but wish to avoid the expense of in-store tag application. These tags are recycled back into distribution following quality assurance thus reducing waste and saving energy. All participants in the retail supply chain are concerned with maximizing efficiency. Reducing time-to-market requires refined production and logistics systems to ensure just-in-time delivery, as well as shorter development, design, and production cycles. Services range from full-color branding labels to tracking labels and, ultimately, fully-integrated labels that include EAS or RFID circuits. This integration is based on the critical objectives of supporting rapid delivery of goods to market while reducing losses, whether through misdirection, tracking failure, theft or counterfeiting, and of reducing labor costs by tagging and labeling products at the source. EAS consumables revenues represented 15%, 16% and 12% of our total revenues for 2010, 2009, and 2008, respectively.
Our Alpha solutions are focused exclusively on protecting high-risk merchandise. Alpha products enable retailers to safely display high-theft merchandise in an open environment, giving consumers easy access and convenient purchasing. For 2010, 2009, and 2008, the Alpha business represented 16%, 12%, and 12% of our revenues, respectively.
Our CheckView® business offers retailers and the financial services sector physical and electronic security solutions in the form of fire and intrusion alarms, digital video surveillance solutions and 24/7 alarm monitoring. For 2010, 2009, and 2008, the CheckView® business represented 16%, 14%, and 17% of our revenues, respectively.
No other product group in this segment accounted for as much as 10% of our revenues.
These broad and flexible product lines, marketed and serviced by our extensive sales and service organizations, have helped us emerge as a preferred supplier to retailers around the world. Shrink Management Solutions represented approximately 70%, 72%, and 75% of total revenues in 2010, 2009, and 2008, respectively.
Electronic Article Surveillance Systems
We have designed EAS systems to act as a deterrent to prevent merchandise theft in retail stores. Our offering includes a wide variety of RF-EAS and EM-EAS solutions to meet the varied requirements of retail store configurations for multiple market segments worldwide. Our EAS systems are primarily comprised of sensors and deactivation units, which respond to or act upon our tags and labels. Together, they are intended to reduce impulse theft, organized retail theft, and employee theft. In addition, our products enable retailers to openly display merchandise, including high-margin and high-cost items, giving consumers easier access to a broader range of products and more convenient purchasing.
In 2008, we introduced our technology-rich EVOLVE™ platform of antennas and deactivators, setting a new standard in retail loss prevention and customer tracking. EVOLVE™ represents the next generation, a flexible, upgradable platform delivering superior performance, including significant energy savings, with advanced data analytics and networking capabilities. EVOLVE™ is compatible with our CheckPro™ software suite and our complete line of EAS labels and tags as well as products of other suppliers.
Our business model relies upon customer commitments for security product installations to a large number of their stores over a period of several months (large chain-wide installations). EVOLVE™ allows existing customers to upgrade their security systems and should lead to increased installations in the future. Furthermore, its enhanced data analytics capabilities enable customers to maximize the return on their hardware investment and gain insight into shrink and operational issues through the use of actionable data.
Our EAS products are designed and built to comply with applicable Federal Communications Commission (FCC) and European Community (EC) regulations governing RF, signal strengths, and other factors.
Electronic Article Surveillance Consumables
We produce EAS-RF and EAS-EM labels that work in combination with our EAS systems to reduce merchandise theft in retail stores. Our diversified product line of discrete disposable labels are designed to enable retailers to protect a wide array of easily-pocketed, high shrink merchandise. While EAS labels can be applied in retail stores and distribution centers, an increasing percentage of our customers are taking advantage of our source tagging program. In source tagging programs, EAS labels and hard tags are configured to the merchandise and specific security requirements of the customer and applied at the point of manufacture. Our paper-thin EAS labels have characteristics that are easily integrated with high-speed automated application systems. We offer a new generation of enhanced performance (EP) labels that are smaller yet provide superior detection capability. This product line, which is easily attached to limited surfaces, offers protection to small items like cosmetics or CDs. In 2010, we launched EP CLEAR, which offers the same kind of protection without covering packaging and allows for scanning of bar codes through the label.
Alpha
We provide retailers with innovative and technically advanced products engineered to protect high-theft merchandise. Alpha products are uniquely designed to protect high-risk merchandise, offering retailers the highest levels of theft protection, aesthetically pleasing design, value and ease of use. Alpha pioneered the “open display” security philosophy by providing retailers a truly safe means to bring merchandise from behind locked cabinets and openly display it. The product line consists of Keepers™, Spider Wraps®, Bottle Security, Cable Loks®, hard tags for in-store application, and Showsafe™ displays. Showsafe™ is a line alarm system for protecting display merchandise. All Alpha products are available in AM, RF, or EM formats.
CheckView® - Video, Fire and Intrusion Systems
We provide complete physical and electronic store monitoring solutions, including fire alarms, intrusion alarms, digital video surveillance systems and 24/7 central station monitoring for retail environments. CheckView’s® exclusive focus on retail offers centralized project coordination supported by a large field management structure. Our product and application teams evaluate and support new technology development and our design department engineers each project. Our video surveillance solutions address shoplifting and internal theft as well as customer and employee safety and security needs. The product line consists of closed circuit television products and services including fixed and high-speed pan/tilt/zoom camera systems, programmable switcher controls, time-lapse recording, and remote video surveillance. In 2010, CheckView® introduced its revolutionary Interactive Public View monitor (IPV), the first of its kind designed with retail integration in mind and with the ability to connect to smart alert fixtures. This new imaging and display technology enables retailers to better leverage their video surveillance investment.
Our fire and intrusion systems provide life safety and property protection, completing the line of loss prevention solutions. In addition to the system installations, we offer a U.S.-based 24-hour central station monitoring service.
In 2008, we expanded our systems solution offering in the U.S. by entering the financial services sector, providing branch banks with physical and electronic security solutions.
Merchandise Visibility (RFID)
We produce RFID tags and labels, leveraging our high volume, low cost RF circuit production and manufacturing knowledge. In October 2006, we announced our intention to focus our RFID initiative on our core retail customers business. During June 2008, we acquired OATSystems, Inc., a recognized leader in RFID-based application software. The addition of OATSystems, Inc. builds on our strategy to help retailers and suppliers with our EVOLVE™ EAS platform to more easily migrate to EPC RFID, as our industry moves to a common EPC standard. In addition, as closed-loop apparel retailers and department stores increasingly see the value of using item-level RFID for tracking apparel through the supply chain and for managing inventory. Our complete end-to-end solution of RFID hardware and software, tags and labels, service and support, is uniquely available from one fully integrated source. With Checkpoint’s merchandise visibility offering, retailers and their suppliers gain deeper visibility of assets and merchandise - further reducing shrink and increasing bottom-line profits while enhancing the on-shelf availability of merchandise for consumers.
APPAREL LABELING SOLUTIONS
Apparel Labeling Solutions (ALS) is our second largest segment. We provide apparel retailers, brand owners, and manufacturers with a single source for all their apparel labeling requirements. ALS also includes our web-based data management service and network of 27 service bureaus strategically located in 21 countries close to where apparel is manufactured. Our data management service offers order entry, logistics, and data management capabilities. It facilitates on-demand printing of variable information onto apparel tags and labels. ALS also offers the integration of EAS-RF and RFID into apparel tags and labels.
Our service bureau network is one of the most extensive in the industry, and its ability to offer fully integrated apparel labeling places it among just a handful of suppliers who possess this capability.
ALS revenues represented 21%, 18%, and 15% of our total revenues for 2010, 2009, and 2008, respectively.
RETAIL MERCHANDISING SOLUTIONS
The Retail Merchandising Solutions segment includes hand-held label applicators and tags, promotional displays, and queuing systems. These traditional products broaden our reach among retailers. Many of the products in this segment represent high-margin items with a high level of recurring sales of associated consumables such as labels. As a result of the increasing use of scanning technology in retail, our hand-held labeling systems serve a declining market. Retail Merchandising Solutions, which is focused on European and Asian markets, represents approximately 9% of our business, with no product group in this segment accounting for as much as 10% of our revenues.
Hand-held Labeling Systems
Our hand-held labeling systems (HLS) include a complete line of hand-held price marking and label application solutions, primarily sold to retailers. Sales of labels, consumables, and service generate a significant source of recurring revenues. As retail scanning becomes widespread, in-store retail price marking applications continue to decline. Our HLS products possess a market-leading position in several European countries.
Retail Display Systems
Our retail display systems (RDS) include a wide range of products for customers in certain retail sectors, such as supermarkets and do-it-yourself, where high-quality signage and in-store price promotion are important. Product categories include traditional retail promotional systems for in-store communication and electronic graphics display, and customer queuing systems.
BUSINESS STRATEGY
Our business strategy focuses on providing end-to-end shrink management and merchandise visibility solutions and apparel labeling solutions to retailers, manufacturers, and distributors. These solutions help our retail and apparel customers identify, track, and protect their assets. We believe that innovative new products and expanded product offerings will provide significant 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, specifically apparel, and 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 realize the benefits of RFID.
To achieve these objectives, we expect to continuously enhance and expand our technologies and products, and provide superior service to our customers. We intend to offer customers a wide variety of integrated shrink management solutions, apparel labeling, and retail merchandising solutions characterized by superior quality, ease-of-use, good value, with enhanced merchandising opportunities.
We continue to evaluate our sales, productivity, manufacturing, supply chain efficiency and overhead structure, and we will take action where specific opportunities exist to improve profitability.
Principal Markets and Marketing Strategy
Through our Shrink Management Solutions segment, we market EAS systems, including hardware, consumables and software, and other security solutions, namely Alpha and CheckView® products and services, primarily to worldwide retailers in the hard goods market and soft goods market. We enjoy significant market share, particularly in the supermarket, drug store, hypermarket, and mass merchandiser market segments.
Shoplifting and employee theft are major causes of retail shrinkage. Data collection systems highlight the problem to retailers. As a result, retailers recognize that the implementation of effective electronic security solutions can significantly reduce shrinkage and increase profitability.
In addition, we offer integrated shrink management and merchandise visibility solutions, apparel labeling solutions, and retail merchandising solutions to manufacturers and retailers worldwide. This entails a broadened focus within the entire retail supply chain by providing branding, tracking, and shrink management solutions to retail stores, distribution centers, and consumer product and apparel manufacturers worldwide.
We are committed to helping retailers grow profitability by providing our customers with a wide variety of solutions. Our ongoing marketing strategy includes the following:
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communicate the synergies within Checkpoint’s product portfolio to demonstrate the collective value that our holistic, end-to-end product line offers;
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open new retail accounts, and expand existing ones, introducing new products that offer integrated, value-added solutions for labeling, security, and merchandising, thereby increasing account penetration;
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establish business-to-business web-based capabilities to enable retailers and manufacturers to initiate and track their orders through the supply chain on a global basis;
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expand market opportunities to manufacturers and distributors, including source tagging and value-added labeling;
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continue to promote source tagging around the world with extensive integration and automation capabilities using new EAS, RFID, and auto-ID technologies; and
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assist retailers in understanding the benefits and implementation of the new EPC using RFID technology.
We market our products primarily:
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by providing total loss prevention, merchandise visibility and apparel labeling solutions to our customers;
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by communicating, messaging and highlighting Checkpoint’s unique position as a single source provider of integrated and complete solutions for retailers;
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by helping retailers sell more merchandise by avoiding stock-outs and making merchandise available to consumers;
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by serving as a single point of contact for auto-ID and EAS labeling and ticketing needs;
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through direct sales efforts, comprehensive public relations efforts, online marketing and targeted trade show participation;
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through superior service and support capabilities; and
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by emphasizing source tagging benefits.
We focus on partnering with retail suppliers worldwide in our source tagging program. Ongoing strategies to increase acceptance of source tagging are as follows:
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increase installation of EAS equipment on a chain-wide basis with leading retailers around the world;
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offer integrated tag solutions, including custom tag conversion, that address the multiple but synergistic need for branding, tracking, and loss prevention;
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assist retailers in promoting source tagging with vendors;
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broaden penetration of existing accounts by promoting our in-house printing, global service bureau network, and labeling solution capabilities;
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support manufacturers and suppliers to speed implementation;
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expand RF tag technologies and products to accommodate the needs of the packaging industry; and
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develop compatibility with EPC/RFID technologies.
MANUFACTURING, RAW MATERIALS, AND INVENTORY
Electronic Article Surveillance
We manufacture our EAS systems and consumables, including Alpha S3 products, in facilities located in Puerto Rico, Japan, China, the U.S., Germany, and the Dominican Republic. Our manufacturing strategy for EAS products is to rely primarily on in-house capability for core components and to outsource manufacturing to the extent economically beneficial. We manage the integration of our in-house capability and our outsourced manufacturing in a way that provides significant control over costs, quality, and responsiveness to market demand, which we believe results in a distinct competitive advantage.
We involve customers, engineering, manufacturing, and marketing in the design and development of our products. For RF sensor production, we purchase raw materials from outside suppliers and assemble electronic components at our facilities in the Dominican Republic for the majority of our sensor product lines. The manufacture of some RF sensors sold in Europe and all EM hardware is outsourced. For our EAS disposable tag production, we purchase raw materials and components from suppliers and complete the manufacturing process at our facilities in Puerto Rico, Japan, Germany, and China. For our Alpha S3 secured merchandising production, we purchase raw materials and components from suppliers and complete the manufacturing process at our facilities in the U.S. as well as using outsourced manufacturing in China. The principal raw materials and components used by us in the manufacture of our products are electronic components and circuit boards for our systems; aluminum foil, resins, paper, and ferric chloride and hydrochloric acid solutions for our disposable tags; and polymer resin for our Alpha S3 products. While most of these materials are purchased from several suppliers, there are alternative sources for all such materials. The products that are not manufactured by us are sub-contracted to manufacturers selected for their manufacturing and assembly skills, quality, and price.
CheckView® - Video, Fire and Intrusion Systems
We market video systems and services in selected countries throughout the world using our own sales staff. These products and services are provided to our EAS retail customers, as well as non-EAS retailers. Fire and intrusion systems are marketed exclusively in the U.S. through a direct sales force.
Apparel Labeling Solutions and Retail Merchandising Solutions
We manufacture labels, tags, and hand-held tools. Our main production facilities are located in Germany, the Netherlands, the U.S., the U.K., China, and Malaysia. Local production facilities are also situated in Hong Kong, China, and Turkey. Our facilities in the Netherlands, the U.S., and the U.K. manufacture labels and tags for laser overprinting. With the acquisition of Brilliant in August 2009, we acquired fabric and woven labels manufacturing facilities in China. ALS has a network of 27 service bureaus located in 21 countries that supplies customers with customized apparel tags and labels to the location where the goods are manufactured. Manufacturing in Germany is focused on HLS labels and print heads for HLS tools. The Malaysian facility produces standard bodies for HLS tools for Europe, complete hand-held tools for the rest of the world, and labels for the local market.
DISTRIBUTION
For our major product lines, we principally sell our products to end customers using our direct sales force of more than 500 sales people. To improve our sales efficiency, we also distribute products through an independent network of resellers. This distribution channel supports and services smaller customers. This indirect channel, which has primarily sold EAS solutions, will be broadened and expanded to include more product lines as we focus on improved sales productivity.
Electronic Article Surveillance
We sell our EAS systems, labels, and Alpha S3 products principally throughout North America, South America, Europe, and the Asia Pacific regions. In North America, we market our EAS products through our own sales personnel and independent representatives.
Internationally, we market our EAS products principally through foreign subsidiaries which sell directly to the end-user and through independent distributors. Our international sales operations are currently located in 14 European countries and in Argentina, Australia, Brazil, Canada, Hong Kong, India, Japan, Malaysia, China, Mexico, New Zealand, and Turkey.
CheckView® - Video, Fire and Intrusion Systems
We market video systems and services in selected countries throughout the world using our own sales staff. These products and services are provided to our EAS retail customers, as well as non-EAS retailers. Fire and intrusion systems are marketed exclusively in the U.S. through a direct sales force.
Apparel Labeling Solutions and Retail Merchandising Solutions
Our customers in the apparel labeling solutions and retail merchandising solutions businesses are primarily found within the retail sector and retail supply chain. Major customers include companies within industries such as food retailing, DIY, department stores, and apparel retailers.
Large national and international customers are handled centrally by key account sales specialists supported by appropriate business specialists. Smaller customers are served by either a general sales force capable of representing all products or, if the complexity or size of the business demands, a dedicated business specialist.
BACKLOG
Our backlog of orders was approximately $48.0 million at December 26, 2010, compared to approximately $50.2 million at December 27, 2009. We anticipate that substantially all of the backlog at the end of 2010 will be delivered during 2011. In the opinion of management, the amount of backlog is not indicative of trends in our business. Our security business generally follows the retail cycle so that revenues are weighted toward the last half of the calendar year as retailers prepare for the holiday season.
TECHNOLOGY
We believe that our patented and proprietary technologies are important to our business and future growth opportunities, and provide us with distinct competitive advantages. We continually evaluate our domestic and international patent portfolio, and where the cost of maintaining the patent exceeds its value, such patent may not be renewed. The majority of our revenues are derived from products or technologies that are patented or licensed. There can be no assurance, however, that a competitor could not develop products comparable to ours. Our competitive position is also supported by our extensive manufacturing experience and know-how.
PATENTS & LICENSING
On October 1, 1995, we acquired certain patents and improvements thereon related to EAS products and manufacturing processes from Arthur D. Little, Inc. for which we paid annual royalties. Our payment obligation terminated on December 31, 2008, and since then we have held a royalty free license.
We also license technologies relating to RFID applications, EAS products, certain sensors, magnetic labels, and fluid tags. These license arrangements have various expiration dates and royalty terms, which are not considered by us to be material.
Apparel Labeling Solutions and Retail Merchandising Solutions
We focus our in-house development efforts on product areas where we believe we can achieve and sustain a competitive cost and positioning advantage, and where delivery service is critical. We also develop and maintain technological expertise in areas that are believed to be important for new product development in our principal business areas. We have a base of technology expertise in the printing, electronics, and software areas and are particularly focused on EAS and labeling capabilities to support the development of higher value-added labels.
SEASONALITY
Our business is subject to seasonal influences, which generally causes us to realize higher levels of sales and income in the second half of the year. Our business’ seasonality substantially follows the retail cycle of our customers, which generally has revenues weighted towards the last half of the calendar year in preparation for the holiday season.
COMPETITION
Electronic Article Surveillance
Currently, EAS systems and consumables are sold to two principal markets: retail establishments and libraries. Our principal global competitor in the EAS industry is Tyco International Ltd. (Tyco), through its ADT Worldwide segment. Tyco is a diversified global company with interests in security products and services, fire protection and detection products and services, valves and controls and other industrial products. Tyco’s 2010 revenues were approximately $17.0 billion, of which $7.4 billion was attributable to the ADT Worldwide segment.
Within the U.S. market, additional competitors include Sentry Technology Corporation and Ketec, Inc. in EAS systems and consumables, and All-Tag Security in EAS-RF labels, principally in the retail market. Within our international markets, mainly Europe, Nedap® is our most significant competitor. The largest competitors of the Alpha S3 secured merchandising product line include Universal Surveillance Systems, Protext International Corporation, Se-Kure Controls, Inc., and Century.
We believe that our product line offers a more diverse range of products than our competition with a variety of disposable and reusable tags and labels, integrated scan/deactivation capabilities, and RF source tagging embedded into products or packaging. As a result, we compete in marketing our products primarily on the basis of their versatility, reliability, affordability, accuracy, and integration into operations. This combination provides many system solutions and allows for protection against a variety of retail merchandise theft. Furthermore, we believe that our manufacturing know-how and efficiencies relating to disposable tags give us a cost advantage over our competitors.
CheckView® - Video, Fire and Intrusion Systems
Our video, fire and intrusion products, which are sold domestically through our CheckView® Group, and video products sold internationally through our international sales subsidiaries, compete primarily with similar products offered by Tyco, Vector Security, Inc., and Stanley Security Solutions. We compete based on our superior design and project management services and believe that our offerings provide our retail and non-retail customers with distinctive system features.
Apparel Labeling Solutions
We sell our apparel labeling solutions, including a full complement of tags and labels, to apparel retailers, brand owners and apparel manufacturers. Major competitors for our label products are Avery Dennison Corporation, SML Group, and Fineline Technologies. Several competitive labeling service companies are also customers as they purchase EAS circuits from us to integrate into their label offerings.
Retail Merchandising Solutions
We face no single competitor in any international market across our entire retail merchandising solutions product range. HL Display AB is our largest competitor in retail display systems, primarily in Europe. In hand-held labeling solutions, we compete with Contact, Garvey Products Inc., Hallo, Avery Dennison Corporation, and Prix.
OTHER MATTERS
Research and Development
We spent $20.5 million, $20.4 million, and $22.6 million, in research and development activities during 2010, 2009, and 2008, respectively. Our R&D emphasis is on continually broadening our product lines, reducing costs, and expanding the markets and applications for all products. We believe that our future growth is dependent, in part, on the products and technologies resulting from these efforts.
Another important source of new products and technologies has been the acquisition of companies and products. The August 2009 acquisition of Brilliant Label Manufacturing Ltd. has strengthened and expanded our core apparel labeling offering. Brilliant Label’s woven and printed label manufacturing capabilities move us closer to becoming a recognized global provider of apparel labeling solutions.
The 2008 acquisition of OATSystems, Inc. built on our strategy to help retailers and suppliers migrate more easily to EPC RFID using our EVOLVE™ EAS platform. As our industry moves to a common EPC standard, we are now able to offer solutions that give retailers and their supply chains clearer visibility of their assets and merchandise - further reducing shrink while increasing bottom-line profits by reducing out-of-stocks.
We continue to assess acquisitions of related businesses or products consistent with our overall product and marketing strategies. We also continue to develop and expand our product lines with improvements in disposable tag performance, disposable tag manufacturing processes, and wide-aisle RF-EAS detection sensors with integration of remote and wireless internet connectivity and RFID integration.
Employees
As of December 26, 2010, we had 5,814 employees, including seven executive officers, 122 employees engaged in research and development activities, and 607 employees engaged in sales and marketing activities. In the United States, 8 of our employees are represented by a union. In Europe, approximately 398 of our employees are represented by various unions or work councils.
Financial Information About Geographic and Business Segments
We operate both domestically and internationally in the three distinct business segments described previously. The financial information regarding our geographic and business segments, which includes net revenues and gross profit for each of the years in the three-year period ended December 26, 2010, and long-lived assets as of December 26, 2010 and December 27, 2009, is provided in Note 18 of the Consolidated Financial Statements.
Available Information
Our internet website is at www.checkpointsystems.com. Investors can obtain copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act as soon as reasonably practicable after we have filed such materials with, or furnished them to, the Securities and Exchange Commission (SEC). We will also furnish a paper copy of such filings free of charge upon request. Investors can also read and copy any materials filed by us with the SEC at the SEC’s Public Reference Room which is located at 100 F Street, NE, Room 1580, Washington, DC 20549. Information about the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. Our filings can also be accessed at the SEC’s internet website: www.sec.gov.
We have adopted a code of business conduct and ethics (the “Code of Ethics”) as required by the listing standards of the New York Stock Exchange and the rules of the SEC. This Code of Ethics applies to all of our directors, officers, and employees. We have also adopted corporate governance guidelines (the “Governance Guidelines”) and a charter for each of our Audit Committee, Compensation Committee and Governance and Nominating Committee (collectively, the “Committee Charters”). We have posted the Code of Ethics, the Governance Guidelines and each of the Committee Charters on our website at www.checkpointsystems.com, and will post on our website any amendments to, or waivers from, the Code of Ethics applicable to any of our directors or executive officers. The foregoing information will also be available in print upon request.
Executive Officers of the Company
The following table sets forth certain current information concerning our executive officers, including their ages, position, and tenure as of the date hereof:
Name
Age
Tenure
with
Company
Position with the Company and
Date of Election to Position
Robert P. van der Merwe
4 years
Chairman since December 2008, President and Chief Executive Officer since December 2007
Raymond D. Andrews
6 years
Senior Vice President and Chief Financial Officer since December 2007
Per H. Levin
16 years
President, Merchandise Visibility since September 2010
Steven Davidson
3 years
President, Global Apparel Labeling Solutions since October 2008
John R. Van Zile
7 years
Senior Vice President, General Counsel and Secretary since June 2003
Farrokh Abadi
7 years
President, Shrink Management Solutions since September 2010
S. James Wrigley
1 year
Group President, Global Customer Management since March 2010
Mr. van der Merwe was appointed President and Chief Executive Officer on December 27, 2007. In December 2008, Mr. van der Merwe was appointed our Chairman of the Board and has been a member of our Board of Directors since October 2007. He previously served as President and Chief Executive Officer of Paxar Corporation, a global leader in providing innovative merchandising systems to retailers and apparel customers. He became Chairman of the Board of Paxar in January 2007, and served in these capacities until Paxar’s sale to Avery Dennison in June 2007. Prior to joining Paxar, Mr. van der Merwe held numerous executive positions with Kimberly-Clark Corporation from 1980 to 1987 and from 1994 to 2005, including the positions of Group President of Kimberly-Clark’s global consumer tissue business and Group President of Europe, Middle East and Africa. Earlier in his career, Mr. van der Merwe held managerial positions in South Africa at Xerox Corporation and Colgate Palmolive.
Mr. Andrews was appointed Senior Vice President and Chief Financial Officer on December 6, 2007. Mr. Andrews was Senior Vice President and Chief Accounting Officer from August 2005 until December 2007. He previously served as Controller of INVISTA S.a’r.l., a subsidiary of Koch Industries, where he oversaw the company’s accounting operations in North and South America, Europe and Asia. Prior to the acquisition by Koch Industries, Mr. Andrews was Director of Accounting Operations of INVISTA Inc. From 1998 to 2002, Mr. Andrews served as Controller for DuPont Pharmaceuticals Company and then Bristol-Myers Squibb Pharma Company, a subsidiary of Bristol-Myers Squibb, when that company acquired DuPont Pharmaceuticals in 2001. Prior to being appointed Controller, he held positions of increasing responsibility at DuPont Merck Pharmaceutical Company and the DuPont Company. Mr. Andrews is a Certified Public Accountant.
Mr. Levin was appointed President, Merchandise Visibility in September 2010. He was President, Shrink Management and Merchandise Visibility Solutions from March 2006 until September 2010. He was President of Europe from June 2004 until March 2006, Executive Vice President, General Manager, Europe from May 2003 until June 2004, and Vice President, General Manager, Europe from February 2001 until May 2003. Mr. Levin was Regional Director, Southern Europe from 1997 to 2001 and joined the Company in January 1995 as Managing Director of Spain.
Mr. Davidson joined Checkpoint in 2008 as President, Global Apparel Labeling Solutions. Previously, he spent 16 years with the Braitrim Group, a company providing products and services to global apparel retailers and garment manufacturers. While with the Braitrim Group, Mr. Davidson made a significant contribution to building their $180 million business, including establishing Sales and Marketing and Manufacturing infrastructures throughout Asia. Following the acquisition of Braitrim by the Spotless Group in 2002, Mr. Davidson remained with the larger organization in the capacity of Managing Director, EMEA, for Spotless Retailer Services. Mr. Davidson’s previous experience includes Senior Management positions at TCI Marketing Consultancy, K Shoes Group in the U.K., and Unilever.
Mr. Van Zile has been Senior Vice President, General Counsel and Secretary since joining Checkpoint in June 2003. Prior to joining us, Mr. Van Zile served as Executive Vice President, General Counsel and Secretary of Exide Corporation from September 2000 until October 2002, and was Vice President and General Counsel from November 1996 until September 2000. Prior to Exide Corporation, Mr. Van Zile held positions of increasing legal responsibility at GM-Hughes Electronics Corporation and Coltec Industries.
Mr. Abadi was appointed President, Shrink Management Solutions in September 2010. He was Senior Vice President and Chief Innovation Officer from October 2008 until September 2010. Mr. Abadi retains responsibility for our procurement and systems supply chain. He also served as Senior Vice President, Worldwide Operations from April 2006 until October 2008 and Vice President and General Manager, Worldwide Research and Development from November 2004 until April 2006. Prior to joining Checkpoint, Mr. Abadi was Senior Vice President of Global Cross-Industry Practices at Atos Origin from February 2004 until November 2004. Mr. Abadi held various senior management positions with Schlumberger for over eighteen years.
Mr. Wrigley joined Checkpoint as Group President, Global Customer Management in March 2010. Prior to joining Checkpoint, Mr. Wrigley was Vice President, EMEA and South Asia, at Avery Dennison Corporation's Retail Information Services business from June 2007 to March 2010. Prior to Avery's acquisition of Paxar Corporation in 2007, Mr. Wrigley was Group President, Global Apparel Solutions from January 2007 until June 2007. Mr. Wrigley was President, Paxar EMEA from 1996 to 2006. Mr. Wrigley served as International Director of the Pepe Group from 1991 until 1996.
Item 1A.
Item 1A. RISK FACTORS
The risks described below are among those that could materially and adversely affect our business, financial condition or results of operations. These risks could cause actual results to differ materially from historical experience and from results predicted by any forward-looking statements related to conditions or events that may occur in the future.
Current economic conditions could adversely impact our business and results of operations.
Our operations and results depend significantly on global market worldwide economic conditions, which have experienced deterioration in recent years. Although conditions have improved over the last year, the future economic factors may continue to be less favorable than in years past and may continue to result in diminished liquidity and tighter credit conditions, leading to decreased credit availability, as well as declines in economic growth and employment levels. As a result of these market conditions, the cost and availability of credit has been and may continue to be adversely affected by illiquid credit markets and wider credit spreads. These conditions may increase the difficulty for us to accurately forecast and plan future business. Customer demand could be impacted by decreased spending by businesses and consumers alike, and competitive pricing pressures could increase. Additionally, the disruption in the credit markets may also adversely affect the availability of financing to support our strategy for future growth through acquisitions. We are unable to predict the length or severity of the current economic conditions. A continuation or further deterioration of these economic factors may have a material and adverse effect on the liquidity and financial condition of our customers and on our results of operations, financial condition, liquidity, including our ability to refinance maturing liabilities, and access the capital markets to meet liquidity needs.
We have significant foreign operations, which are subject to political, economic and other risks inherent in operating in foreign countries.
We are a multinational manufacturer and marketer of identification, tracking security, and merchandising solutions for the retail industry. We have significant operations outside of the U.S. We currently operate directly in 31 countries, and our international operations generate approximately 65% of our revenue. We expect net revenue generated outside of the U.S. to continue to represent a significant portion of total net revenue. Business operations outside of the U.S. are subject to political, economic and other risks inherent in operating in certain countries, such as:
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the difficulty in enforcing agreements, collecting receivables and protecting assets through foreign legal systems;
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trade protection measures and import or export licensing requirements;
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difficulty in staffing and managing widespread operations and the application of foreign labor regulations;
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compliance with a variety of foreign laws and regulations;
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changes in the general political and economic conditions in the countries where we operate, particularly in emerging markets;
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the threat of nationalization and expropriation;
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increased costs and risks of doing business in a number of foreign jurisdictions;
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changes in enacted tax laws;
§
limitations on repatriation of earnings; and
§
fluctuations in equity and revenues due to changes in foreign currency exchange rates.
Changes in the political or economic environments in the countries in which we operate, as well as the impact of economic conditions on underlying demand for our products could have a material adverse effect on our financial condition, results of operations or cash flows.
As we continue to explore the expansion of our global reach, an increasing focus of our business may be in emerging markets, including South America and Southwest Asia. In many of these emerging markets, we may be faced with risks that are more significant than if we were to do business in developed countries, including undeveloped legal systems, unstable governments and economies, and potential governmental actions affecting the flow of goods and currency.
Volatility in currency exchange rates and interest rates may adversely affect our financial condition, results of operations or cash flows.
We are exposed to a variety of market risks, including the effects of changes in currency exchange rates and interest rates. See Part 7A. Quantitative and Qualitative Disclosures About Market Risk.
Our net revenue derived from sales in non-U.S. markets is approximately 65% of our total net revenue, and we expect revenue from non-U.S. markets to continue to represent a significant portion of our net revenue. When the U.S. dollar strengthens in relation to the currencies of the foreign countries where we sell our products, our U.S. dollar reported revenue and income will decrease. Changes in the relative values of currencies occur regularly and, in some instances, may have a significant effect on our results of operations. Our financial statements reflect recalculations of items denominated in non-U.S. currencies to U.S. dollars, which is our functional currency.
We monitor these exposures as an integral part of our overall risk management program. In some cases, we enter into contracts to reduce the risks of currency fluctuations on short-term inter-company receivables and payables, and on projected future billings in non-functional currencies and use third-party borrowings in foreign currencies to hedge a portion of our net investments in, and cash flows derived from, our foreign subsidiaries. Nevertheless, changes in currency exchange rates and interest rates may have a material adverse effect on our financial condition, results of operations, or cash flows.
Our business could be materially adversely affected as a result of lower than anticipated demand by retailers and other customers for our products, particularly in the current economic environment.
Our business is heavily dependent on the retail marketplace. Changes in the economic environment including the liquidity and financial condition of our customers or reductions in retailer spending could adversely affect our revenues and results of operations. In a period of decreased consumer spending, retailers could respond by reducing their spending on new store openings and loss prevention budgets. This reduction could directly impact our SMS business, as a reduction in new store openings will lower demand for SMS EAS systems and consumables and CheckView® installations. Additionally, lower loss prevention budgets could reduce the amount retailers will be willing to spend to upgrade existing store technology. Label demand could also be impacted due to lower loss prevention budgets as retailers may reduce the percentage of items covered. In addition, our label volume increases as more items are sold through the retailer and lower demand decreases the volume related to the items tagged by the retailer. As retail sales volumes decline, label demand may also decline. A decrease in the demand for our products resulting from reduced spending by retailers due to fewer store openings, reduced loss prevention budgets and slower adoption of our new technology could have a material adverse effect on our revenues and results of operations.
Our business could be materially adversely affected as a result of slower commitments of retail customers to chain-wide installations and/or source tagging adoption or expansion.
Our revenues are dependent on our ability to maintain and increase our system installation base. The SMS EAS system installation base leads to additional revenues, which we term as “recurring revenues,” through the sale of maintenance services and SMS EAS consumables, including sensor tags. In addition, we partner with manufacturers to include our sensor tags into the product during manufacturing, an approach known as source tagging.
The level of commitments for chain-wide installations may decline due to decreased consumer spending which results in reduced spending on loss prevention by our retail customers, our failure to develop new technology that entices the customer to maintain their commitment to our loss prevention products and services, and competing technologies. A reduction in the commitment for chain-wide installations may also impact our ability to expand utilization of our source tagging program. A reduction in commitments to chain-wide installations and utilization of our source tagging program could have an adverse effect on our revenues and results of operations.
The markets we serve are highly competitive and we may be unable to compete effectively if we are unable to provide and market innovative and cost-effective products at competitive prices.
We face competition around the world, including competition from other large, multinational companies and other regional companies. Some of these companies may have substantially greater financial and other resources than the Company. We face competition in several aspects of our business. In the SMS EAS systems and Alpha S3 businesses and SMS EAS consumables business, we compete primarily on the basis of integrated security solutions and diversified, sophisticated, and quality product lines targeted at meeting the loss prevention needs of our retail customers. In our CheckView® business, we compete primarily on the basis of efficient installation capability that is in place in North America. In the ALS business, we compete primarily on the capability to effectively and quickly deliver retail customer specified tags and labels to manufacturing sites in multiple countries. It is possible that our competitors will be able to offer additional products, services, lower prices, or other incentives that we cannot offer or that will make our products less profitable. It is also possible that our competitors will offer incentive programs or will market and advertise their products in a way that will impact customers’ preferences, and we may not be able to compete effectively.
We may be unable to anticipate the timing and scale of our competitors’ activities and initiatives, or we may be unable to successfully counteract them, which could harm our business. In addition, the cost of responding to our competitors’ activities may affect our financial performance in the relevant period. Our ability to compete also depends on our ability to attract and retain key talent, protect patent and trademark rights, and develop innovative and cost-effective products. A failure to compete effectively could adversely affect our growth and profitability.
Our long term success is largely dependent upon our ability to develop new technologies, and if we are unable to successfully develop those technologies, our business could be materially adversely affected.
Our growth depends on continued sales of existing products, as well as the successful development and introduction of new products, which face the uncertainty of retail and consumer acceptance and reaction from competitors. In addition, our ability to create new products and to sustain existing products is affected by whether we can:
§
develop and fund technological innovations, such as those related to our next generation EAS product solutions, continued investment in evolving RFID technologies, and other innovative security device, software, and systems initiatives;
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receive and maintain necessary patent and trademark protection; and
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successfully anticipate customer needs and preferences.
The failure to develop and launch successful new products could hinder the growth of our business. Research and development for each of our operating segments is complex and uncertain and requires innovation and anticipation of market trends. Also, delay in the development or launch of a new product could compromise our competitive position, particularly if our competitors announce or introduce new products and services in advance of us.
An inability to acquire, protect or maintain our intellectual property, including patents, could harm our ability to compete or grow.
Because our products involve complex technology and chemistry, we rely on protections of our intellectual property and proprietary information to maintain a competitive advantage. The expiration of these patents will reduce the barriers to entry into our existing lines of business and may result in loss of market share and a decrease in our competitive abilities, thus having a potential adverse effect on our financial condition, results of operations and cash flows. At this time we do not anticipate any significant impact from the expiration of patents over the next two to three years.
Our business could be materially adversely affected as a result of possible increases in per unit product manufacturing costs as a result of slowing economic conditions or other factors.
Our manufacturing capacity is designed to meet our current and future anticipated demands. If our product demand decreases as a result of economic conditions and other factors, it could increase our cost per unit. If an increase in our cost per unit is passed on to our customers, it may decrease our competitive position, which may have an adverse effect on our revenues and results of operations. If an increase in cost per unit is not passed on to our customers, it may reduce our gross margins, which may have an adverse effect on our results of operations. Our SMS EAS consumables and ALS manufacturing have various low price competitors globally. In order for us to maintain and improve our market position, we need to continuously monitor and seek to improve our manufacturing effectiveness while maintaining our high quality standard. If we are unsuccessful in our efforts to improve manufacturing and supply chain effectiveness, then our cost per unit may increase which could have an adverse impact on our results of operations.
If we cannot obtain sufficient quantities of raw materials and component parts required for our manufacturing activities at competitive prices and quality and on a timely basis, our financial condition, results of operations or cash flows may suffer.
We purchase materials and component parts from third parties for use in our manufacturing operations. Our ability to grow earnings will be affected by inflationary and other increases in the cost of component parts and raw materials, including electronic components, circuit boards, aluminum foil, resins, paper, and ferric chloride and hydrochloric acid solutions. Inflationary and other increases in the costs of raw materials, labor, and energy have occurred in the past and are expected to recur, and our performance depends in part on our ability to pass these cost increases on to customers in the prices for our products and to effect improvements in productivity. We may not be able to fully offset the effects of higher component parts and raw material costs through price increases, productivity improvements or cost reduction programs. If we cannot obtain sufficient quantities of these items at competitive prices and quality and on a timely basis, we may not be able to produce sufficient quantities of product to satisfy market demand, product shipments may be delayed, or our material or manufacturing costs may increase. A disruption to our supply chain could adversely affect our sales and profitability. Any of these problems could result in the loss of customers and revenue, provide an opportunity for competing products to gain market acceptance and otherwise adversely affect our financial condition, results of operations, or cash flows.
Possible increases in the payment time for receivables as a result of economic conditions or other market factors could have a material effect on our results from operations and anticipated cash from operating activities.
The majority of our customer base is in the retail marketplace. Although we have a rigorous process to administer credit granted to customers and believe our allowance for doubtful accounts is adequate, we have experienced, and in the future may experience, losses as a result of our inability to collect our accounts receivable. During the past several years, various retailers have experienced significant financial difficulties, which in some cases have resulted in bankruptcies, liquidations and store closings. The financial difficulties of a customer could result in reduced business with that customer. We may also assume higher credit risk relating to receivables of a customer experiencing financial difficulty. If these developments occur, our inability to shift sales to other customers or to collect on our trade accounts receivable from a major customer could substantially reduce our income and have a material adverse effect on our results of operations and cash flows from operating activities.
We have entered into a senior secured credit facility agreement and senior secured notes agreement that restrict certain activities, and failure to comply with these agreements may have an adverse effect on our financial condition, results of operations and cash flows.
We maintain a senior secured credit facility and senior secured notes that contain restrictive financial covenants, including financial covenants that require us to comply with specified financial ratios. We may have to curtail some of our operations to comply with these covenants. In addition, our senior secured credit facility and senior secured notes agreements contain other affirmative and negative covenants that could restrict our operating and financing activities. These provisions limit our ability to, among other things, incur future indebtedness, contingent obligations or liens, guarantee indebtedness, make certain investments and capital expenditures, sell stock or assets and pay dividends, and consummate certain mergers or acquisitions. Because of the restrictions on our ability to create or assume liens, we may find it difficult to secure additional indebtedness if required. Furthermore, if we fail to comply with the requirements of the senior secured credit facility and/or senior secured notes agreements, we may be in default, and we may not be able to obtain the necessary amendments to the respective agreements or waivers of an event of default. Upon an event of default, if the respective agreements are not amended or the event of default is not waived, the lenders could declare all amounts outstanding, together with accrued interest, to be immediately due and payable. If this happens, we may not be able to make those payments or borrow sufficient funds from alternative sources to make those payments. Even if we were to obtain additional financing, that financing may be on unfavorable terms.
Changes in legislation or governmental regulations, policies or standards applicable to our products may have a significant impact on our ability to compete in our target markets.
We operate in regulated industries. Our U.S. operations are subject to regulation by federal, state, and local governmental agencies with respect to safety of operations and equipment, labor and employment matters, and financial responsibility. Our SMS EAS products are subject to FCC regulation, and our international operations are regulated by the countries in which they operate, including regulation of the Conformité Européene (CE) in Europe. Failure to comply with laws or regulations could result in substantial fines or revocation of our operating permits or licenses. If laws and regulations change and we fail to comply, our financial condition, results of operations, or cash flows could be materially and adversely affected.
Our ability to implement cost reductions in field services, selling, general and administrative expenses, and our manufacturing and supply chain operations may have a significant impact on our business and future revenues and profits.
We have taken actions to rationalize our field service, improve our sales productivity, reduce our general and administrative expenses, and reconfigure our manufacturing and supply chain operations. Such rationalization actions require management judgment on the development of cost reduction strategies and precision on the execution of those strategies. We may not realize, in full or in part, the anticipated benefits from these initiatives, and other events and circumstances, such as difficulties, delays, or unexpected costs may occur, which could result in our not realizing all or any of the anticipated benefits. We also cannot predict whether we will realize improved operating performance as a result of any cost reduction strategies. Further, in the event the market continues to fluctuate, we may not have the appropriate level of resources and personnel to react to the change. We are also subject to the risk of business disruption in connection with our restructuring initiatives, which could have a material adverse effect on our business and future revenues and profits.
We continue to evaluate opportunities to restructure our business and rationalize our operations in an effort to optimize our cost structure and efficiencies. As a result of these evaluations, we may take similar rationalization steps in the future. Future actions could result in restructuring and related charges, including but not limited to workforce reduction costs and charges relating to consolidation of excess facilities that could be significant.
If we fail to manage our growth effectively, our business could be harmed.
Our strategy is to maximize value by achieving growth both organically and through acquisitions. Our ability to effectively manage and control any future growth may be limited. To manage any growth, our management must continue to improve our operational, information and financial systems, procedures and controls and expand, train, retain and manage our employees. If our systems, procedures and controls are inadequate to support our operations, any expansion could decrease or stop, and investors may lose confidence in our operations or financial results. If we are unable to manage growth effectively, our business and operating results could be adversely affected, and any failure to develop and maintain adequate internal controls over financial reporting could cause the trading price of our shares to decline substantially.
Our ability to integrate acquisitions and to achieve our financial and operational goals for these acquired businesses could have an impact on future revenues and profits.
In August 2009, we acquired Brilliant, a Hong Kong and China-based manufacturer of woven and printed labels, which will allow us to strengthen and expand our core apparel labeling offering and provides us with additional capacity in a key geographical location. Upon full integration of the acquisition, Brilliant’s woven and printed label manufacturing capabilities will establish us as a full range global supplier for the apparel labeling solutions business. Additionally, in January of 2011 we announced that we had entered into an agreement to acquire equity and/or assets of Shore to Shore, Inc., including the Adapt Group and related assets. Together, this acquisition represents a retail apparel and footwear product identification business which designs, manufactures and sells tags and labels, hang tags, price tickets, printed paper tags, pressure sensitive products, woven labels, leather and leather-like labels, heat transfer labels and brand protection and EAS solutions/labels which may or may not contain RFID tags, chips or inlays. The closing of this transaction is subject to the satisfaction of certain conditions.
Various risks, uncertainties and costs are associated with acquisitions. Effective integration of systems, key business processes, controls, objectives, personnel, management practices, product lines, markets, customers, supply chain operations, and production facilities can be difficult to achieve and the results are uncertain, particularly across our internationally diverse organization. We may not be able to retain key personnel of an acquired company and we may not be able to successfully execute integration strategies or achieve projected performance targets set for the business segment into which an acquired company is integrated. Our ability to execute the integration plans could have an impact on future revenues and profits and may adversely affect our financial condition, results of operations or cash flows. There can be no assurance that these acquisitions or others will be successful and contribute to our profitability.
Any acquisition, strategic relationship, joint venture or investment could disrupt our business and harm our financial condition.
We actively pursue acquisitions, strategic relationships, joint ventures, collaborations and investments that we believe may allow us to complement our growth strategy, increase market share in our current markets or expand into adjacent markets, or broaden our technology and intellectual property. Such transactions may be complex, time consuming and expensive, and may present numerous challenges and risks. Lack of control over the actions of our business partners in any strategic relationship, joint venture or collaboration, could significantly delay the introduction of planned products or otherwise make it difficult or impossible to realize the expected benefits of such relationship.
An impairment in the carrying value of goodwill or other assets could negatively affect our consolidated results of operations and net worth.
Pursuant to accounting principles generally accepted in the United States, we are required to annually assess our goodwill, intangibles and other long-lived assets to determine if they are impaired. In addition, interim reviews must be performed whenever events or changes in circumstances indicate that impairment may have occurred. If the testing performed indicates that impairment has occurred, we are required to record a non-cash impairment charge for the difference between the carrying value of the goodwill or other intangible assets and the implied fair value of the goodwill or other intangible assets in the period the determination is made. Disruptions to our business, end market conditions and protracted economic weakness, unexpected significant declines in operating results of reporting units, divestitures and market capitalization declines may result in additional charges for goodwill and other asset impairments. We have significant intangible assets, including goodwill with an indefinite life, which are susceptible to valuation adjustments as a result of changes in such factors and conditions. We assess the potential impairment of goodwill and indefinite lived intangible assets on an annual basis, as well as when interim events or changes in circumstances indicate that the carrying value may not be recoverable. We assess definite lived intangible assets when events or changes in circumstances indicate that the carrying value may not be recoverable.
Our 2010 annual impairment test indicated no impairment of our goodwill or intangible assets. Although our analysis regarding the fair values of the goodwill and indefinite lived intangible assets indicates that they exceed their respective carrying values, materially different assumptions regarding the future performance of our businesses or significant declines in our stock price could result in additional goodwill impairment losses. We also evaluate other assets on our balance sheet whenever events or changes in circumstances indicate that their carrying value may not be recoverable. Materially different assumptions regarding the future performance of our businesses could result in significant asset impairment losses.
Our future results may be affected by various legal and regulatory proceedings.
We cannot predict with certainty the outcome of litigation matters, government proceedings and investigations, and other contingencies and uncertainties that may arise out of the conduct of our business, including matters relating to intellectual property, employment, commercial and other matters. Resolution of such matters can be prolonged and costly, and the ultimate results or judgments are uncertain due to the inherent uncertainty in litigation and other proceedings. Moreover, our potential liabilities are subject to change over time due to new developments, changes in settlement strategy or the impact of evidentiary requirements, and we may be required to pay fines, damage awards or settlements, or become subject to fines, damage awards or settlements, that could have a material adverse effect on our results of operations, financial condition, and liquidity.
The failure to effectively maintain and upgrade our information systems could adversely affect our business.
Our business depends significantly on effective information systems, and we have many different information systems for our various businesses. Our information systems require an ongoing commitment of significant resources to maintain and enhance existing systems and develop new systems in order to keep pace with continuing changes in information processing technology, evolving industry and regulatory standards, and changing customer preferences. In addition, we may from time to time obtain significant portions of our systems-related or other services or facilities from independent third parties, which may make our operations vulnerable to such third parties’ failure to perform adequately. Our failure to maintain effective and efficient information systems, or our failure to efficiently and effectively consolidate our information systems to eliminate redundant or obsolete applications, could have a material adverse effect on our business, financial condition and results of operations. Additionally, any disruption or failure of such networks, systems, or other technology may disrupt our operations, cause customer dissatisfaction, and loss of customer revenues.
Risks generally associated with a company-wide implementation of an enterprise resource planning (ERP) system may adversely affect our business and results of operations or the effectiveness of internal control over financial reporting.
We are preparing to implement a company-wide ERP system to handle the business and financial processes within our operations and corporate functions. ERP implementations are complex and time-consuming projects that involve substantial expenditures on system software and implementation activities that can continue for several years. ERP implementations also require transformation of business and financial processes in order to reap the benefits of the ERP system. Our business and results of operations may be adversely affected if we experience operating problems and/or cost overruns during the ERP implementation process, or if the ERP system and the associated process changes do not give rise to the benefits that we expect. Additionally, if we do not effectively implement the ERP system as planned or if the system does not operate as intended, it could adversely affect the effectiveness of our internal controls over financial reporting.
As a global business, we have a relatively complex tax structure, and there is a risk that tax authorities will disagree with our tax positions.
Since we conduct operations worldwide through our foreign subsidiaries, we are subject to complex transfer pricing regulations in the countries in which we operate. Transfer pricing regulations generally require that, for tax purposes, transactions between us and our foreign affiliates be priced on a basis that would be comparable to an arm’s length transaction and that contemporaneous documentation be maintained to support the tax allocation. Although uniform transfer pricing standards are emerging in many of the countries in which we operate, there is still a relatively high degree of uncertainty and inherent subjectivity in complying with these rules. To the extent that any foreign tax authorities disagree with our transfer pricing policies, we could become subject to significant tax liabilities and penalties.
Our tax returns are subject to review by taxing authorities in the jurisdictions in which we operate. Although we believe that we have provided for all tax exposures, the ultimate outcome of a tax review could differ materially from our provisions.
We record a valuation allowance to reduce our deferred tax assets to the amount that it is more likely than not to be realized. Our assessments about the realizability of our deferred tax assets are based on estimates of our future taxable income by tax jurisdiction, the prudence and feasibility of possible tax planning strategies, and the economic environments in which we do business. Any changes in these assessments could have a material impact on our results of operations.
Item 1B.
Item 1B. UNRESOLVED STAFF COMMENTS
None.
Item 2.
Item 2. PROPERTIES
Our principal corporate offices are located at One Commerce Square, 2005 Market Street, Suite 2410, Philadelphia, Pennsylvania. As of December 26, 2010, we owned or leased approximately 2.8 million square feet of space worldwide which is used primarily for sales, distribution, manufacturing, and general administration. These facilities include offices located throughout North and South America, Europe, Asia, and Australia. Our principal manufacturing facilities are located in Bangladesh, China, the Dominican Republic, Germany, Hong Kong, India, Japan, Malaysia, the Netherlands, Puerto Rico, Turkey, the U.K. and the U.S. We believe our current manufacturing capacity will support our needs for the foreseeable future.
Item 3.
Item 3. LEGAL PROCEEDINGS
We are 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 that the ultimate resolution of such matters is unlikely to have a material adverse effect on our consolidated results of operations and/or financial condition, except as described below.
Matter related to All-Tag Security S.A., et al
We originally filed suit on May 1, 2001, alleging that the disposable, deactivatable radio frequency security tag manufactured by All-Tag Security S.A. and All-Tag Security Americas, Inc.’s (jointly “All-Tag”) and sold by Sensormatic Electronics Corporation (Sensormatic) infringed on a U.S. Patent No. 4,876,555 (Patent) owned by us. On April 22, 2004, the United States District Court for the Eastern District of Pennsylvania granted summary judgment to defendants All-Tag and Sensormatic on the ground that our Patent was invalid for incorrect inventorship. We appealed this decision. On June 20, 2005, we won an appeal when the Federal Circuit reversed the grant of summary judgment and remanded the case to the District Court for further proceedings. On January 29, 2007 the case went to trial, and on February 13, 2007, a jury found in favor of the defendants on infringement, the validity of the Patent and the enforceability of the Patent. On June 20, 2008, the Court entered judgment in favor of defendants based on the jury’s infringement and enforceability findings. On February 10, 2009, the Court granted defendants’ motions for attorneys’ fees designating the case as an exceptional case and awarding an unspecified portion of defendants’ attorneys’ fees under 35 U.S.C. § 285. Defendants are seeking approximately $5.7 million plus interest. We recognized this amount during the fourth fiscal quarter ended December 28, 2008 in litigation settlements on the consolidated statement of operations. On March 6, 2009, we filed objections to the defendants’ bill of attorneys’ fees. Those objections are still pending before the Court. We intend to appeal any specified award of legal fees.
Other Settlements
During 2009, we recorded $1.3 million of litigation expense related to the settlement of a dispute with a consultant for $0.9 million and the acquisition of a patent related to our Alpha business for $0.4 million. We purchased the patent for $1.7 million related to our Alpha business. A portion of this purchase price was attributable to use prior to the date of acquisition and as a result we recorded $0.4 million in litigation expense and $1.3 million in intangibles.
PART II
Item 5.
Item 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is listed on the New York Stock Exchange (NYSE) under the symbol CKP. The following table sets forth, for the periods indicated, the high and low sale prices for our common stock as reported on the NYSE Composite Tape.
Holders of Record
As of February 11, 2011, there were 602 holders of record of our common stock.
Dividends
We have never paid a cash dividend on our common stock (except for a nominal cash distribution in April 1997 to redeem the rights outstanding under our 1988 Shareholders’ Rights Plan). We do not anticipate paying any cash dividends in the near future. We have retained, and expect to continue to retain, our earnings for reinvestment into the business. The declaration and payment of dividends in the future, and their amounts, will be determined by the Board of Directors in light of conditions then existing, including our earnings, our financial condition and business requirements (including working capital needs), and other factors.
Recent Sales of Unregistered Securities
There has been no sale of unregistered securities in fiscal years 2010, 2009, or 2008.
STOCK PERFORMANCE GRAPH
The following graph compares the cumulative total shareholder return on the Common Stock of the Company for the period beginning December 25, 2005 and ending on December 26, 2010, with the cumulative total return on the Center for Research in Security Prices Index (CRSP Index) for NYSE/AMEX/NASDAQ Stock market, and the CRSP Index for NASDAQ Electronic Components and Accessories, assuming the investment of $100 in the Company’s Stock, the CRSP Index for NYSE/AMEX/NASDAQ Stock market, and the CRSP Index for NASDAQ Electronic Components and Accessories and the reinvestment of all dividends.
Year
Checkpoint
Systems, Inc.
NYSE/AMEX/NASDAQ
Stock Market Index
NASDAQ Electronic
Components and
Accessories Index
100.00
100.00
100.00
81.96
115.98
95.07
105.44
122.02
110.97
39.93
73.08
56.72
61.88
94.33
91.13
83.39
111.39
104.65
This Stock Performance Graph shall not be deemed incorporated by reference by any general statement incorporating by reference this annual report into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent that the Company specifically incorporates this information by reference, and shall not otherwise be deemed filed under such Acts.
Comparison of 5 Year Cumulative Total Return
Assumes Initial Investment of $100
December 2010
Notes:
A.
Note: Data complete through last fiscal year.
B.
Note: Corporate Performance Graph with peer group uses peer group only performance (excludes only company).
C.
Note: Peer group indices use beginning of period market capitalization weighting.
D.
Note: Data and graph are calculated from CRSP Total Return Index for the NYSE/AMEX/NASDAQ Stock Market (US Companies), Center for Research in Security Prices (CRSP), Graduate School of Business, The University of Chicago.
Item 6.
Item 6. SELECTED FINANCIAL DATA
The following tables set forth our selected financial data and should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and Notes thereto included elsewhere herein.
(amounts in thousands, except per share data)
Year ended
Dec. 26,
Dec. 27,
Dec. 28,
Dec. 30,
Dec. 31,
STATEMENT OF OPERATIONS DATA
Net revenues
$ 834,498
$ 772,718
$ 917,082
$ 834,156
$ 687,775
Earnings (loss) from continuing operations before income taxes
$ 37,022
$ 35,985
$ (29,209)
$ 70,576
$ 41,975
Income taxes expense
$ 9,767
$ 10,290
$ 719
$ 12,174
$ 6,987
Earnings (loss) from continuing operations
$ 27,255
$ 25,695
$ (29,928)
$ 58,402
$ 34,988
Discontinued operations, net of tax
$ -
$ -
$ -
$ 359
$ 903
Net earnings (loss) attributable to Checkpoint Systems, Inc.
$ 27,371(1)
$ 26,142(2)
$ (29,805)(3)
$ 58,768(4)
$ 35,922(5)
Earnings (loss) attributable to Checkpoint Systems, Inc. per share from continuing operations:
Basic
$ .69
$ .67
$ (.76)
$ 1.46
$ .89
Diluted
$ .68
$ .66
$ (.76)
$ 1.43
$ .87
Earnings (loss) attributable to Checkpoint Systems, Inc. per share:
Basic
$ .69
$ .67
$ (.76)
$ 1.47
$ .91
Diluted
$ .68
$ .66
$ (.76)
$ 1.44
$ .89
Depreciation and amortization
$ 34,477
$ 32,325
$ 30,788
$ 21,059
$ 19,504
(1)
Includes a $8.2 million restructuring charge ($6.2 million, net of tax) and a valuation allowance adjustment of $4.3 million. Also included is a $1.7 million tax charge and a $0.8 million selling, general and administrative charge ($0.8 million, net of tax) related to adjustments to acquisition related liabilities pertaining to the period prior to the acquisition date.
(2)
Includes a $5.4 million restructuring charge ($4.0 million, net of tax), a $1.3 million litigation settlement charge ($0.8 million, net of tax), and a valuation allowance adjustment of $5.3 million.
(3)
Includes a $59.6 million goodwill impairment charge ($58.5 million, net of tax), a $6.4 million restructuring charge ($4.6 million, net of tax), a $6.2 million litigation settlement charge ($3.8 million, net of tax), a $3.0 million intangible asset impairment charge ($2.2 million, net of tax), a $1.5 million fixed asset impairment charge ($1.1 million, net of tax), and a $1.0 million gain from the sale of our Czech subsidiary ($1.0 million, net of tax).
(4)
Includes a $2.7 million ($2.0 million, net of tax) restructuring charge, a $4.4 million ($2.9 million, net of tax) charge related to the CEO transition, and a $2.6 million ($2.5 million, net of tax) gain from the sale of our Austrian subsidiary.
(5)
Includes a $7.0 million ($4.8 million, net of tax) restructuring charge, a $2.3 million ($1.5 million, net of tax) litigation settlement charge, and a $1.8 million ($1.1 million, net of tax) gain from the settlement of a capital lease. Also included in discontinued operations is a $2.8 million ($1.4 million, net of tax) gain on the divestment of our barcode business.
(amounts in thousands)
Dec. 26,
Dec. 27,
Dec. 28,
Dec. 30,
Dec. 31,
AT YEAR END
Working capital
$ 298,794
$ 241,809
$ 282,752
$ 297,056
$ 254,024
Total debt
$ 141,949
$ 116,872
$ 145,286
$ 95,512
$ 16,534
Total equity
$ 584,291
$ 558,554
$ 511,135
$ 595,202
$ 480,434
Total assets
$ 1,035,273
$ 1,024,233
$ 991,613
$ 1,036,941
$ 787,088
FOR THE YEAR ENDED
Capital expenditures
$ 23,712
$ 13,757
$ 15,217
$ 13,363
$ 11,520
Cash provided by operating activities
$ 10,904
$ 114,826
$ 77,206
$ 66,971
$ 22,386
Cash (used in) provided by investing activities
$ (23,185)
$ (38,645)
$ (54,704)
$ (106,151)
$ 7,963
Cash provided by (used in) financing activities
$ 28,891
$ (50,316)
$ (4,460)
$ 7,164
$ (6,945)
RATIOS
Return on net sales(a)
3.28
%
3.38
%
(3.25)
%
7.05
%
5.22
%
Return on average equity(b)
4.79
%
4.89
%
(5.39)
%
10.93
%
8.13
%
Return on average assets(c)
2.66
%
2.59
%
(2.94)
%
6.44
%
4.69
%
Current ratio(d)
2.40
2.00
2.34
2.42
2.31
Percent of total debt to capital(e)
19.55
%
17.30
%
22.13
%
13.83
%
3.33
%
(a)
“Return on net sales” is calculated by dividing net earnings (loss) after the cumulative effect of change in accounting principle by net sales.
(b)
“Return on average equity” is calculated by dividing net earnings (loss) after the cumulative effect of change in accounting principle by average equity.
(c)
“Return on average assets” is calculated by dividing net earnings (loss) after the cumulative effect of change in accounting principle by average assets.
(d)
“Current ratio” is calculated by dividing current assets by current liabilities.
(e)
“Percent of total debt to capital” is calculated by dividing total debt by total debt and equity.
(amounts in thousands, except employee data)
Dec. 26,
Dec. 27,
Dec. 28,
Dec. 30,
Dec. 31,
OTHER INFORMATION
Weighted average number of shares outstanding - diluted
40,445
39,552
39,408(1)
40,724
40,233
Number of employees
5,814
5,785
3,878
3,930
3,213
Backlog
$ 47,974
$ 50,186
$ 51,799
$ 73,462
$ 54,899
(1)
Excludes 518 common shares from stock options and awards and 22 common shares from deferred compensation arrangements as they are anti-dilutive due to our net loss for the year.
Item 7.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following section highlights significant factors impacting the consolidated operations and financial condition of the Company and its subsidiaries. The following discussion should be read in conjunction with Item 6 “Selected Financial Data” and Item 8 “Financial Statements and Supplementary Data.”
Overview
We are a multinational manufacturer and marketer of identification, tracking, security and merchandising solutions primarily for the retail industry. We provide technology-driven integrated supply chain 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, electronic article surveillance (EAS), custom tags and labels (Apparel Labeling Solutions), store monitoring solutions (CheckView®), hand-held labeling systems (HLS), retail merchandising systems (RMS), and radio frequency identification (RFID) systems and software. Applications of these products include primarily retail security, asset and merchandise visibility, automatic identification, and pricing and promotional labels and signage. Operating directly in 31 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.
Historically, we have reported our results of operations into three segments: Shrink Management Solutions, Intelligent Labels, and Retail Merchandising. During the first quarter of 2009, resulting from a change in our management structure, we began reporting our segments into three new segments: Shrink Management Solutions, Apparel Labeling Solutions, and Retail Merchandising Solutions. Fiscal year 2008 has been conformed to reflect the segment change. The margins for each of the segments and the identifiable assets attributable to each reporting segment are set forth in Note 18 “Business Segments and Geographic Information” to the Consolidated Financial Statements. Shrink Management Solutions now includes results of our EAS labels and library businesses. Apparel Labeling Solutions, formerly referred to as Check-Net®, includes tag and label solutions sold to apparel manufacturers and retailers, which leverage our graphic and design expertise, strategically located service bureaus, and our Check-Net® e-commerce capabilities. Our apparel labeling services, coupled with our EAS and RFID capabilities, provide a combination of apparel branding and identification with loss prevention and supply chain visibility. There were no changes to the Retail Merchandising Solutions segment.
Historically, we have reported RF and EM Hard Tags as part of the SMS EAS Systems product line. During the first quarter of 2010, we began reporting our RF and EM Hard Tags as part of the Alpha product line. This change results in all hard tags for in-store application being recorded in the same product line as the Alpha hard tags. Because both product lines are reported within the Shrink Management Solutions segment, the change in classification does not impact segment reporting. The years ended 2009 and 2008 have been conformed to reflect the product line change within the SMS segment. We have adjusted all prior year comparative amounts and explanations within Management’s Discussion and Analysis to reflect this change in classification to be consistent for all periods presented.
Our business has been impacted by the unprecedented credit crisis and on-going softening of the global economic environment. 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. We believe that the strength of our core business and our ability to generate positive cash flow will sustain us through this challenging period.
During 2009, we initiated a 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 subsequent phases initiated during fiscal year 2010. In September 2010, we announced the remaining phases of the plan in which we anticipate the total plan to result in restructuring charges of approximately $20 million to $25 million, or $0.49 to $0.61 per diluted share. We expect the implementation of this program to be substantially complete by the end of 2011 and to result in annual cost savings of approximately $20 million to $25 million. We expect to realize approximately $15 million to $17 million of annual cost savings in 2011.
In August 2008, we announced a manufacturing and supply chain restructuring program designed to accelerate profitable growth in our ALS business and to support incremental improvements in our EAS systems and labels businesses. As of December 26, 2010 the implementation of this program is substantially complete with total restructuring charges incurred of approximately $4.2 million, or $0.10 per diluted share. We expect to realize approximately $6 million of annual cost savings related to this program in 2011.
In July 2009, we entered into an agreement to purchase the business of Brilliant Label, a China-based manufacturer of woven and printed labels, and settled the acquisition in August 2009. As of the second quarter of 2010, our financial statements reflected the final allocations of the Brilliant Label purchase price based on estimated fair values at the date of acquisition. The results from the acquisition and related goodwill are included in the Apparel Labeling Solutions segment. This acquisition has allowed us to strengthen and expand our core apparel labeling offering and provides us with additional capacity in a key geographical location. Brilliant Label’s woven and printed label manufacturing capabilities will establish us as a full range global supplier for the apparel labeling solutions business.
Future financial results will be dependent upon our ability to 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, and reduce the cost of our products and infrastructure to respond to competitive pricing pressures.
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, and our borrowing capacity should provide us with adequate cash flow and liquidity to execute our business plan.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles (GAAP) in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities.
Note 1 of the notes to the Consolidated Financial Statements describes the significant accounting policies used in the preparation of the consolidated financial statements. Certain of these significant accounting policies are considered to be critical accounting policies. A critical accounting policy is defined as one that is both material to the presentation of our consolidated financial statements and requires management to make difficult, subjective or complex judgments that could have a material effect on our financial condition or results of operations.
Specifically, these policies have the following attributes: (1) we are required to make assumptions about matters that are highly uncertain at the time of the estimate; and (2) different estimates we could reasonably have used, or changes in the estimate that are reasonably likely to occur, would have a material effect on our financial condition or results of operations. Estimates and assumptions about future events and their effects cannot be determined with certainty. On an on-going basis, we evaluate our estimates on historical experience and on various other assumptions believed to be applicable and reasonable under the circumstances. These estimates may change as new events occur, as additional information is obtained and as our operating environment changes. These changes have historically been minor and have been included in the consolidated financial statements as soon as they became known. Senior management reviews the development and selection of our accounting policies and estimates with the Audit Committee. The critical accounting policies have been consistently applied throughout the accompanying financial statements.
We believe the following accounting policies are critical to the preparation of our consolidated financial statements:
Revenue Recognition. We recognize revenue when revenue is realized or realizable and earned. Revenue is realized or realizable and earned when all of the following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; the price to the buyer is fixed or determinable; and collectability is reasonably assured. We enter into contracts to sell our products and services, and, while the majority of our sales agreements contain standard terms and conditions, there are agreements that contain multiple elements or non-standard terms and conditions. As a result, significant contract interpretation is sometimes required to determine the appropriate accounting, including whether the deliverables specified in a multiple element arrangement should be treated as separate units of accounting for revenue recognition purposes, and, if so, how the price should be allocated among the elements and when to recognize revenue for each element. Unearned revenue is recorded when payments are received in advance of performing our service obligations and is recognized over the service period.
For arrangements with multiple elements, we determine the fair value of each element and then allocate the total arrangement consideration among the separate elements. In instances when the fair value is not known for the delivered items, and is known for the undelivered items, the residual method is used. We recognize revenue when installation is complete or other post-shipment obligations have been satisfied. Equipment leased to customers under sales-type leases is accounted for as the equivalent of a sale. The present value of such lease revenues is recorded as net revenues, and the related cost of the equipment is charged to cost of revenues. The deferred finance charges applicable to these leases are recognized over the terms of the leases. Rental revenue from equipment under operating leases is recognized over the term of the lease. Installation revenue from SMS EAS equipment is recognized when the systems are installed. Service revenue is recognized, for service contracts, on a straight-line basis over the contractual period, and, for non-contract work, as services are performed.
Revenues from software license agreements are recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, no significant vendor obligations are remaining to be fulfilled, the fee is fixed or determinable, and collection is probable. Revenue from software contracts for both licenses and professional services that require significant production, modification, customization, or implementation are recognized together using the percentage of completion method based upon the ratio of labor incurred to total estimated labor to complete each contract. In instances where there is a term license combined with services, revenue is recognized ratably over the term.
We record estimated reductions to revenue for customer incentive offerings, including volume-based incentives and rebates. We record revenues net of an allowance for estimated return activities. Return activity was immaterial to revenue and results of operations for all periods presented.
We believe the following judgments and estimates have a significant effect on our consolidated financial statements:
Allowance for Doubtful Accounts. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. These allowances are based on specific facts and circumstances surrounding individual customers as well as our historical experience. The adequacy of the reserves for doubtful accounts is continually assessed by periodically evaluating each customer’s receivable balance, considering our customers’ financial condition and credit history, and considering current economic conditions. Historically, our reserves have been adequate to cover all losses associated with doubtful accounts. If the financial condition of our customers were to deteriorate, impairing their ability to make payments, additional allowances may be required. If economic or political conditions were to change in the countries where we do business, it could have a significant impact on the results of operations, and our ability to realize the full value of our accounts receivable. Furthermore, we are dependent on customers in the retail markets. Economic difficulties experienced in those markets could have a significant impact on our results of operations and our ability to realize the full value of our accounts receivables. If our historical experiences changed by 10%, it would require an increase or decrease of $0.2 million to our reserve.
Inventory Valuation. We write down our inventory for estimated obsolescence or unmarketable items equal to the difference between the cost of the inventory and the estimated net realizable value based upon assumptions of future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. If our estimates were to change by 10%, it would cause a change in inventory value of $0.7 million.
Valuation of Long-lived Assets. Our long-lived assets include property, plant, and equipment, goodwill, and identified intangible assets. With the exception of goodwill and indefinite-lived intangible assets, long-lived assets are depreciated or amortized over their estimated useful lives, and are reviewed for impairment whenever changes in circumstances indicate the carrying value may not be recoverable. Recoverability is determined based upon our estimates of future undiscounted cash flows. If the carrying value is determined to be not recoverable, an impairment charge would be necessary to reduce the recorded value of the assets to their fair value. The fair value of the long-lived assets other than goodwill is based upon appraisals, quoted market prices of similar assets, or discounted cash flows.
Goodwill and indefinite-lived intangible assets are subject to tests for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. We test for impairment on an annual basis as of fiscal month end October of each fiscal year, relying on a number of factors including operating results, business plans, and anticipated future cash flows. Our management uses its judgment in assessing whether goodwill has become impaired between annual impairment tests. Reporting units are primarily determined as the geographic areas comprising our business segments, except in situations when aggregation of the reporting units is appropriate. Recoverability of goodwill is evaluated using a two-step process. The first step involves a comparison of the fair value of a reporting unit with its carrying value. If the carrying amount of the reporting unit exceeds the fair value, then the second step of the process involves a comparison of the implied fair value and carrying value of the goodwill of that reporting unit. If the carrying value of the goodwill of a reporting unit exceeds the fair value of that goodwill, an impairment loss is recognized in an amount equal to the excess.
The implied fair value of our reporting units is dependent upon our estimate of future discounted cash flows and other factors. Our estimates of future cash flows include assumptions concerning future operating performance and economic conditions and may differ from actual future cash flows. Estimated future cash flows are adjusted by an appropriate discount rate derived from our market capitalization plus a suitable control premium at the date of evaluation. The financial and credit market volatility directly impacts our fair value measurement through our weighted average cost of capital that we use to determine our discount rate, and through our stock price that we use to determine our market capitalization. Therefore, changes in the stock price may also affect the result of the impairment test. Market capitalization is determined by multiplying the number of shares outstanding on the assessment date by the average market price of our common stock over a 30-day period before each assessment date. We use this 30-day duration to consider inherent market fluctuations that may affect any individual closing price. We believe that our market capitalization alone does not fully capture the fair value of our business as a whole, or the substantial value that an acquirer would obtain from its ability to obtain control of our business. The difference between the sum total of the fair value of our reporting units and our market capitalization represents the control premium. As of the date of our goodwill impairment test, management has assessed our control premium to be within a reasonable range.
We have not made any changes to our methodology used in our annual impairment test since the adoption of ASC 350. Determination of the fair value of a reporting unit is a matter of judgment and involves the use of estimates and assumptions, which are based on management’s best estimates at the time.
We use an income approach (discounted cash flow approach) for the determination of fair value of our reporting units. Our projected cash flows incorporate many assumptions, the most significant of which include variables such as future sales, growth rates, operating margin, and the discount rates applied.
Assumptions related to revenue, growth rates and operating margin are based on management’s annual and ongoing forecasting, budgeting and planning processes and represent our best estimate of the future results of operations across the company. These estimates are subject to many assumptions, such as the economic environment across the segments in which we operate, end demand for our products, and competitor actions. The use of different assumptions would increase or decrease estimated discounted future cash flows and could increase or decrease an impairment charge. If the use of these assets or the projections of future cash flows change in the future, we may be required to record impairment charges. An erosion of future business results in any of the business units or significant declines in our stock price could result in an impairment to goodwill or other long-lived assets. These risks are discussed in Item 1A. “Risk Factors.”
As of the date of our fiscal 2009 impairment test, the fair values of all of our reporting units exceeded their respective carrying values by more than 20%, with the exception of one reporting unit in our Retail Merchandising segment. The fair value of this reporting unit exceeded its respective carrying value by approximately 10%. A 10% decline in operating results for this reporting unit or a 2% increase in our discount rate as of the date of our fiscal 2009 impairment test, could have resulted in a future impairment.
As of the date of our fiscal 2010 impairment test, however, the fair values for the reporting units in all of our segments exceeded their respective carrying values by more than 34%. Based on our most recent goodwill impairment assessment of the reporting units of our segments and our understanding of currently projected trends of the business and the economy, we do not believe that there is a significant risk of impairment for these reporting units for a reasonable period of time. For more information, see Notes 1 and 5 of the Consolidated Financial Statements.
Income Taxes. In determining income for financial statement purposes, we must make certain estimates and judgments. These estimates and judgments affect the calculation of certain tax liabilities and the determination of recoverability of certain of the deferred tax assets, which arise from temporary differences between tax and financial statement recognition of revenue and expense. We record a valuation allowance to reduce our deferred tax assets to the amount that it is more likely than not to be realized. In assessing the realizability of deferred tax assets, we consider future taxable income by tax jurisdictions and tax planning strategies. If we were to determine that we would be able to realize deferred tax assets in the future in excess of the net recorded amount, an adjustment to the valuation allowance would increase income in the period such determination was made. Likewise, should we determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the valuation allowance would decrease income in the period such determination was made. (See Note 12 of the Consolidated Financial Statements.)
Changes in tax laws and rates could also affect recorded deferred tax assets and liabilities in the future. We are not aware of any such changes that would have a material effect on our results of operations, cash flows or financial position.
In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations in a multitude of jurisdictions across our global operations. We record tax liabilities for the anticipated settlement of tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes will be due. Our income tax expense includes amounts intended to satisfy income tax assessments that result from these audit issues. Determining the income tax expense for these potential assessments and recording the related assets and liabilities requires management judgments and estimates. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is different from our estimate of tax liabilities. If payment of these amounts ultimately proves to be greater or less than the recorded amounts, the change of the liabilities would result in tax expense or benefit being recognized in that period. We’ve evaluated our uncertain tax positions and believe that our reserve for uncertain tax positions, including related interest and penalty, is adequate.
Pension Plans. We have various unfunded pension plans outside the U.S. These plans have significant pension costs and liabilities that are developed from actuarial valuations. Inherent in these valuations are key assumptions including discount rates, expected return on plan assets, mortality rates, and merit and promotion increases. We are required to consider current market conditions, including changes in interest rates, in selecting these assumptions. Changes in the related pension costs or liabilities may occur in the future due to changes in the assumptions. A change in discount rates of 0.25% would have less than a $0.1 million effect on pension expense.
Stock Compensation. We recognize stock-based compensation expense for all share-based payment awards net of an estimated forfeiture rate and only recognize compensation cost for those shares expected to vest. Stock compensation expense is recognized for all share-based payments on a straight-line basis over the requisite service period of the award.
Determining the fair value of share-based payment awards requires the input of highly subjective assumptions, including the expected life of the share-based payment awards and stock price volatility. The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our share-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. If our actual forfeiture rate is materially different from our estimate, the share-based compensation expense could be significantly different from what we have recorded in the current period. A change in the estimated forfeiture rate of 10% would have a $0.2 million effect on stock compensation expense. As of December 26, 2010, there was $1.7 million and $2.7 million of unrecognized stock-based compensation expense related to nonvested stock options and restricted stock units, respectively. Such costs are expected to be recognized over a weighted-average period of 1.7 years and 1.6 years, respectively. (See Note 8 of the Consolidated Financial Statements for further discussion on share-based compensation.)
Liquidity and Capital Resources
Our liquidity needs have been, and are expected to continue to be driven by acquisitions, capital investments, product development costs, potential future restructuring related to the rationalization of the business, and working capital requirements. We have met our liquidity needs primarily through cash generated from operations. Based on an analysis of liquidity utilizing conservative assumptions for the next twelve months, we believe that cash on hand from operating activities and funding available under our credit agreements should be adequate to service our debt and working capital needs, meet our capital investment requirements, other potential restructuring requirements, and product development requirements.
The ongoing financial and credit crisis has reduced credit availability and liquidity for many companies. We believe, however, that the strength of our core business, cash position, access to credit markets, and our ability to generate positive cash flow will sustain us through this challenging period. We are working to reduce our liquidity risk by accelerating efforts to improve working capital while reducing expenses in areas that will not adversely impact the future potential of our business. Additionally, we have increased our monitoring of counterparty risk. We evaluate the creditworthiness of all existing and potential counterparties for all debt, investment, and derivative transactions and instruments. Our policy allows us to enter into transactions with nationally recognized financial institutions with a credit rating of “A” or higher as reported by one of the credit rating agencies that is a nationally recognized statistical rating organization by the U.S. Securities and Exchange Commission. The maximum exposure permitted to any single counterparty is $50.0 million. Counterparty credit ratings and credit exposure are monitored monthly and reviewed quarterly by our Treasury Risk Committee.
As of December 26, 2010, our cash and cash equivalents were $173.8 million compared to $162.1 million as of December 27, 2009. Cash and cash equivalents increased in 2010 primarily due to $28.9 million of cash provided by financing activities and $10.9 million of cash provided by operating activities, partially offset by $23.2 million of cash used in investing activities. Cash provided by operating activities was $103.9 million less in 2010 compared to 2009. In 2010, our cash from operating activities was impacted negatively by increases in inventory and accounts receivable and a decrease in unearned revenues, which was partially offset by an increase in accounts payable. Inventory and accounts payable increased due to an increase in stock in anticipation of orders in the first quarter of 2011. Accounts receivable increased primarily due to the timing of collections and a decrease in the allowance for doubtful accounts through an improvement in the aging of receivables resulting from enhanced collection efforts. Unearned revenues decreased due to the fulfillment of customer orders during the first quarter of 2010 associated with our hard tag at source program. Accounts payable increased due to increased purchases of inventory during the year.
Cash used in investing activities was $15.5 million less in 2010 compared to 2009. This was primarily due to payments of $18.7 million for the acquisition of Brilliant and $6.8 million for Alpha contingent consideration in 2009, which were partially offset by an increase in property, plant and equipment in 2010. Cash provided by financing activities was $79.2 million greater in 2010 compared to the 2009. The increase in cash provided by financing activities was primarily due to an increase in borrowings from the Senior Secured Credit Facility and Senior Secured Notes (see Note 7 of the Consolidated Financial Statements) which were entered into during July 2010, partially offset by a $102.2 million payment to extinguish the Secured Credit Facility and a $7.2 million payment to extinguish our existing Japanese local line of credit during the third quarter of 2010. The increase in cash provided by financing activities was also due to a $23.0 million payment to retire the Senior Unsecured Multi-currency Credit Facility, a $23.0 million payment to reduce the Secured Credit Facility, $15.5 million in payments to reduce the debt acquired in the Brilliant acquisition, and an $8.5 million payment to extinguish our Japanese local line of credit in 2009.
Our percentage of total debt to total equity as of December 26, 2010, was 24.3% compared to 20.9% as of December 27, 2009. As of December 26, 2010, our working capital was $298.8 million compared to $241.8 million as of December 27, 2009.
We continue to reinvest in the Company through our investment in technology and process improvement. During 2010, our investment in research and development amounted to $20.5 million, as compared to $20.4 million in 2009. These amounts are reflected in cash used in operations, as we expense our research and development as it is incurred. In 2011, we anticipate spending of approximately $20 million on research and development to support achievement of our strategic plan.
We have various unfunded pension plans outside the U.S. These plans have significant pension costs and liabilities that are developed from actuarial valuations. For fiscal 2010, our contribution to these plans was $5.1 million. Our funding expectation for 2011 is $4.7 million. We believe our current cash position, cash generated from operations, and the availability of cash under our revolving line of credit will be adequate to fund these requirements. The Contractual Obligation table details our anticipated funding requirements related to pension obligations for the next ten years.
Acquisition of property, plant, and equipment and intangibles during 2010 totaled $23.7 million compared to $13.8 million during 2009. During 2010, our acquisition of property, plant, and equipment and intangibles included $10.3 million of capitalized internal-use software costs related to an ERP system implementation, compared to $2.8 million during 2009. We anticipate our capital expenditures, used primarily to upgrade information technology and improve our production capabilities, to approximate $36 million in 2011.
On July 1, 1997, Checkpoint Systems Japan Co. Ltd. (Checkpoint Japan), a wholly-owned subsidiary of the Company, issued newly authorized shares to Mitsubishi Materials Corporation (Mitsubishi) in exchange for cash. In February 2006, Checkpoint Japan repurchased 26% of these shares from Mitsubishi in exchange for $0.2 million in cash. In August 2010, Checkpoint Manufacturing Japan Co., LTD. repurchased the remaining 74% of these shares from Mitsubishi in exchange for $0.8 million in cash.
On December 30, 2009, we entered into a new Hong Kong banking facility. The banking facility includes a trade finance facility, a revolving loan facility, and a term loan. The maximum availability under the facility is $8.2 million (HKD 63.7 million). The banking facility is secured by all plant, machinery, fittings and equipment. The book value of the collateral as of December 26, 2010 is $11.6 million (HKD 90.0 million). Payments associated with the Hong Kong banking facility are included in the cash used in financing activities section of our consolidated statement of cash flows.
As of December 26, 2010, the Company has outstanding $4.6 million (HKD 35.7 million) against the term loan, $2.6 million (HKD 20.0 million) against the trade finance facility, and $0.4 million (HKD 3.0 million) against the revolving loan facility. The banking facility is subject to the bank’s right to call the liabilities at any time, and is therefore included in short-term borrowings in the accompanying Consolidated Balance Sheets.
In September 2010, $7.2 million (¥600 million) was paid in order to extinguish our existing Japanese local line of credit. The line of credit was included in short-term borrowings in the accompanying consolidated balance sheets. In November 2010, we entered into a new Japanese local line of credit for $1.8 million (¥150 million). As of December 26, 2010, the Japanese local line of credit is $1.8 million (¥150 million) and is fully drawn. The line of credit matures in November 2011.
During fiscal 2010, our outstanding Asialco loans of $3.7 million (RMB 25 million) were paid down.
In December 2009, we entered into new full-recourse factoring arrangements. The arrangements are secured by trade receivables. The Company received a weighted average of 92.4% of the face amount of receivables that it desired to sell and the bank agreed, at its discretion, to buy. As of December 26, 2010 the factoring arrangements had a balance of $1.7 million (€1.3 million), of which $0.4 million (€0.3 million) was included in the current portion of long-term debt and $1.3 million (€1.0 million) was included in long-term borrowings in the accompanying Consolidated Balance Sheets since the receivables are collectable through 2016.
In October 2009, the Company entered into a $12.0 million (€8.0 million) full-recourse factoring arrangement. The arrangement is secured by trade receivables. Borrowings bear interest at rates of EURIBOR plus a margin of 3.00%. As of December 26, 2010, the interest rate was 4.03%. As of December 26, 2010, our short-term full-recourse factoring arrangement equaled $10.5 million (€8.0 million) and is included in short-term borrowings in the accompanying Consolidated Balance Sheets. The full-recourse factoring arrangement was renewed in December 2010 for a twelve month period.
On July 22, 2010, we entered into an Amended and Restated Senior Secured Credit Facility (the “Senior Secured Credit Facility”) with a syndicate of lenders. The Senior Secured Credit Facility provides us with a $125.0 million four-year senior secured multi-currency revolving credit facility.
The Senior Secured Credit Facility amended and restated the terms of our existing $125.0 million senior secured multi-currency revolving credit agreement (“Secured Credit Facility”). The amendments primarily reflect an extension of the terms of the Secured Credit Facility, reductions in the interest rates charged on the outstanding balances, and favorable changes with regard to the collateral provided under the Senior Secured Credit Facility. Prior to entering into the Senior Secured Credit Facility, $102.2 million of the Secured Credit Facility was paid down during the third quarter of 2010.
The Senior Secured Credit Facility provides for a revolving commitment of up to $125.0 million with a term of four years from the effective date of July 22, 2010. We may borrow, prepay and re-borrow under the Senior Secured Credit Facility as long as the sum of the outstanding principal amounts is less than the aggregate facility availability. The Senior Secured Credit Facility also includes an expansion option that will allow us to request an increase in the Senior Secured Credit Facility of up to an aggregate of $50.0 million, for a potential total commitment of $175.0 million. As of December 26, 2010, we did not elect to request the $50.0 million expansion option.
Borrowings under the Senior Secured Credit Facility, other than swingline loans, bear interest at our option of either a spread ranging from 1.25% to 2.50% over the Base Rate (as described below), or a spread ranging from 2.25% to 3.50% over the LIBOR rate, and in each case fluctuating in accordance with changes in our leverage ratio, as defined in the Senior Secured Credit Facility. 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 1.0%. Swingline loans bear interest of (i) a spread ranging from 1.25% to 2.50% over the Base Rate with respect to swingline loans denominated in U.S. dollars, or (ii) a spread ranging from 2.25% to 3.50% over the LIBOR rate for one month U.S. dollar deposits, as of 11:00 a.m., London time. We pay an unused line fee ranging from 0.30% to 0.75% per annum based on the unused portion of the commitment under the Senior Secured Credit Facility.
Pursuant to the terms of the Senior Secured Credit Facility, we are subject to various requirements, including covenants requiring the maintenance of a maximum total leverage ratio of 2.75 and a minimum fixed charge coverage ratio of 1.25. The Senior Secured Credit Facility also contains customary representations and warranties, affirmative and negative covenants, notice provisions and events of default, including change of control, cross-defaults to other debt, and judgment defaults. Upon a default under the Senior Secured Credit Facility, including the non-payment of principal or interest, our obligations under the Senior Secured Credit Facility may be accelerated and the assets securing such obligations may be sold. Certain wholly-owned subsidiaries with respect to the Company are guarantors of our obligations under the Senior Secured Credit Facility. As of December 26, 2010, we were in compliance with all covenants.
As of December 26, 2010, the Company incurred $1.7 million in fees and expenses in connection with the Senior Secured Credit Facility, which are amortized over the term of the Senior Secured Credit Facility to interest expense on the consolidated statement of operations. The remaining unamortized debt issuance costs recognized in connection with the Secured Credit Facility of $2.4 million are amortized over the term of the Senior Secured Credit Facility to interest expense on the consolidated statement of operations.
Also on July 22, 2010, we entered into a Note Purchase and Private Shelf Agreement (the “Senior Secured Notes Agreement”) with a lender, and certain other purchasers party thereto (together with the lender, the “Purchasers”).
Under the Senior Secured Notes Agreement, we issued to the Purchasers its Series A Senior Secured Notes in an aggregate principal amount of $25.0 million (the “Series A Notes”), its Series B Senior Secured Notes in an aggregate principal amount of $25.0 million (the “Series B Notes”), and its Series C Senior Secured Notes in an aggregate principal amount of $25.0 million (the “Series C Notes”); together with the Series A Notes and the Series B Notes, (the “2010 Notes”). The Series A Notes bear interest at a rate of 4.00% per annum and mature on July 22, 2015. The Series B Notes bear interest at a rate of 4.38% per annum and mature on July 22, 2016. The Series C Notes bear interest at a rate of 4.75% per annum and mature on July 22, 2017. The 2010 Notes are not subject to any scheduled prepayments. The entire outstanding principal amount of each of the 2010 Notes shall become due on their respective maturity date.
The Senior Secured Notes Agreement also provides that for a three-year period ending on July 22, 2013, we may issue, and our lender may, in its sole discretion, purchase, additional fixed-rate senior secured notes (the “Shelf Notes”); together with the 2010 Notes, (the “Notes”), up to an aggregate amount of $50.0 million. The aggregate principal amount of the Shelf Notes issued at any time shall be no less than $5.0 million. The Shelf Notes will have a maturity date of no more than 10 years from the respective maturity date and an average life of no more than 7 years after the date of issue. The Shelf Notes will have such other terms, including principal amount, interest rate and repayment schedule, as agreed with our lender at the time of issuance. As of December 26, 2010, we had not issued additional fixed-rate senior secured notes.
We may prepay the Notes in a minimum principal amount of $1.0 million and in $0.1 million increments thereafter, at 100% of the principal amount so prepaid, plus an amount equal to the excess, if any, of the present value of the remaining scheduled payments of principal and interest on the amount repaid, over the principal amount repaid. Either we or our lender may terminate the private shelf facility with respect to undrawn amounts upon 30 days’ written notice, and our lender may terminate the private shelf facility with respect to undrawn amounts upon the occurrence and/or continuation of an event of default or acceleration of any Note.
The Senior Secured Notes Agreement is subject to covenants that are substantially similar to the covenants in the Senior Secured Credit Facility Agreement, including covenants requiring the maintenance of a maximum total leverage ratio of 2.75 and a minimum fixed charge coverage ratio of 1.25. The Senior Secured Notes Agreement also contains representations and warranties, affirmative and negative covenants, notice provisions and events of default, including change of control, cross-defaults to other debt, and judgment defaults that are substantially similar to those contained in the Senior Secured Credit Facility, and those that are customary for similar private placement transactions. Upon a default under the Senior Secured Notes Agreement, including the non-payment of principal or interest, our obligations under the Senior Secured Notes Agreement may be accelerated and the assets securing such obligations may be sold. Certain of our wholly-owned subsidiaries are also guarantors of our obligations under the Notes. As of December 26, 2010, we were in compliance with all covenants.
As of December 26, 2010, the Company incurred $0.2 million in fees and expenses in connection with the Senior Secured Notes, which are amortized over the term of the notes to interest expense on the consolidated statement of operations.
In October 2010, we acquired a software programming and development business based in the Philippines from Napar Contracting and Allied Services, Inc. for $0.5 million. The transaction was paid in cash. Based on the terms of the transaction, 60% of the purchase price was due upon signing the agreement and the remaining 40% is due on January 1, 2011. The $0.2 million due on January 1, 2011 is included in other current liabilities in the accompanying Consolidated Balance Sheets.
In July 2009, we entered into an agreement to purchase the business of Brilliant, a China-based manufacturer of woven and printed labels, and settled the acquisition on August 14, 2009 for approximately $38.3 million, including cash acquired of $0.6 million and the assumption of debt of $19.6 million. The payment to acquire Brilliant is reflected in the acquisition of businesses line within investing activities on the consolidated statement of cash flows. During 2009, $15.5 million of debt payments were made and consisted of $6.8 million of the current portion of long-term debt, $5.1 million in factoring payments, $2.8 million of bank overdraft payments, and $0.8 million of term loans. All payments are included in the cash used in financing activities section of our Consolidated Statement of Cash Flows.
In June 2008, we purchased the business of OATSystems, Inc., a privately held company, for approximately $37.2 million, net of cash acquired of $0.9 million, and including the assumption of $3.2 million of OATSystems, Inc. debt. The transaction was paid in cash. Additionally, we acquired $1.3 million in liabilities.
In January 2008, we purchased the business of Security Corporation, Inc., a privately held company, for $7.9 million plus $1.0 million of liabilities acquired. The transaction was paid in cash.
On November 1, 2007, Checkpoint Systems, Inc. and one of its direct subsidiaries and Alpha Security Products, Inc. and one of its direct subsidiaries (collectively, “the Seller”) entered into an Asset Purchase Agreement and a Dutch Assets Sale and Transfer Agreement (collectively, the “Agreements”) under which we purchased all of the assets of Alpha’s S3 business for approximately $142 million, subject to a post-closing working capital adjustment, plus additional performance-based contingent payments up to a maximum of $8 million plus interest thereon. The purchase price was funded by $67 million of cash and $75 million of borrowings under our senior unsecured credit facility. Subject to the Agreements, contingent payments were earned if the revenue derived from the S3 business exceeded $70 million during the period from December 31, 2007, until December 28, 2008. In the event that the revenue derived from the S3 business exceeded $83 million during such period, the Seller was entitled to a maximum payment of $8 million. During the fourth fiscal quarter ended December 28, 2008, revenues for the S3 business exceeded the minimum contingency payment thresholds. An accrual of $6.8 million was recognized at December 28, 2008 for the contingent payment, with a corresponding increase to goodwill recorded on the acquisition. The payment of $6.8 million was made during the first quarter of 2009, and is reflected in the acquisition of businesses line within investing activities on the consolidated statement of cash flows.
We have never paid a cash dividend (except for a nominal cash distribution in April 1997 to redeem the rights outstanding under our 1988 Shareholders’ Rights Plan). We do not anticipate paying any cash dividends in the near future.
As we continue to implement our strategic plan in a volatile global economic environment, our focus will remain on operating our business in a manner that addresses the reality of the current economic marketplace without sacrificing the capability to effectively execute our strategy when economic conditions and the retail environment stabilize. Based upon an analysis of liquidity using our current forecast, management believes that our anticipated cash needs can be funded from cash and cash equivalents on hand, the availability of cash under the Senior Secured Credit Facility, Senior Secured Notes, and cash generated from future operations over the next twelve months.
Off-Balance Sheet Arrangements
We do not utilize material off-balance sheet arrangements apart from operating leases that have, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources. We use operating leases as an alternative to purchasing certain property, plant, and equipment. Our future rental commitment under all non-cancelable operating leases was $36.0 million as of December 26, 2010. The scheduled timing of these rental commitments is detailed in our “Contractual Obligations” section.
Contractual Obligations
Our contractual obligations and commercial commitments at December 26, 2010 are summarized below:
Contractual Obligation
(amounts in thousands)
Total
Due in less
than 1 year
Due in
1-3 years
Due in
3-5 years
Due after
5 years
Long-term debt (1)
$ 138,616
$ 4,819
$ 9,552
$ 98,515
$ 25,730
Capital leases (2)
2,418
1,671
-
Operating leases
35,978
15,379
16,447
4,093
Pension obligations (3)
48,510
4,359
9,076
9,593
25,482
Acquisition obligation (4)
-
-
-
Inventory purchase commitments (5)
6,439
6,403
-
-
Total contractual cash obligations
$ 232,161
$ 32,831
$ 35,808
$ 112,251
$ 51,271
Commercial Commitments
(amounts in thousands)
Total
Due in less
than 1 year
Due in
1-3 years
Due in
3-5 years
Due after
5 years
Standby letters of credit
$ 1,434
$ 1,434
$ -
$ -
$ -
Surety bonds
1,899
1,679
-
-
Total commercial commitments
$ 3,333
$ 3,113
$ 220
$ -
$ -
(1)
Includes Senior Secured Credit Facility, Senior Secured Notes, long-term full-recourse factoring liabilities, and related interest payments through maturity of $19,189.
(2)
Includes interest payments through maturity of $105.
(3)
Amounts represent undiscounted projected benefit payments to our unfunded plans over the next 10 years. The expected benefit payments are estimated based on the same assumptions used to measure our accumulated benefit obligation at the end of 2010 and include benefits attributable to estimated future employee service of current employees.
(4)
The acquisition obligation represents $0.2 million of deferred payments related to the acquisition of a software programming and development business based in the Philippines.
(5)
Inventory purchase commitments represent our legally binding agreements to purchase fixed or minimum quantities of goods at determinable prices.
The table above excludes our gross liability for uncertain tax positions, including accrued interest and penalties, which totaled $16.4 million as of December 26, 2010, since we cannot predict with reasonable reliability the timing of cash settlements to the respective taxing authorities.
Pension Plans
We maintain several defined benefit pension plans, principally in Europe. The majority of these pension plans are unfunded. Our pension expense for 2010, 2009, and 2008 was $5.2 million, $5.7 million, and $5.7 million, respectively. Included in pension expense in 2008 is a pension settlement of $37 thousand.
We review our pension assumptions annually. Our assumptions for the year ended December 26, 2010, were a discount rate of 5.77%, an expected return of 4.00% and an expected rate of increase in future compensation of 2.52%. In developing the discount rate assumption for each country, we use a yield curve approach. The yield curve is based on the AA rated bonds underlying the Barclays Capital corporate bond index. As of December 26, 2010, and December 27, 2009, the weighted average discount rate was 5.27% and 5.77%, respectively. We calculate the weighted average duration of the plans in each country, and then select the discount rate from the appropriate yield curve which best corresponds to the plans' liability profile. The expected rate of the return was developed using the historical rate of returns of the foreign government bonds currently held.
As of December 31, 2006, we recognized previously unrecognized losses into the accrued pension liability with an offsetting charge to accumulated other comprehensive income. The total amount recognized for losses in accumulated other comprehensive income as of December 31, 2006 was $14.7 million. As of December 25, 2005, these amounts were unrecognized and amounted to $14.5 million. The primary component of the unrecognized losses are actuarial losses, a transition obligation, and prior period service costs. Unrecognized losses are amortized over the average remaining service period of the employees expected to receive the benefit in accordance with pension accounting rules. The weighted average remaining service period is approximately 12 years. The impact of recognizing the actuarial gains on 2010, 2009, and 2008 pension expense are $0.1 million, $0.1 million, and $0.1 million, respectively. The total projected amortization for these gains in 2011 is approximately $0.2 million.
Exposure to Foreign Currency
We manufacture products in the U.S., the Caribbean, Europe, and the Asia Pacific regions for both the local marketplace and for export to our foreign subsidiaries. The foreign 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 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.
We selectively purchase currency forward exchange contracts to reduce the risks of currency fluctuations on short-term inter-company receivables and payables. These contracts guarantee a predetermined exchange rate at the time the contract is purchased. This allows us to shift the effect of positive or negative currency fluctuations to a third party. Transaction gains or losses resulting from these contracts are recognized at the end of each reporting period. We use the fair value method of accounting, recording realized and unrealized gains and losses on these contracts. These gains and losses are included in other gain (loss), net on our Consolidated Statements of Operations. As of December 26, 2010, we had currency forward exchange contracts with notional amounts totaling approximately $11.7 million. The fair values of the forward exchange contracts were reflected as a $27 thousand asset and $20 thousand liability and are included in other current assets and other current liabilities in the accompanying balance sheets. The contracts are in the various local currencies covering primarily our operations in the U.S., the Caribbean, and Western Europe. Historically, we have not purchased currency forward exchange contracts where it is not economically efficient, specifically for our operations in South America and Asia, with the exception of Japan.
Hedging Activity
Beginning in the second quarter of 2008, we entered into various foreign currency contracts to reduce our exposure to forecasted Euro-denominated inter-company revenues. These contracts were designated as cash flow hedges. The foreign currency contracts mature at various dates from January 2011 to December 2011. The purpose of these cash flow hedges is to eliminate the currency risk associated with Euro-denominated forecasted inter-company revenues due to changes in exchange rates. These cash flow hedging instruments are marked to market and the changes are recorded in other comprehensive income. Amounts recorded in other comprehensive income are recognized in cost of goods sold as the inventory is sold to external parties. Any hedge ineffectiveness is charged to other gain (loss), net on our Consolidated Statements of Operations. As of December 26, 2010, the fair value of these cash flow hedges were reflected as a $0.9 million asset and a $0.3 million liability and are included in other current assets and other current liabilities in the accompanying Consolidated Balance Sheets. The total notional amount of these hedges is $33.3 million (€24.8 million) and the unrealized gain recorded in other comprehensive income was $0.4 million (net of taxes of $0.2 million), of which the full amount is expected to be reclassified to earnings over the next twelve months. During the year ended December 26, 2010, a $1.2 million benefit related to these foreign currency hedges was recorded to cost of goods sold as the inventory was sold to external parties. We recognized a $9 thousand loss during the year ended December 26, 2010 for hedge ineffectiveness.
During the first quarter of 2008, we entered into an interest rate swap agreement with a notional amount of $40.0 million. The purpose of this interest rate swap agreement was to hedge potential changes to our cash flows due to the variable interest nature of our senior secured credit facility. The interest rate swap was designated as a cash flow hedge. This cash flow hedging instrument was marked to market and the changes are recorded in other comprehensive income. The interest rate swap matured on February 18, 2010.
Provision for Restructuring
Restructuring expense for the periods ended December 26, 2010, December 27, 2009, and December 28, 2008 were as follows:
(amounts in thousands)
December 26,
December 27,
December 28,
SG&A Restructuring Plan
Severance and other employee-related charges
$ 6,993
$ 2,828
$ -
Manufacturing Restructuring Plan
Severance and other employee-related charges
1,481
Consulting fees
-
-
Other exit costs
-
-
2005 Restructuring Plan
Severance and other employee-related charges
-
1,149
4,563
Lease termination costs
-
(57)
-
Acquisition integration costs
-
-
2003 Restructuring Plan
Severance and other employee-related charges
-
-
(253)
Lease termination costs
-
-
Total
$ 8,211
$ 5,401
$ 6,442
Restructuring accrual activity for the periods ended December 26, 2010, and December 27, 2009, were as follows:
(amounts in thousands)
Fiscal 2010
Accrual at
Beginning of
Year
Charged to
Earnings
Charge
Reversed to
Earnings
Cash
Payments
Other
Exchange
Rate
Changes
Accrual at
12/26/2010
SG&A Restructuring Plan
Severance and other employee-related charges
$ 2,810
$ 7,732
$ (739)
$ (3,005)
$ -
$ (138)
$ 6,660
Manufacturing Restructuring Plan
Severance and other employee-related charges
1,481
1,203
(562)
(1,339)
-
(64)
Other exit costs(1)
-
-
(541)
-
Total
$ 4,291
$ 9,512
$ (1,301)
$ (4,885)
$ 107
$ (202)
$ 7,522
(1)
During 2010, lease termination and other exit costs of $0.6 million were recorded due to the closing of a manufacturing facility, which were partially offset by a deferred rent charge of $0.1 million previously incurred in prior periods for the manufacturing facility.
(amounts in thousands)
Fiscal 2009
Accrual at
Beginning of
Year
Charged to
Earnings
Charge
Reversed to
Earnings
Cash
Payments
Other
Exchange
Rate
Changes
Accrual at
12/27/2009
SG&A Restructuring Plan
Severance and other employee-related charges
$ -
$ 2,828
$ -
$ (103)
$ -
$ 85
$ 2,810
Manufacturing Restructuring Plan
Severance and other employee-related charges
1,614
(133)
(676)
-
1,481
Total
$ 652
$ 4,442
$ (133)
$ (779)
$ -
$ 109
$ 4,291
SG&A Restructuring Plan
During 2009, we initiated a 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 subsequent phases initiated during 2010. The remaining phases of the plan are expected to be substantially complete by the end of 2011.
As of December 26, 2010, the net charge to earnings of $7.0 million represents the current year activity related to the SG&A Restructuring Plan. The anticipated total costs related to the plan are expected to approximate $20 million to $25 million, of which $9.8 million have been incurred. The total number of employees currently affected by the SG&A Restructuring Plan were 198, of which 79 have been terminated. Termination benefits are planned to be paid one month to 24 months after termination. Upon completion, the annual savings related to the phases of the SG&A Restructuring Plan that have been implemented are anticipated to be approximately $20 million to $25 million.
Manufacturing Restructuring Plan
In August 2008, we announced a manufacturing and supply chain restructuring program designed to accelerate profitable growth in our Apparel Labeling Solutions (ALS) business, formerly Check-Net®, and to support incremental improvements in our EAS systems and labels businesses. For the year ended December 26, 2010, there was a net charge to earnings of $1.2 million recorded in connection with the Manufacturing Restructuring Plan. The charge was composed of severance accruals and other exit costs associated with the closing of manufacturing facilities.
The total number of employees currently affected by the Manufacturing Restructuring Plan were 418, of which 371 have been terminated. As of December 26, 2010 the implementation of the Manufacturing Restructuring Plan is substantially complete, with total costs incurred of $4.2 million. Termination benefits are planned to be paid one month to 24 months after termination. Annual savings in connection with the Manufacturing Restructuring Plan are anticipated to be approximately $6 million.
2005 Restructuring Plan
During 2009, a net charge of $1.1 million was recorded in connection with the 2005 Restructuring Plan. The charge was composed of severance accruals and related costs, partially offset by the release of a lease termination liability.
2003 Restructuring Plan
During 2008, we reversed $0.3 million of previously accrued severance and incurred $0.1 million of lease termination costs related to the 2003 Restructuring Plan.
Goodwill Impairments
We perform an assessment of goodwill by comparing each individual reporting unit’s carrying amount of net assets, including goodwill, to their fair value at least annually during the fourth quarter of each fiscal year and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. In 2010 and 2009, annual assessments did not result in an impairment charge. Future annual assessments could result in impairment charges, which would be accounted for as an operating expense.
During the year ended December 28, 2008, we completed step one of our fiscal 2008 annual analysis and test for impairment of goodwill and it was determined that certain goodwill related to the Shrink Management Solutions, Apparel Labeling Solutions and Retail Merchandising Solutions segments were impaired. The second step of the goodwill impairment test was not completed prior to the issuance of the fiscal 2008 financial statements. Therefore, we recognized a charge of $59.6 million as a reasonable estimate of the impairment loss in its fiscal 2008 financial statements. The impairment charge was recorded in goodwill impairment on the Consolidated Statement of Operations. The impairment charge was attributed to a combination of a decline in our market capitalization and a decline in the estimated forecasted discounted cash flows expected by the Company.
During the first quarter of fiscal 2009, we completed the second step of our fiscal 2008 annual analysis and test for impairment of goodwill and it was determined that no further adjustment to the estimated impairment recorded at December 28, 2008 was needed.
Asset Impairments
In 2008, asset impairment expense was $4.5 million, or 0.5% of revenues. There were no asset impairment charges in 2010 and 2009.
During our 2008 goodwill and indefinite-lived intangibles annual impairment test, we determined that the indefinite-lived trade mark intangible in our Shrink Management Solutions segment was impaired. As a result we recorded an impairment charge of $0.4 million in the fourth quarter of 2008. This charge was recorded in asset impairments on the consolidated statement of operations.
As a result of changes in business circumstances related to the customer relationship intangible recognized in connection with the SIDEP/Asialco acquisition, we recorded an impairment charge of $2.6 million in the fourth quarter ended December 28, 2008. The impairment charge was recorded in asset impairments in the Shrink Management Solutions segment on the Consolidated Statement of Operations.
In 2008, we recorded a $1.5 million fixed asset impairment. The charge consisted of $1.1 million related to the write down of a building in France and $0.4 million related to the write down of land and a building in Japan. These impairments were recorded in asset impairments on the Consolidated Statement of Operations.
Results of Operations
(All comparisons are with the previous fiscal year, 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.
Analysis of Statement of Operations
The following table presents for the periods indicated certain items in the consolidated statement of operations as a percentage of total revenues and the percentage change in dollar amounts of such items compared to the indicated prior period:
N/A - Comparative percentages are not meaningful.
Fiscal 2010 compared to Fiscal 2009
Net Revenues
During 2010, revenues increased by $61.8 million, or 8.0%, from $772.7 million to $834.5 million. Foreign currency translation had a negative impact on revenues of $4.3 million for the full year of 2010.
(amounts in millions)
Year ended
December 26,
(Fiscal 2010)
December 27,
(Fiscal 2009)
Dollar
Amount
Change
Fiscal 2010
vs.
Fiscal 2009
Percentage
Change
Fiscal 2010
vs.
Fiscal 2009
Net Revenues:
Shrink Management Solutions
$ 589.6
$ 553.7
$ 35.9
6.5
%
Apparel Labeling Solutions
172.9
141.9
31.0
21.9
Retail Merchandising Solutions
72.0
77.1
(5.1)
(6.6)
Net Revenues
$ 834.5
$ 772.7
$ 61.8
8.0
%
Shrink Management Solutions
Shrink Management Solutions revenues increased $35.9 million, or 6.5%, in 2010 compared to 2009. Foreign currency translation had a negative impact of approximately $0.8 million. The increase in our SMS business was due to organic growth in our Alpha business, CheckView® business, and EAS consumables business, of $42.5 million, $16.4 million, and $4.9 million, respectively. These increases were partially offset by decreases in our EAS systems business, Merchandise Visibility (RFID) business, and Library business revenues of $20.6 million, $4.8 million, and $1.7 million, respectively.
Our Alpha business revenues increased $42.5 million in 2010 as compared to 2009. The increase was due to increases in revenues in all regions as a result of a general increase in demand for Alpha products as market conditions for high theft prevention products improved during 2010, and is expected to continue in 2011.
CheckView® revenues increased $16.4 million in 2010 as compared to 2009. The increase was due to improvements in installations and on-going services with existing customers, primarily in the U.S. Although revenues have improved since last year, our CheckView® business is dependent on new store openings and the capital spending of our customers, all of which have been impacted, and may continue to be impacted in the future by current economic trends.
EAS consumables revenues increased $4.9 million in 2010 as compared to 2009. The increase was primarily due to revenues from our hard tag at source program in Europe. This was partially offset by a decrease in revenue in our North American hard tag at source program as it transitioned from high volumes associated with of initial roll-out to lower program maintenance level volumes.
EAS systems revenues decreased $20.6 million in 2010 as compared to 2009. The decrease was primarily due to declines in revenues primarily in Europe. Our EAS systems business is dependent upon new store openings and the liquidity and financial condition of our customers, all of which have been impacted by current economic trends. Our plan is to partially mitigate this issue by selling new solutions to existing customers and increasing our market share through innovative products such as Evolve™ and other faster payback products in our EAS consumables and Alpha businesses.
Merchandise Visibility (RFID) revenues decreased $4.8 million in 2010 as compared to 2009. The decrease was due to decreases in revenues primarily in Europe. This decrease was due to a substantial roll-out with RFID enabled technology in 2009, which did not occur in 2010.
Library revenues decreased $1.7 million in 2010 as compared to the 2009. The decline was due to reduced distributor revenues.
Apparel Labeling Solutions
Apparel Labeling Solutions revenues increased $31.0 million, or 21.9%, in 2010 as compared to 2009. Foreign currency translation had a negative impact of approximately $2.2 million. Included in 2010 were $21.9 million of non-comparable Brilliant Label revenues since our Brilliant Label business was acquired in August 2009. The remaining increase of $11.3 million was primarily due to increases in Europe and Asia as a result of higher demand from our apparel retailer customers and changes in product mix.
Retail Merchandising Solutions
Retail Merchandising Solutions revenues decreased $5.1 million, or 6.6%, in 2010 as compared to 2009. Foreign currency translation had a negative impact of approximately $1.2 million. The remaining decrease of $3.9 million in our Retail Merchandising Solutions business was due to a decrease in our revenues from Retail Display Solutions (RDS) of $3.5 million and a decrease in revenues from Hand-held Labeling Soutions (HLS) of $0.4 million. RDS declined due to a general reduction of store remodel work in Europe. We anticipate RDS and HLS to continue to face difficult revenue trends in 2011 due to the impact of pricing pressures on the RDS business and continued shifts in market demand for HLS products.
Gross Profit
During 2010, gross profit increased $15.3 million, or 4.6%, from $331.3 million to $346.6 million. The negative impact of foreign currency translation on gross profit was approximately $1.1 million. Gross profit, as a percentage of net revenues, decreased from 42.9% to 41.5%.
Shrink Management Solutions
Shrink Management Solutions gross profit as a percentage of Shrink Management Solutions revenue decreased to 42.4% in 2010, from 43.7% in 2009. The decrease in the gross profit percentage of Shrink Management Solutions was primarily due to margin decreases in our CheckView®, EAS Consumables, EAS Systems, and Alpha businesses. Our CheckView® business margins decreased due to increased field service costs and declines in installation and monitoring margins. The decline in EAS Consumables margin was due to higher product costs, changes in product mix and pricing pressures in certain markets. EAS Systems margins decreased primarily due to an increase in field service costs as a percentage of revenues in 2010. The increase in field service costs in 2010 was due primarily to reduced salary expense in 2009 related to our temporary global payroll reduction and furlough program and decreased EAS Systems revenues to absorb field service costs. Alpha margins declined slightly due to an unfavorable product mix and an increase in warranty reserve that was offset by favorable manufacturing variances related to the higher volumes in 2010.
Apparel Labeling Solutions
Apparel Labeling Solutions gross profit as a percentage of Apparel Labeling Solutions revenues decreased to 35.7% in 2010 from 37.0% in 2009. Apparel Labeling Solutions margins decreased primarily due to changes in our product mix and due to non-comparable lower margins in our Brilliant Label business resulting from its acquisition in August 2009.
Retail Merchandising Solutions
The Retail Merchandising Solutions gross profit as a percentage of Retail Merchandising Solutions revenues increased to 48.5% in 2010 from 47.5% in 2009. This increase in Retail Merchandising Solutions gross profit percentage was primarily due to improved margins in our HLS business resulting from improved manufacturing efficiencies. The increase in HLS margin was partially offset by a decrease in RDS. The decrease in RDS was due primarily to increased product and freight costs in 2010.
Selling, General, and Administrative Expenses
Selling, general, and administrative (SG&A) expenses increased $12.6 million, or 4.8%, in 2010 compared to 2009. Foreign currency translation decreased SG&A expenses by approximately $2.3 million. Included in SG&A expense was $5.4 million of non-comparable expense incurred during 2010 related to our Brilliant acquisition in August 2009. The increase in SG&A expense was also due to the adjustment of an acquisition related liability of $0.8 million pertaining to the period prior to the acquisition date. The remaining increase in SG&A expense of $8.7 million was primarily due to increased sales and marketing expense related to the increase in revenues over the prior year and increased expenditures used to upgrade information technology and improve our production capabilities. The increase in SG&A expense was also due to the impact of our temporary global payroll reduction and furlough program, which reduced costs during 2009. These reductions in SG&A were partially offset by an adjustment to reduce performance incentive accruals in 2010, without a comparable reduction in 2009.
Research and Development Expenses
Research and development (R&D) expenses were $20.5 million, or 2.4% of revenues, in 2010 and $20.4 million, or 2.6% of revenues in 2009.
Restructuring Expenses
Restructuring expenses were $8.2 million, or 1.0% of revenues in 2010 compared to $5.4 million or 0.7% of revenues in 2009. The current and the prior year expenses are detailed in the “Provision for Restructuring” section.
Litigation Settlement
Litigation settlement expense was $1.3 million in 2009, with no comparable charge in 2010. Included in litigation expense in 2009 was $0.9 million of expense related to the settlement of a dispute with a consultant and $0.4 million related to the acquisition of a patent related to our Alpha business. We purchased the patent for $1.7 million related to our Alpha business. A portion of this purchase price was attributable to use prior to the date of acquisition and as a result we recorded $0.4 million in litigation expense and $1.3 million in intangibles.
Interest Income and Interest Expense
Interest income in 2010 increased $1.1 million from the comparable period in 2009. The increase in interest income was due to higher cash balances and increased interest income recognized for sales-type leases during 2010 compared to 2009.
Interest expense for 2010 decreased $0.9 million from the comparable period in 2009. The decrease in interest expense was primarily due to reduced interest rates related to the expiration of an interest rate swap during the first quarter of 2010.
Other Gain (Loss), net
Other gain (loss), net was a net loss of $2.2 million in 2010 compared to a net loss of $0.2 million in 2009. The increase of $2.0 million was primarily due to losses on foreign currency. The primary drivers of the increase in foreign currency loss were fluctuations in the value of the U.S. Dollar to the Euro and the Japanese Yen.
Income Taxes
The effective rate of tax at December 26, 2010 was 26.4%. At December 27, 2009, the effective tax rate was 28.6%. The 2010 tax rate was impacted by a $7.9 million release of tax reserves, partially offset by charges of $5.1 million related to establishing a full valuation allowance against the U.S. State deferred tax assets and provision to return adjustments of $4.0 million and $1.1 million, respectively. The 2010 effective tax rate was also impacted by a $1.7 million adjustment of an acquisition related liability pertaining to the period prior to the acquisition date.
The 2009 tax rate includes a benefit of $0.1 million in tax reserves and a net increase to the valuation allowance of $7.6 million. The main components of the valuation allowance change were a charge of $1.1 million in connection with our Italy operations and a charge of $4.6 million related to operations in Japan. The valuation allowance was also impacted by a charge of $2.0 million in connection with state net operating losses, of which $0.3 million was related to activity in 2009. The remainder of the valuation allowance movement relates to benefits from the current year utilization of deferred tax assets that a valuation was recorded against in prior periods. A benefit of $0.1 million was recorded related to tax audits settled in the current year.
Net Earnings (Loss) Attributable to Checkpoint Systems, Inc.
Net earnings attributable to Checkpoint Systems, Inc. were $27.4 million, or $0.68 per diluted share, for 2010 compared to $26.1 million, or $0.66 per diluted share, for 2009. The weighted-average number of shares used in the diluted earnings per share computation was 40.4 million and 39.6 million for 2010 and 2009, respectively.
Fiscal 2009 compared to Fiscal 2008
Net Revenues
During 2009, revenues decreased by $144.4 million, or 15.7%, from $917.1 million to $772.7 million. Foreign currency translation had a negative impact on revenues of $28.4 million for the full year of 2009.
(amounts in millions)
Year ended
December 27,
(Fiscal 2009)
December 28,
(Fiscal 2008)
Dollar
Amount
Change
Fiscal 2009
vs.
Fiscal 2008
Percentage
Change
Fiscal 2009
vs.
Fiscal 2008
Net Revenues:
Shrink Management Solutions
$ 553.7
$ 687.4
$ (133.7)
(19.4)
%
Apparel Labeling Solutions
141.9
135.3
6.6
4.8
Retail Merchandising Solutions
77.1
94.4
(17.3)
(18.3)
Net Revenues
$ 772.7
$ 917.1
$ (144.4)
(15.7)
%
Shrink Management Solutions
Shrink Management Solutions revenues decreased by $133.7 million, or 19.4%, in 2009 compared to 2008. Foreign currency translation had a negative impact of approximately $17.9 million. The remaining revenue decrease was due primarily to declines in EAS systems, CheckView®, and Alpha businesses of $81.5 million, $41.2 million, and $13.4 million, respectively. These declines were partially offset by a $16.7 million increase in our EAS consumables business and a $3.6 million increase in our RFID business.
EAS systems revenues decreased $81.5 million in 2009 as compared to 2008. The decrease was due primarily to declines in revenues of $46.9 million in Europe, $21.4 million in the U.S., and $12.1 million in Asia. The decline in Europe was due primarily to 2008 large chain-wide roll-outs in Spain, France, Italy and Belgium without comparable roll-outs in 2009 coupled with a general overall decline in revenues due to the weak economic conditions in Europe. The decline in Europe was partially offset by an increase in Germany due primarily to a new large roll-out in 2009. The decline in the U.S. was due primarily to large installations in 2008 without comparable roll-outs during 2009. The decline in Asia was due primarily to weak economic conditions in Japan and Hong Kong coupled with large chain-wide installations in Australia and New Zealand during 2008 without comparable roll-outs in 2009. The decrease in Asia was partially offset by a large chain-wide roll-out in China. Our EAS systems business is dependent upon new store openings and the liquidity and financial condition of our customers which has been impacted by current economic trends. Our plan is to partially mitigate this issue by selling new solutions to existing customers and increasing our market share through innovative products such as Evolve™.
CheckView® revenues decreased $41.2 million in 2009 as compared to 2008. The CheckView® business declined primarily due to decreases in the U.S. and Asia of $35.3 million and $5.9 million, respectively. The U.S. revenues associated with our 2008 banking acquisitions benefited by $1.0 million due to a full year of revenues in 2009 with only a partial year in 2008. The decline in our U.S. retail business was $28.9 million, due primarily to an overall decline in capital expenditures as a result of the current weak economic conditions in the U.S. Our banking business, excluding the non-comparable acquisition, declined $7.4 million due primarily to decreased customer spending as a result of the current economic condition in the financial services sector. We anticipate our U.S. CheckView® business will continue to experience difficulties in 2010 as constraints on capital spending by our customers and the slowing of new store openings will likely continue as a result of the current economic conditions. The decline in Asia was due primarily to large orders in Japan in 2008 without comparable installations in 2009.
Our Alpha business declined by $13.4 million during 2009 as compared to 2008. The decrease was due primarily to declines in revenues of $11.3 million in Europe and $2.3 million in the U.S., which was partially offset by a $0.9 million increase in Asia. The decrease in Europe was primarily due to a decrease in volumes due to the current weak economic condition in Europe. The decrease in the U.S. was primarily due to a decrease in volumes with several large customers due to the current weak economic conditions in the U.S. The increase in Asia was primarily due to an increase in Australia due to sales to several new large customers during 2009.
EAS consumables revenues increased by $16.7 million in 2009 as compared to 2008. The increase was due primarily to increases in revenues of $16.5 million in Europe and $4.2 million in the U.S., which were partially offset by a $3.9 million decrease in Asia. The increases in Europe and the U.S. were due primarily to the implementation of our new hard tag at source program. The decline in Asia was due primarily to the anticipated loss of customers associated with the acquisition of SIDEP/Asialco.
RFID revenues increased by $3.6 million during 2009 as compared to 2008. The increase was due primarily to increases in revenues of $3.1 million in Europe and $0.6 million in the U.S. The increase in revenues in Europe was due to the sale of detachers associated with our hard tag at source program that are RFID enabled for future use. The increase was partially offset by decreases in Germany and France due to large roll-outs that were completed in 2008 with no such comparable roll-outs during 2009. The increase in the U.S. was primarily due to $1.4 million in non-comparable OATSystems Inc. revenues during the first half of 2009, which was partially offset by a decline in OATSystems Inc. revenues during the second half of 2009 due to a decrease in non-recurring licensing fees in 2009.
Apparel Labeling Solutions
Apparel Labeling Solutions revenues increased by $6.6 million, or 4.8%, in 2009 as compared to 2008. Foreign currency translation had a negative impact of approximately $5.1 million. Apparel Labeling Solutions benefited by $12.7 million due to our newly acquired Brilliant business. The remaining decrease of $1.0 million was due to a general overall decline resulting from current economic conditions.
Retail Merchandising Solutions
Retail Merchandising Solutions revenues decreased by $17.3 million, or 18.3%, in 2009 as compared to 2008. The negative impact of foreign currency translation was approximately $5.4 million. The remaining decrease in our RMS business was due to a decrease in our revenues from RDS of $8.5 million and a decrease in revenues of HLS of $3.4 million. Our RDS decline is due to a general reduction of store remodel work in Europe due to the current economic environment. The decrease in HLS is due to increased competition and pricing pressures as well as a general shift in market demand away from HLS products as retail scanning technology continues to grow worldwide. We anticipate RDS and HLS to continue to face difficult revenue trends in 2010 due to the impact of current economic conditions on the RDS business and continued shifts in market demand for HLS products.
Gross Profit
During 2009, gross profit decreased by $46.8 million, or 12.4%, from $378.1 million to $331.3 million. The negative impact of foreign currency translation on gross profit was approximately $10.4 million. Gross profit, as a percentage of net revenues, increased from 41.2% to 42.9%.
Shrink Management Solutions
Shrink Management Solutions gross profit as a percentage of Shrink Management Solutions revenues increased to 43.7% in 2009, from 41.4% in 2008. The increase in the gross profit percentage of Shrink Management Solutions was due primarily to higher margins in EAS consumables, EAS systems, and CheckView®, partially offset by lower margins in our Alpha business. EAS consumables margins improved due primarily to lower royalties due to the expiration of our EAS licensing obligation in December 2008. EAS consumables also improved due to the favorable product mix. EAS systems margins improved due to product mix resulting from fewer chain-wide rollouts in 2009, improved manufacturing margins, and lower royalties due to the expiration of our EAS licensing obligation in December 2008. CheckView® margins improved due to better project management during 2009 and cost control. Alpha margins decreased in 2009 due to manufacturing variances related to lower volumes in 2009.
Apparel Labeling Solutions
Apparel Labeling Solutions gross profit as a percentage of Apparel Labeling Solutions revenues increased to 37.0% in 2009, from 34.7% in 2008. Apparel Labeling Solutions margins increased due primarily to better utilization of low cost manufacturing facilities, which resulted in improved product costs and reductions in freight.
Retail Merchandising Solutions
The Retail Merchandising Solutions gross profit as a percentage of Retail Merchandising Solutions revenues decreased to 47.5% in 2009 from 49.4% in 2008. The decrease in Retail Merchandising Solutions gross profit percentage was the result of a decline in volumes and pricing pressures in our HLS and RDS businesses.
Selling, General, and Administrative Expenses
Selling, general, and administrative (SG&A) expenses decreased $34.3 million, or 11.5%, over 2008. Foreign currency translation decreased SG&A expenses by approximately $8.4 million. The remaining decrease was due primarily to lower bad debt expense, lower sales and marketing expense, and lower general and administrative expenses. The decrease was also due to $1.4 million of deferred compensation expense in 2008 without a comparable charge in 2009. The decrease in bad debt expense was attributable to an improved focus on working capital during 2009. The decrease in sales and marketing expense corresponds to the decrease in revenues over the prior year, coupled with an increased effort by management to reduce costs. The decrease in general and administrative expense is due to efforts to reduce costs, coupled with an additional expense that was incurred during the second quarter of 2008 due to a change in executive management with no comparable transition costs in 2009. The cost reduction efforts were due primarily to better control of discretionary spending and the impact of our temporary global payroll reduction and furlough program. These reductions were partially offset by an increase of expenses related to our Brilliant acquisition coupled with $2.8 million of non-comparable OATSystems, Inc. expenses during the first half of 2009.
Research and Development Expenses
Research and development (R&D) expenses were $20.4 million, or 2.6% of revenues, in 2009 and $22.6 million, or 2.5% of revenues in 2008. Foreign currency translation decreased R&D costs by approximately $0.2 million. Non-comparable R&D expenses generated by OATSystems, Inc. operations during the first half of 2009 were $1.0 million. The remaining decrease was due to efforts to reduce costs. The cost reduction efforts were due primarily to the impact of our temporary global payroll reduction and furlough program.
Restructuring Expenses
Restructuring expenses were $5.4 million, or 0.7% of revenues in 2009 compared to $6.4 million or 0.7% of revenues in 2008. The current and the prior year expenses are detailed in the “Provision for Restructuring” section.
Goodwill Impairment
Goodwill impairment expense was $59.6 million, or 6.5% of revenues in 2008, without a comparable charge in 2009. The 2008 expense is detailed in the “Goodwill Impairment” section following “Liquidity and Capital Resources.”
Asset Impairment
Asset impairment expense was $4.5 million, or 0.5% of revenues in 2008, without a comparable charge in 2009. The 2008 expense is detailed in the “Asset Impairment” section following “Liquidity and Capital Resources.”
Litigation Settlement
Litigation settlement expense was $1.3 million in 2009, compared to $6.2 million in 2008. Included in the 2009 litigation expense was $0.9 million of expense related to the settlement of a dispute with a consultant and $0.4 million related to the acquisition of a patent related to our Alpha business. We purchased the patent for $1.7 million related to our Alpha business. A portion of this purchase price was attributable to use prior to the date of acquisition and as a result we recorded $0.4 million in litigation expense and $1.3 million in intangibles.
The 2008 litigation settlement expense is primarily attributed to a $5.7 million litigation accrual recorded during the fourth quarter of 2008 related to a patent infringement counter suit in which we were found to be liable for the other party’s associated legal fees. We plan to appeal the ruling but have accrued the full amount of the judgment. The remaining $0.5 million of the litigation expense was due to a contract settlement with a product manufacturer in the third quarter of 2008. We do not anticipate any additional charges related to this issue.
Other Operating Income
Other operating income was $1.0 million, or 0.1% of revenues in 2008, without a comparable gain in 2009. Other operating income was recorded in 2008 due to the sale of our Czech Republic subsidiary, which is now operating as a distributor of our products.
Interest Income and Interest Expense
Interest income for 2009 decreased $0.7 million from the comparable period in 2008. The decrease in interest income was due to lower cash balances during 2009 compared to 2008.
Interest expense for 2009 increased $1.6 million from the comparable period in 2008. The increase in interest expense was due to higher debt levels in 2009 compared to 2008.
Other Gain (Loss), net
Other gain (loss), net was a loss of $0.2 million in 2009 compared to a net loss of $8.9 million in 2008. The increase of $8.7 million was due primarily to a foreign exchange loss of $0.4 million in 2009 as compared to a foreign exchange loss of $9.2 million in 2008. During 2008, the primary drivers of the foreign currency loss were fluctuations in the value of the U.S. Dollar to the Euro and the Japanese Yen, as well as the Euro to the British Pound.
Income Taxes
The effective rate of tax at December 27, 2009 was 28.6%. At December 28, 2008, the effective tax rate was (2.5%). The 2009 tax rate includes a benefit of $0.1 million in tax reserves and a net increase to the valuation allowance of $7.6 million. The main components of the valuation allowance change were a charge of $1.1 million in connection with our Italy operations and a charge of $4.6 related to operations in Japan. The valuation allowance was also impacted by a charge of $2.0 million in connection with state net operating losses, of which $0.3 million was related to activity in 2009. The remainder of the valuation allowance movement relates to benefits from the current year utilization of deferred tax assets that a valuation was recorded against in prior periods. A benefit of $0.1 million was recorded related to tax audits settled in the current year.
The 2008 tax rate includes a $1.2 million change in tax reserves and a net valuation allowance benefit of $2.9 million. The main components of the valuation allowance benefit was a release of $4.7 million relating to net operating losses in Brazil, a charge of $1.2 million in connection to our United Kingdom operations, and a charge of $0.8 million in connection to state net operating losses. A charge of $0.7 million was recorded related to tax audits settled in the current year. In addition, an income tax benefit was not recorded in 2008 on $58.5 million of the $59.6 million impairment as it related to non-deductible goodwill.
Net Earnings (Loss) Attributable to Checkpoint Systems, Inc.
Net earnings (loss) attributable to Checkpoint Systems, Inc. were $26.1 million, or $0.66 per diluted share, for 2009 compared to ($29.8) million, or ($0.76) per diluted share, for 2008. The weighted average number of shares used in the diluted earnings per share computation were 39.6 million and 39.4 million for 2009 and 2008, respectively.
Other Matters
Recently Adopted Accounting Standards
In December 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-17, “Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities” which amends ASC 810, “Consolidation” to address the elimination of the concept of a qualifying special purpose entity. The standard also replaces the quantitative-based risks and rewards calculation for determining which enterprise has a controlling financial interest in a variable interest entity (“VIE”) with an approach focused on identifying which enterprise has the power to direct the activities of a VIE and the obligation to absorb losses of the entity or the right to receive benefits from the entity. This standard also requires continuous reassessments of whether an enterprise is the primary beneficiary of a VIE whereas previous accounting guidance required reconsideration of whether an enterprise was the primary beneficiary of a VIE only when specific events had occurred. The standard provides more timely and useful information about an enterprise’s involvement with a VIE and is effective as of the beginning of interim and annual reporting periods that begin after November 15, 2009, which for us was December 28, 2009, the first day of our 2010 fiscal year. The adoption of this standard did not have a material effect on our consolidated results of operations and financial condition.
In December 2009, the FASB issued ASU No. 2009-16, “Accounting for Transfers of Financial Assets” which amends ASC 860 “Transfers and Servicing” by eliminating the concept of a qualifying special-purpose entity (QSPE); clarifying and amending the derecognition criteria for a transfer to be accounted for as a sale; amending and clarifying the unit of account eligible for sale accounting; and requiring that a transferor initially measure at fair value and recognize all assets obtained (for example beneficial interests) and liabilities incurred as a result of a transfer of an entire financial asset or group of financial assets accounted for as a sale. Additionally, on and after the effective date, existing QSPEs (as defined under previous accounting standards) must be evaluated for consolidation by reporting entities in accordance with the applicable consolidation guidance. The standard requires enhanced disclosures about, among other things, a transferor’s continuing involvement with transfers of financial assets accounted for as sales, the risks inherent in the transferred financial assets that have been retained, and the nature and financial effect of restrictions on the transferor’s assets that continue to be reported in the statement of financial position. The standard is effective as of the beginning of interim and annual reporting periods that begin after November 15, 2009, which for us was December 28, 2009, the first day of our 2010 fiscal year. The adoption of this standard did not have a material effect on our consolidated results of operations and financial condition. Any required enhancements to disclosures have been included in our financial statements beginning with the first quarter ended March 28, 2010.
In January 2010, the FASB issued ASU No. 2010-06, “Improving Disclosures About Fair Value Measurements,” which provides amendments to ASC 820 “Fair Value Measurements and Disclosures,” including requiring reporting entities to make more robust disclosures about (1) the different classes of assets and liabilities measured at fair value, (2) the valuation techniques and inputs used, (3) the activity in Level 3 fair value measurements including information on purchases, sales, issuances, and settlements on a gross basis and (4) the transfers between Levels 1, 2, and 3. The standard is effective for interim and annual reporting periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures which are effective for annual periods beginning after December 15, 2010. Any required enhancements to disclosures have been included in our financial statements beginning with the first quarter ended March 28, 2010. Additionally, the adoption of this standard’s Level 3 reconciliation disclosures did not have a material impact on our consolidated financial statements.
In February 2010, the FASB issued ASU No. 2010-09, “Amendments to Certain Recognition and Disclosure Requirements,” which addresses both the interaction of the requirements of Topic 855, Subsequent Events, with the SEC’s reporting requirements and the intended breadth of the reissuance disclosures provision related to subsequent events. Specifically, the amendments state that SEC filers are no longer required to disclose the date through which subsequent events have been evaluated in originally issued and revised financial statements. The standard was effective immediately upon issuance. The adoption of this standard did not have a material impact on our consolidated financial statements. Removal of the disclosure requirement did not affect the nature or timing of our subsequent event evaluations.
In July 2010, the FASB issued ASU 2010-20 "Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses" (ASU 2010-20). ASU 2010-20 requires further disaggregated disclosures that improve financial statement users' understanding of (1) the nature of an entity's credit risk associated with its financing receivables and (2) the entity's assessment of that risk in estimating its allowance for credit losses as well as changes in the allowance and the reasons for those changes. The new and amended disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures under this standard were effective for us for the fiscal year ending December 26, 2010. The adoption of this standard did not have a material effect on our consolidated results of operations and financial condition. In January 2011, the FASB announced that it was deferring the effective date of new disclosure requirements for troubled debt restructurings prescribed by ASU 2010-20. The effective date for those disclosures will be concurrent with the effective date for proposed ASU, Receivables (Topic 310): Clarifications to Accounting for Troubled Debt Restructurings by Creditors. Currently, that guidance is anticipated to be effective for interim and annual periods ending after June 15, 2011.
New Accounting Pronouncements and Other Standards
In October 2009, the FASB issued ASU 2009-13, “Multiple-Deliverable Revenue Arrangements, (amendments to ASC Topic 605, Revenue Recognition)” (ASU 2009-13) and ASU 2009-14, “Certain Arrangements That Include Software Elements, (amendments to ASC Topic 985, Software)” (ASU 2009-14). ASU 2009-13 requires entities to allocate revenue in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The amendments eliminate the residual method of revenue allocation and require revenue to be allocated using the relative selling price method. ASU 2009-14 removes tangible products from the scope of software revenue guidance and provides guidance on determining whether software deliverables in an arrangement that includes a tangible product are covered by the scope of the software revenue guidance. ASU 2009-13 and ASU 2009-14 should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. We do not expect the adoption of the standard to have a material impact on our consolidated results of operations and financial condition.
In April 2010, FASB issued ASU 2010-13 "Compensation-Stock Compensation (Topic 718) Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades" (ASU 2010-13). Topic 718 is amended to clarify that a share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity's equity securities trades shall not be considered to contain a market, performance, or service condition. Therefore, such an award is not to be classified as a liability if it otherwise qualifies as equity classification. The amendments in this standard are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. The guidance should be applied by recording a cumulative-effect adjustment to the opening balance of retained earnings for all outstanding awards as of the beginning of the fiscal year in which the amendments are initially applied. We do not expect the adoption of the standard to have a material impact on our consolidated results of operations and financial condition.
In December 2010, FASB issued ASU 2010-28 “Intangibles-Goodwill and Other (Topic 350)” (ASU 2010-28). Topic 350 is amended to clarify the requirement to test for impairment of goodwill. Topic 350 has required that goodwill be tested for impairment if the carrying amount of a reporting unit exceeds its fair value. Under ASU 2010-28, when the carrying amount of a reporting unit is zero or negative an entity must assume that it is more likely than not that a goodwill impairment exists, perform an additional test to determine whether goodwill has been impaired and calculate the amount of that impairment. The modifications to ASC Topic 350 resulting from the issuance of ASU 2010-28 are effective for fiscal years beginning after December 15, 2010 and interim periods within those years. Early adoption is not permitted. We do not expect the adoption of the standard to have a material impact on our consolidated results of operations and financial condition.
In December 2010, the FASB issued ASU 2010-29 “Business Combinations (Topic 805) - Disclosure of Supplementary Pro Forma Information for Business Combinations” (ASU 2010-29). This standard update clarifies that, when presenting comparative financial statements, SEC registrants should disclose revenue and earnings of the combined entity as though the current period business combinations had occurred as of the beginning of the comparable prior annual reporting period only. The update also expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 is effective prospectively for material (either on an individual or aggregate basis) business combinations entered into in fiscal years beginning on or after December 15, 2010 with early adoption permitted. We do not expect the adoption of the standard to have a material impact on our consolidated results of operations and financial condition.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Factors
Fluctuations in interest and foreign currency exchange rates affect our financial position and results of operations. We enter into forward exchange contracts denominated in foreign currency to reduce the risks of currency fluctuations on short-term inter-company receivables and payables. We also enter into various foreign currency contracts to reduce our exposure to forecasted Euro-denominated inter-company revenues. We have historically not used financial instruments to minimize our exposure to currency fluctuations on our net investments in and cash flows derived from our foreign subsidiaries. We have used third party borrowings in foreign currencies to hedge a portion of our net investments in and cash flows derived from our foreign subsidiaries. As of December 26, 2010, all third party borrowings were in the functional currency of the subsidiary borrower. Additionally, we enter, on occasion, into interest rate swaps to reduce the risk of significant interest rate increases in connection with our floating rate debt.
We are subject to foreign currency exchange risk on our foreign currency forward exchange contracts which represent a $27 thousand asset position and $20 thousand liability position as of December 26, 2010, and a $0.1 million asset position and $0.2 million liability position as of December 27, 2009. The sensitivity analysis assumes an instantaneous 10% change in foreign currency exchange rates from year-end levels, with all other variables held constant. At December 26, 2010, a 10% strengthening of the U.S. dollar versus other currencies would result in an increase of $0.5 million in the net asset position, while a 10% weakening of the dollar versus all other currencies would result in a decrease of $0.5 million.
Foreign exchange forward contracts are used to hedge certain of our firm foreign currency cash flows. Thus, there is either an asset or cash flow exposure related to all the financial instruments in the above sensitivity analysis for which the impact of a movement in exchange rates would be in the opposite direction and substantially equal to the impact on the instruments in the analysis. There are presently no significant restrictions on the remittance of funds generated by our operations outside the U.S. At December 26, 2010, unremitted earnings of subsidiaries outside the United States were deemed to be permanently reinvested.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 26, 2010 and December 27, 2009
Consolidated Statements of Operations for each of the years in the three-year period ended December 26, 2010
Consolidated Statements of Equity for each of the years in the three-year period ended December 26, 2010
Consolidated Statements of Comprehensive Income (Loss) for each of the years in the three-year period ended December 26, 2010
Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 26, 2010
Notes to Consolidated Financial Statements
36-58
Financial Statement Schedules, Schedule II - Valuation and Qualifying Accounts
Report of Independent Registered Public Accounting Firm
To The Board of Directors and Stockholders of
Checkpoint Systems, Inc.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, comprehensive income (loss), equity and cash flows present fairly, in all material respects, the financial position of Checkpoint Systems, Inc. and its subsidiaries at December 26, 2010 and December 27, 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 26, 2010, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 26, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Annual Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
PricewaterhouseCoopers LLP
Philadelphia, PA
February 22, 2011
CHECKPOINT SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(amounts in thousands)
December 26,
December 27,
ASSETS
CURRENT ASSETS:
Cash and cash equivalents
$ 173,802
$ 162,097
Restricted cash
Accounts receivable, net of allowance of $10,472 and $14,524
178,636
173,057
Inventories
106,974
89,247
Other current assets
32,655
33,068
Deferred income taxes
20,622
24,576
Total Current Assets
512,829
482,690
REVENUE EQUIPMENT ON OPERATING LEASE, net
2,340
2,016
PROPERTY, PLANT, AND EQUIPMENT, net
121,258
117,598
GOODWILL
231,325
244,062
OTHER INTANGIBLES, net
90,823
104,733
DEFERRED INCOME TAXES
52,506
46,389
OTHER ASSETS
24,192
26,745
TOTAL ASSETS
$ 1,035,273
$ 1,024,233
LIABILITIES AND EQUITY
CURRENT LIABILITIES:
Short-term borrowings and current portion of long-term debt
$ 22,225
$ 25,772
Accounts payable
63,366
61,700
Accrued compensation and related taxes
29,308
36,050
Other accrued expenses
47,646
45,791
Income taxes
4,395
11,427
Unearned revenues
12,196
23,458
Restructuring reserve
7,522
4,697
Accrued pensions - current
4,358
4,613
Other current liabilities
23,019
27,373
Total Current Liabilities
214,035
240,881
LONG-TERM DEBT, LESS CURRENT MATURITIES
119,724
91,100
ACCRUED PENSIONS
75,396
77,621
OTHER LONG-TERM LIABILITIES
30,502
43,772
DEFERRED INCOME TAXES
11,325
12,305
COMMITMENTS AND CONTINGENCIES
CHECKPOINT SYSTEMS, INC. STOCKHOLDERS’ EQUITY:
Preferred stock, no par value, 500,000 shares authorized, none issued
-
-
Common stock, par value $.10 per share, 100,000,000 shares authorized, issued
43,843,095 and 43,078,498
4,384
4,307
Additional capital
407,383
390,379
Retained earnings
233,322
205,951
Common stock in treasury, at cost, 4,035,912 and 4,035,912 shares
(71,520)
(71,520)
Accumulated other comprehensive income, net of tax
10,722
28,603
TOTAL CHECKPOINT SYSTEMS, INC. STOCKHOLDERS’ EQUITY
584,291
557,720
NONCONTROLLING INTERESTS
-
TOTAL EQUITY
584,291
558,554
TOTAL LIABILITIES AND EQUITY
$ 1,035,273
$ 1,024,233
See Notes to Consolidated Financial Statements.
CHECKPOINT SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands)
Year ended
December 26,
December 27,
December 28,
Net revenues
$ 834,498
$ 772,718
$ 917,082
Cost of revenues
487,850
441,434
538,983
Gross profit
346,648
331,284
378,099
Selling, general, and administrative expenses
275,282
262,649
296,935
Research and development
20,507
20,354
22,607
Restructuring expenses
8,211
5,401
6,442
Litigation settlement
-
1,300
6,167
Asset impairment
-
-
4,510
Goodwill impairment
-
-
59,583
Other operating income
-
-
Operating income (loss)
42,648
41,580
(17,177)
Interest income
3,118
1,971
2,660
Interest expense
6,507
7,386
5,768
Other gain (loss), net
(2,237)
(180)
(8,924)
Earnings (loss) before income taxes
37,022
35,985
(29,209)
Income taxes expense
9,767
10,290
Net earnings (loss)
27,255
25,695
(29,928)
Less: (loss) attributable to noncontrolling interests
(116)
(447)
(123)
Net earnings (loss) attributable to Checkpoint Systems, Inc.
$ 27,371
$ 26,142
$ (29,805)
Net earnings (loss) attributable to Checkpoint Systems, Inc. per Common Shares:
Basic Earnings (Loss) Per Share
$ .69
$ .67
$ (.76)
Diluted Earnings (Loss) Per Share
$ .68
$ .66
$ (.76)
See Notes to Consolidated Financial Statements.
CHECKPOINT SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF EQUITY
(amounts in thousands)
See Notes to Consolidated Financial Statements.
CHECKPOINT SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(amounts in thousands)
Year ended
December 26,
December 27,
December 28,
Net earnings (loss)
$ 27,255
$ 25,695
$ (29,928)
Amortization of pension plan actuarial losses, net of tax
Change in realized and unrealized gains (losses) on derivative hedges, net of tax
(1,182)
Unrealized (loss) adjustment on marketable securities, net of tax
-
-
(16)
Recognized (loss) gain on pension, net of tax
(3,405)
1,934
(169)
Foreign currency translation adjustment
(15,221)
11,974
(24,912)
Comprehensive income (loss)
$ 9,411
$ 38,505
$ (54,073)
Less: comprehensive (loss) attributable to noncontrolling interests
(834)
(90)
(53)
Comprehensive income (loss) attributable to Checkpoint Systems, Inc.
$ 10,245
$ 38,595
$ (54,020)
See Notes to Consolidated Financial Statements.
CHECKPOINT SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
Year ended
December 26,
December 27,
December 28,
Cash flows from operating activities:
Net earnings (loss)
$ 27,255
$ 25,695
$ (29,928)
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization
34,477
32,325
30,788
Deferred taxes
(2,227)
(7,109)
(13,716)
Stock-based compensation
8,751
7,135
7,096
Excess tax benefit on stock compensation
(1,662)
(12)
(2,229)
Provision for losses on accounts receivable
(117)
5,810
Gain on sale of subsidiaries
-
-
(968)
Loss on disposal of fixed assets
Goodwill impairment
-
-
59,583
Asset impairment
-
-
4,510
(Increase) decrease in current assets, net of the effects of acquired companies:
Accounts receivable
(9,467)
27,308
(215)
Inventories
(20,707)
17,078
5,469
Other current assets
8,993
3,920
Increase (decrease) in current liabilities, net of the effects of acquired companies:
Accounts payable
2,491
(6,348)
(12,278)
Income taxes
(5,253)
3,584
5,951
Unearned revenues
(9,750)
11,654
(3,208)
Restructuring reserve
3,044
Other current and accrued liabilities
(16,355)
(6,133)
15,799
Net cash provided by operating activities
10,904
114,826
77,206
Cash flows from investing activities:
Acquisition of property, plant, and equipment and intangibles
(23,712)
(13,757)
(15,217)
Acquisitions of businesses, net of cash acquired
(300)
(25,535)
(39,629)
Change in restricted cash
-
Other investing activities
Net cash (used in) investing activities
(23,185)
(38,645)
(54,704)
Cash flows from financing activities:
Proceeds from stock issuances
6,022
9,005
Excess tax benefit on stock compensation
1,662
2,229
Proceeds of short-term debt
7,621
11,215
3,582
Payment of short-term debt
(12,344)
(12,941)
(3,596)
Proceeds of long-term debt
141,747
93,793
105,898
Payment of long-term debt
(114,458)
(144,650)
(65,813)
Net change in factoring and bank overdrafts
1,413
5,380
-
Debt issuance costs
(1,991)
(3,970)
-
Payment of notes payable
-
-
(4,866)
Purchase of treasury stock
-
-
(50,899)
Repurchase of noncontrolling interests
(781)
-
-
Net cash provided by (used in) financing activities
28,891
(50,316)
(4,460)
Effect of foreign currency rate fluctuations on cash and cash equivalents
(4,905)
4,010
(4,091)
Net increase in cash and cash equivalents
11,705
29,875
13,951
Cash and cash equivalents:
Beginning of year
162,097
132,222
118,271
End of year
$ 173,802
$ 162,097
$ 132,222
See Notes to Consolidated Financial Statements.
CHECKPOINT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
We are a multinational manufacturer and marketer of identification, tracking, security and merchandising solutions primarily for the retail industry. We provide technology-driven integrated supply chain 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, electronic article surveillance (EAS), custom tags and labels (Apparel Labeling Solutions), store monitoring solutions (CheckView®), hand-held labeling systems (HLS), retail merchandising systems (RMS), and radio frequency identification (RFID) systems and software. Applications of these products include primarily retail security, asset and merchandise visibility, automatic identification, and pricing and promotional labels and signage. Operating directly in 31 countries, we have a global network of subsidiaries and distributors, and provide customer service and technical support around the world.
During the second quarter of 2010, we identified an error in the accounting for a deferred tax liability related to a 2005 transaction. Specifically, we concluded that an existing deferred tax liability in the amount of $5.9 million should have been recognized as income in 2005 rather than remain as a liability on our consolidated balance sheet at that time. We have assessed the materiality of this item on prior periods in accordance with the SEC's Staff Accounting Bulletin ("SAB") No. 99 and concluded that the error was not material to any such periods. We also concluded that the impact of correcting the error in the quarter ended June 27, 2010 would have been misleading to the users of the financial statements and therefore, have not recorded an adjustment in the current year. In this regard, in accordance with SAB 108, we have revised our consolidated balance sheet as of December 27, 2009 to increase retained earnings and reduce long term deferred tax liabilities in the amount of $5.9 million. This revision results in no other change to our consolidated financial statements presented in this report. We will make corresponding revisions to retained earnings and long term deferred tax liabilities in prior periods the next time those financial statements are filed.
Out of Period Adjustments
During the third quarter of 2010, we recorded additional income tax expense of $0.7 million related to provision-to-return adjustments resulting from the misapplication of tax law to the foreign tax credit calculation associated with the payment of a dividend from one of our wholly owned subsidiaries to the Company. This adjustment related to the fourth quarter of 2009 and was not material to the financial results for prior interim or annual periods or to the third quarter or full year of fiscal 2010. As a result, we did not restate our previously issued financial statements.
During the fourth quarter of 2009, we recorded a benefit to income tax expense of $1.3 million related to the settlement of a tax matter in an overseas jurisdiction for which the assessment was received in the third quarter of 2009. This adjustment related to the third quarter of 2009 was not material to the financial results for previously issued interim financial data or to the fourth quarter of fiscal 2009. As a result, we did not restate our previously issued interim financial data.
During the fourth quarter of 2008, we identified an error in our financial statements related to fiscal year 2006. This error related to the accounting for a building impairment in France. We corrected the error during the fourth quarter of 2008, which had the effect of increasing asset impairment expense $1.1 million and reducing net income by $0.8 million. This prior period error was not material to the financial results for previously issued annual financial statements or previously issued interim financial data prior to fiscal 2008 as well as for the twelve months ended December 28, 2008. As a result, we did not restate our previously issued annual financial statements or previously issued interim financial data.
During the first quarter of 2008, we identified errors in our financial statements for the fiscal years ended 1999 through fiscal year 2007. These errors primarily related to the accounting for a deferred compensation arrangement. We incorrectly accounted for a deferred payment arrangement to a former executive of the Company. These deferred payments should have been appropriately accounted for in prior periods. We corrected these errors during the first quarter of 2008, which had the effect of increasing selling, general and administrative expenses by $1.4 million and reducing net income by $0.8 million. These prior period errors individually and in the aggregate were not material to the financial results for previously issued annual financial statements or previously issued interim financial data prior to fiscal 2008 as well as the twelve months ended December 28, 2008. As a result, we did not restate our previously issued annual financial statements or previously issued interim financial data.
Principles of Consolidation
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.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Fiscal Year
Our fiscal year is the 52 or 53 week period ending the last Sunday of December. References to 2010, 2009, and 2008, are for the 52 weeks ended December 26, 2010, December 27, 2009, and December 28, 2008, respectively.
Reclassifications
Certain reclassifications and retrospective adjustments have been made to prior period information to conform to current period presentation. These reclassifications and retrospective adjustments result from our adoption of an accounting standard codified within Financial Accounting Standards Board (“FASB”) Accounting Standards Codification™ (“ASC”) 810, “Consolidation,” related to noncontrolling interests, and our change in segment reporting to conform to our current management structure, respectively.
Noncontrolling Interests
On December 29, 2008, we adopted a standard codified within ASC 810, “Consolidation,” which establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This standard clarifies that a noncontrolling interest should be reported as equity in the consolidated financial statements and requires net income attributable to both the parent and the noncontrolling interest to be disclosed separately on the face of the consolidated statement of income. The presentation and disclosure requirements of this standard require retrospective application to all prior periods presented.
On July 1, 1997, Checkpoint Systems Japan Co. Ltd. (Checkpoint Japan), a wholly-owned subsidiary of the Company, issued newly authorized shares to Mitsubishi Materials Corporation (Mitsubishi) in exchange for cash. In February 2006, Checkpoint Japan repurchased 26% of these shares from Mitsubishi in exchange for $0.2 million in cash. In August 2010, Checkpoint Manufacturing Japan Co., LTD. repurchased the remaining 74% of these shares from Mitsubishi in exchange for $0.8 million in cash.
We have classified noncontrolling interests as equity on our consolidated balance sheets as of December 26, 2010 and December 27, 2009 and presented net income attributable to noncontrolling interests separately on our consolidated statements of operations for the years ended December 26, 2010, December 27, 2009, and December 28, 2008. No changes in the ownership interests of Checkpoint Japan occurred during the years ended December 27, 2009 and December 28, 2008, respectively.
Stock Repurchase Program
During the first half of 2008, we executed our previously approved stock repurchase program in which we are authorized to purchase up to two million shares of the Company’s common stock. In total, we repurchased two million shares of our common stock at an average cost of $25.42, spending a total of $50.9 million. Prior to 2008, no shares were repurchased under this plan. As of December 26, 2010, no shares remain available for purchase under the current program. Common stock obtained by the Company through the repurchase program has been added to our treasury stock holdings.
Subsequent Events
We perform a review of subsequent events in connection with the preparation of our financial statements. The accounting for and disclosure of events that occur after the balance sheet date, but before our financial statements are issued or available to be issued are reflected where appropriate or required in our financial statements. Refer to Note 20 “Subsequent Events”.
Cash and Cash Equivalents
Cash in excess of operating requirements is invested in short-term, income-producing instruments or used to pay down debt. Cash equivalents include commercial paper and other securities with original maturities of 90 days or less at the time of purchase. Book value approximates fair value because of the short maturity of those instruments.
Restricted Cash
We classify restricted cash as cash that cannot be made readily available for use. Restrictions may include legally restricted deposits held as compensating balances against short-term borrowing arrangements, contracts entered into with others, or company statements of intention with regard to particular deposits. As of December 26, 2010, the unused portion of a grant from the Chinese government of $0.1 million (RMB 0.9 million) was recorded within restricted cash in the accompanying Consolidated Balance Sheets.
Accounts Receivable
Accounts receivables are recorded at net realizable values. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. These allowances are based on specific facts and circumstances surrounding individual customers as well as our historical experience. Provisions for the losses on receivables are charged to income to maintain the allowance at a level considered adequate to cover losses. Receivables are charged off against the reserve when they are deemed uncollectible.
Inventories
Inventories are stated at the lower of cost (first-in, first-out method) or market. A provision is made to reduce excess or obsolete inventory to its net realizable value.
Revenue Equipment on Operating Lease
The cost of the equipment leased to customers under operating leases is depreciated on a straight-line basis over the lesser of the length of the contract or estimated useful life of the asset, which is usually between three and five years.
Property, Plant, and Equipment
Property, plant, and equipment is carried at cost less accumulated depreciation. Maintenance, repairs, and minor renewals are expensed as incurred. Additions, improvements, and major renewals are capitalized. Depreciation is provided on a straight-line basis over the estimated useful lives of the assets. Assets subject to capital leases are depreciated over the lesser of the estimated useful life of the asset or length of the contract. Buildings, equipment rented to customers, and leased equipment on capitalized leases use the following estimated useful lives of fifteen to thirty years, three to five years, and five years, respectively. Machinery and equipment estimated useful lives range from three to ten years. Leasehold improvement useful lives are the lesser of the minimum lease term or the useful life of the item. The cost and accumulated depreciation applicable to assets retired are removed from the accounts and the gain or loss on disposition is included in income.
We review our property, plant, and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. If it is determined that an impairment, based on expected future undiscounted cash flows, exists, then the loss is recognized on the Consolidated Statements of Operations. The amount of the impairment is the excess of the carrying amount of the impaired asset over its fair value.
Internal-Use Software
Included in fixed assets is the capitalized cost of internal-use software. We capitalize costs incurred during the application development stage of internal-use software and amortize these costs over their estimated useful lives, which generally range from three to five years. Costs incurred related to design or maintenance of internal-use software is expensed as incurred.
During 2009, we announced that we were in the initial stages of implementing a company-wide ERP system to handle the business and finance processes within our operations and corporate functions. The total amount of internal-use software costs capitalized since the beginning of the ERP implementation as of December 26, 2010 and December 27, 2009 were $13.1 million and $2.8 million, respectively. As of December 26, 2010, $0.4 million was recorded in machinery and equipment related to supporting software packages that were placed in service. The remaining costs of $12.7 million and $2.8 million as of December 26, 2010 and December 27, 2009, respectively, are capitalized as construction-in-progress until such time as the ERP system has been placed in service.
Goodwill
Goodwill is carried at cost and is not amortized. We test goodwill for impairment on an annual basis as of fiscal month end October of each fiscal year, relying on a number of factors including operating results, business plans and anticipated future cash flows. Company management uses its judgment in assessing whether goodwill has become impaired between annual impairment tests. Reporting units are primarily determined as the geographic areas comprising the Company’s business segments, except in situations when aggregation of the reporting units is appropriate. Recoverability of goodwill is evaluated using a two-step process. The first step involves a comparison of the fair value of a reporting unit with its carrying value. If the carrying amount of the reporting unit exceeds its fair value, then the second step of the process involves a comparison of the implied fair value and carrying value of the goodwill of that reporting unit. If the carrying value of the goodwill of a reporting unit exceeds the fair value of that goodwill, an impairment loss is recognized in an amount equal to the excess.
The fair value of our reporting units is dependent upon our estimate of future discounted cash flows and other factors. Our estimates of future cash flows include assumptions concerning future operating performance and economic conditions and may differ from actual future cash flows. Estimated future cash flows are adjusted by an appropriate discount rate derived from our market capitalization plus a suitable control premium at the date of evaluation. The financial and credit market volatility directly impacts our fair value measurement through our weighted average cost of capital that we use to determine our discount rate and through our stock price that we use to determine our market capitalization. Therefore, changes in the stock price may also affect the amount of impairment recorded. Market capitalization is determined by multiplying the shares outstanding on the assessment date by the average market price of our common stock over a 30-day period before each assessment date. We use this 30-day duration to consider inherent market fluctuations that may affect any individual closing price. We believe that our market capitalization alone does not fully capture the fair value of our business as a whole, or the substantial value that an acquirer would obtain from its ability to obtain control of our business. As such, in determining fair value, we add a control premium to our market capitalization. To estimate the control premium, we considered our unique competitive advantages that would likely provide synergies to a market participant. In addition, we considered external market factors which we believe contributed to the decline and volatility in our stock price that did not reflect our underlying fair value. Refer to Note 5 of the Consolidated Financial Statements.
Other Intangibles
Indefinite-lived intangible assets are carried at cost and are not amortized, but are subject to tests for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable.
Definite-lived intangibles are amortized on a straight-line basis over their useful lives (or legal lives if shorter). We review our other intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable.
If it is determined that an impairment, based on expected future cash flows, exists, then the loss is recognized on the Consolidated Statements of Operations. The amount of the impairment is the excess of the carrying amount of the impaired asset over the fair value of the asset. The fair value represents expected future cash flows from the use of the assets, discounted at the rate used to evaluate potential investments. Refer to Note 5 of the Consolidated Financial Statements.
Other Assets
Included in other assets are $15.6 million and $18.2 million of net long-term customer-based receivables at December 26, 2010 and December 27, 2009, respectively.
Deferred Financing Costs
Financing costs are capitalized and amortized to interest expense over the life of the debt. The net deferred financing costs at December 26, 2010 and December 27, 2009 were $3.9 million and $3.2 million, respectively. The financing cost amortization expense was $1.2 million, $1.0 million, and $0.2 million, for 2010, 2009, and 2008, respectively.
Revenue Recognition
We recognize revenue when revenue is realized or realizable and earned. Revenue is realized or realizable and earned when all of the following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; the price to the buyer is fixed or determinable; and collectability is reasonably assured. For arrangements with multiple elements, we determine the fair value of each element and then allocate the total arrangement consideration among the separate elements. In instances when the fair value is not known for the delivered items, and is known for the undelivered items, the residual method is used. We recognize revenue when installation is complete or other post-shipment obligations have been satisfied. Equipment leased to customers under sales-type leases is accounted for as the equivalent of a sale. The present value of such lease revenues is recorded as net revenues, and the related cost of the equipment is charged to cost of revenues. The deferred finance charges applicable to these leases are recognized over the terms of the leases. Rental revenue from equipment under operating leases is recognized over the term of the lease. Installation revenue from SMS EAS equipment is recognized when the systems are installed. Service revenue is recognized, for service contracts, on a straight-line basis over the contractual period, and, for non-contract work, as services are performed. Unearned revenue is recorded when payments are received in advance of performing our service obligations and is recognized over the service period.
Revenues from software license agreements are recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, no significant vendor obligations are remaining to be fulfilled, the fee is fixed or determinable, and collection is probable. Revenue from software contracts for both licenses and professional services that require significant production, modification, customization, or implementation are recognized together using the percentage of completion method based upon the ratio of labor incurred to total estimated labor to complete each contract. In instances where there is a term license combined with services, revenue is recognized ratably over the term.
We record estimated reductions to revenue for customer incentive offerings, including volume-based incentives and rebates. The accrual for these incentives and rebates, which are included in the Other Accrued Expenses section of our Consolidated Balance Sheet, was $12.4 million and $10.0 million as of December 26, 2010 and December 27, 2009, respectively. We record revenues net of an allowance for estimated return activities. Return activity was immaterial to revenue and results of operations for all periods presented.
Shipping and Handling Fees and Costs
Shipping and handling fees are accounted for in net revenues and shipping and handling costs in cost of revenues.
Cost of Revenues
The principal elements of cost of revenues are product cost, field service and installation cost, freight, and product royalties paid to third parties.
Warranty Reserves
We provide product warranties for our various products. These warranties vary in length depending on product and geographical region. We establish our warranty reserves based on historical data of warranty transactions.
The following table sets forth the movement in the warranty reserve which is located in the Other Accrued Expenses section of our Consolidated Balance Sheet:
(amounts in thousands)
December 26,
December 27,
Balance at beginning of year
$ 6,116
$ 8,403
Accruals for warranties issued
5,940
3,708
Settlements made
(5,735)
(6,163)
Foreign currency translation adjustment
(151)
Balance at end of period
$ 6,170
$ 6,116
Royalty Expense
Royalty expenses related to security products approximated $0.1 million, $0.2 million, and $3.7 million, in 2010, 2009, and 2008, respectively. These expenses are included as part of cost of revenues. Our payment obligation to Arthur D. Little, Inc. terminated on December 31, 2008.
Research and Development Costs
Research and development costs are expensed as incurred and consist of development work associated with the Company’s existing and potential products and processes. The Company’s research and development expenses relate primarily to payroll costs for engineering personnel, costs associated with various projects, including testing, developing prototypes and related expenses.
Stock Options
We recognize stock-based compensation expense for all share-based payments net of an estimated forfeiture rate and only recognize compensation cost for those shares expected to vest. Stock compensation expense is recognized for all share-based payments on a straight-line basis over the requisite service period of the award.
We use the Black-Scholes option pricing model to value all stock options. The table below presents the weighted average expected life in years. The expected life computation is based on historical exercise patterns and post-vesting termination behavior. Volatility is determined using changes in historical stock prices. The interest rate for periods within the expected life of the award is based on the U.S. Treasury yield curve in effect at the time of grant.
The fair value of share-based payment units was estimated using the Black-Scholes option pricing model with the following assumptions and weighted average fair values as follows:
Year Ended,
December 26,
Year Ended,
December 27,
Year Ended,
December 28,
Weighted-average fair value of grants
$ 7.51
$ 3.59
$ 8.04
Valuation assumptions:
Expected dividend yield
0.00
%
0.00
%
0.00
%
Expected volatility
.4829
.4474
.3883
Expected life (in years)
4.93
4.86
4.84
Risk-free interest rate
1.845
%
1.700
%
2.450
%
See Note 8 of the Consolidated Financial Statements for a further discussion on stock-based compensation.
Income Taxes
Deferred tax liabilities and assets are determined based on the difference between the financial statement basis and the tax basis of assets and liabilities, using enacted statutory tax rates in effect at the balance sheet date. Changes in enacted tax rates are reflected in the tax provision as they occur. A valuation allowance is recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period when the change is enacted.
We utilize a two-step approach to recognizing and measuring uncertain tax positions (tax contingencies). The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. We include interest and penalties related to our tax contingencies in income tax expense.
Taxes and Value Added Collected from Customers
Sales and value added taxes collected from customers are excluded from revenues. The obligation is included in other current liabilities until the taxes are remitted to the appropriate taxing authorities.
Foreign Currency Translation and Transactions
Our balance sheet accounts of foreign subsidiaries are translated into U.S. dollars at the rate of exchange in effect at the balance sheet dates. Revenues, costs, and expenses of our foreign subsidiaries are translated into U.S. dollars at the year-to-date average rate of exchange. The resulting translation adjustments are recorded as a separate component of shareholders’ equity. Gains or losses on certain long-term inter-company transactions are excluded from the net earnings (loss) and accumulated in the cumulative translation adjustment as a separate component of consolidated stockholders’ equity. All other foreign currency transaction gains and losses are included in net earnings (loss).
Accounting for Hedging Activities
We enter into certain foreign exchange forward contracts in order to hedge anticipated rate fluctuations in Western Europe, Canada, Japan and Australia. Transaction gains or losses resulting from these contracts are recognized at the end of each reporting period. We use the fair value method of accounting, recording realized and unrealized gains and losses on these contracts. These gains and losses are included in other gain (loss), net on our Consolidated Statements of Operations.
We enter into various foreign currency contracts to reduce our exposure to forecasted Euro-denominated inter-company revenues. These cash flow hedging instruments are marked to market and the changes are recorded in other comprehensive income. Amounts recorded in other comprehensive income are recognized in cost of goods sold as the inventory is sold to external parties. Any hedge ineffectiveness is charged to other gain (loss), net on our Consolidated Statements of Operations.
We enter, on occasion, into interest rate swaps to reduce the risk of significant interest rate increases in connection with floating rate debt. This cash flow hedging instrument is marked to market and the changes are recorded in other comprehensive income. Any hedge ineffectiveness is charged to interest expense.
See Note 14 of the Consolidated Financial Statements for further information.
Recently Adopted Accounting Standards
In December 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-17, “Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities” which amends ASC 810, “Consolidation” to address the elimination of the concept of a qualifying special purpose entity. The standard also replaces the quantitative-based risks and rewards calculation for determining which enterprise has a controlling financial interest in a variable interest entity (“VIE”) with an approach focused on identifying which enterprise has the power to direct the activities of a VIE and the obligation to absorb losses of the entity or the right to receive benefits from the entity. This standard also requires continuous reassessments of whether an enterprise is the primary beneficiary of a VIE whereas previous accounting guidance required reconsideration of whether an enterprise was the primary beneficiary of a VIE only when specific events had occurred. The standard provides more timely and useful information about an enterprise’s involvement with a VIE and is effective as of the beginning of interim and annual reporting periods that begin after November 15, 2009, which for us was December 28, 2009, the first day of our 2010 fiscal year. The adoption of this standard did not have a material effect on our consolidated results of operations and financial condition.
In December 2009, the FASB issued ASU No. 2009-16, “Accounting for Transfers of Financial Assets” which amends ASC 860 “Transfers and Servicing” by eliminating the concept of a qualifying special-purpose entity (QSPE); clarifying and amending the derecognition criteria for a transfer to be accounted for as a sale; amending and clarifying the unit of account eligible for sale accounting; and requiring that a transferor initially measure at fair value and recognize all assets obtained (for example beneficial interests) and liabilities incurred as a result of a transfer of an entire financial asset or group of financial assets accounted for as a sale. Additionally, on and after the effective date, existing QSPEs (as defined under previous accounting standards) must be evaluated for consolidation by reporting entities in accordance with the applicable consolidation guidance. The standard requires enhanced disclosures about, among other things, a transferor’s continuing involvement with transfers of financial assets accounted for as sales, the risks inherent in the transferred financial assets that have been retained, and the nature and financial effect of restrictions on the transferor’s assets that continue to be reported in the statement of financial position. The standard is effective as of the beginning of interim and annual reporting periods that begin after November 15, 2009, which for us was December 28, 2009, the first day of our 2010 fiscal year. The adoption of this standard did not have a material effect on our consolidated results of operations and financial condition. Any required enhancements to disclosures have been included in our financial statements beginning with the first quarter ended March 28, 2010.
In January 2010, the FASB issued ASU No. 2010-06, “Improving Disclosures About Fair Value Measurements,” which provides amendments to ASC 820 “Fair Value Measurements and Disclosures,” including requiring reporting entities to make more robust disclosures about (1) the different classes of assets and liabilities measured at fair value, (2) the valuation techniques and inputs used, (3) the activity in Level 3 fair value measurements including information on purchases, sales, issuances, and settlements on a gross basis and (4) the transfers between Levels 1, 2, and 3. The standard is effective for interim and annual reporting periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures which are effective for annual periods beginning after December 15, 2010. Any required enhancements to disclosures have been included in our financial statements beginning with the first quarter ended March 28, 2010. Additionally, the adoption of this standard’s Level 3 reconciliation disclosures did not have a material impact on our consolidated financial statements.
In February 2010, the FASB issued ASU No. 2010-09, “Amendments to Certain Recognition and Disclosure Requirements,” which addresses both the interaction of the requirements of Topic 855, Subsequent Events, with the SEC’s reporting requirements and the intended breadth of the reissuance disclosures provision related to subsequent events. Specifically, the amendments state that SEC filers are no longer required to disclose the date through which subsequent events have been evaluated in originally issued and revised financial statements. The standard was effective immediately upon issuance. The adoption of this standard did not have a material impact on our consolidated financial statements. Removal of the disclosure requirement did not affect the nature or timing of our subsequent event evaluations.
In July 2010, the FASB issued ASU 2010-20 "Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses" (ASU 2010-20). ASU 2010-20 requires further disaggregated disclosures that improve financial statement users' understanding of (1) the nature of an entity's credit risk associated with its financing receivables and (2) the entity's assessment of that risk in estimating its allowance for credit losses as well as changes in the allowance and the reasons for those changes. The new and amended disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures under this standard were effective for us for the fiscal year ending December 26, 2010. The adoption of this standard did not have a material effect on our consolidated results of operations and financial condition. In January 2011, the FASB announced that it was deferring the effective date of new disclosure requirements for troubled debt restructurings prescribed by ASU 2010-20. The effective date for those disclosures will be concurrent with the effective date for proposed ASU, Receivables (Topic 310): Clarifications to Accounting for Troubled Debt Restructurings by Creditors. Currently, that guidance is anticipated to be effective for interim and annual periods ending after June 15, 2011.
New Accounting Pronouncements and Other Standards
In October 2009, the FASB issued ASU 2009-13, “Multiple-Deliverable Revenue Arrangements, (amendments to ASC Topic 605, Revenue Recognition)” (ASU 2009-13) and ASU 2009-14, “Certain Arrangements That Include Software Elements, (amendments to ASC Topic 985, Software)” (ASU 2009-14). ASU 2009-13 requires entities to allocate revenue in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The amendments eliminate the residual method of revenue allocation and require revenue to be allocated using the relative selling price method. ASU 2009-14 removes tangible products from the scope of software revenue guidance and provides guidance on determining whether software deliverables in an arrangement that includes a tangible product are covered by the scope of the software revenue guidance. ASU 2009-13 and ASU 2009-14 should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. We do not expect the adoption of the standard to have a material impact on our consolidated results of operations and financial condition.
In April 2010, FASB issued ASU 2010-13 "Compensation-Stock Compensation (Topic 718) Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades" (ASU 2010-13). Topic 718 is amended to clarify that a share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity's equity securities trades shall not be considered to contain a market, performance, or service condition. Therefore, such an award is not to be classified as a liability if it otherwise qualifies as equity classification. The amendments in this standard are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. The guidance should be applied by recording a cumulative-effect adjustment to the opening balance of retained earnings for all outstanding awards as of the beginning of the fiscal year in which the amendments are initially applied. We do not expect the adoption of the standard to have a material impact on our consolidated results of operations and financial condition.
In December 2010, FASB issued ASU 2010-28 “Intangibles-Goodwill and Other (Topic 350)” (ASU 2010-28). Topic 350 is amended to clarify the requirement to test for impairment of goodwill. Topic 350 has required that goodwill be tested for impairment if the carrying amount of a reporting unit exceeds its fair value. Under ASU 2010-28, when the carrying amount of a reporting unit is zero or negative an entity must assume that it is more likely than not that a goodwill impairment exists, perform an additional test to determine whether goodwill has been impaired and calculate the amount of that impairment. The modifications to ASC Topic 350 resulting from the issuance of ASU 2010-28 are effective for fiscal years beginning after December 15, 2010 and interim periods within those years. Early adoption is not permitted. We do not expect the adoption of the standard to have a material impact on our consolidated results of operations and financial condition.
In December 2010, the FASB issued ASU 2010-29 “Business Combinations (Topic 805) - Disclosure of Supplementary Pro Forma Information for Business Combinations” (ASU 2010-29). This standard update clarifies that, when presenting comparative financial statements, SEC registrants should disclose revenue and earnings of the combined entity as though the current period business combinations had occurred as of the beginning of the comparable prior annual reporting period only. The update also expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 is effective prospectively for material (either on an individual or aggregate basis) business combinations entered into in fiscal years beginning on or after December 15, 2010 with early adoption permitted. We do not expect the adoption of the standard to have a material impact on our consolidated results of operations and financial condition.
Note 2. ACQUISITIONS
Acquisitions in Fiscal 2010
In October, 2010 the Company entered into a Services and Purchase Agreement with Napar Contracting and Allied Services, Inc. (“Napar”) a Philippines based job contracting & outsourcing company with expertise in web development, software development, software quality assurance and such other similar services for $0.5 million. The transaction was paid in cash. Based on the terms of the transaction, 60% of the purchase price was due upon signing the agreement and the remaining 40% is due on January 1, 2011. The $0.2 million due on January 1, 2011 is included in other current liabilities in the accompanying Consolidated Balance Sheets.
At December 26, 2010, the financial statements reflect the final allocation of the Napar purchase price. This allocation resulted in acquired goodwill of $467 thousand, which is not tax deductible. Equipment included in this acquisition totaled $33 thousand, and is included in property, plant, & equipment, net in the accompanying Consolidated Balance Sheets. The results from the acquisition date through December 26, 2010 are included in the Apparel Labeling Solutions segment and were not material to the consolidated financial statements.
Pro forma results of operations have not been presented individually or in the aggregate for this acquisition because the effects of the acquisition were not material to our consolidated financial statements.
Acquisitions in Fiscal 2009
In July 2009, the Company entered into an agreement to purchase the business of Brilliant, a China-based manufacturer of woven and printed labels, and settled the acquisition on August 14, 2009 for approximately $38.3 million, including cash acquired of $0.6 million and the assumption of debt of $19.6 million. The transaction was paid in cash and the purchase price includes the acquisition of 100% of Brilliant’s voting equity interests. Acquisition costs incurred in connection with the transaction are recognized within selling, general and administrative expenses in the Consolidated Statement of Operations and approximate $0.3 million, $0.6 million, and $0.7 million for the years ended December 26, 2010, December 27, 2009, and December 28, 2008, respectively.
At December 27, 2009, the financial statements reflected the preliminary allocation of the Brilliant purchase price based on estimated fair values at the date of acquisition. The allocation of the purchase price remained open for certain information related to deferred income taxes. This allocation resulted in acquired goodwill of $4.3 million, which is not tax deductible. Intangible assets included in this acquisition were $1.4 million. The intangible assets were composed of a non-compete agreement ($0.9 million), customer lists ($0.4 million), and trade names ($0.1 million). The useful lives were 5 years for the non-compete agreement, 10 years for the customer lists, and 3 years for the trade names. The results from the acquisition date through December 27, 2009 are included in the Apparel Labeling Solutions segment and were not material to the consolidated financial statements.
During the second quarter of 2010 we finalized our purchase accounting related to income taxes for the Brilliant acquisition and as a result we recorded a decrease to goodwill of $1.1 million. As of the second quarter of 2010, the financial statements reflect the final allocations of the purchase price based on the estimated fair values at the date of acquisition.
Pro forma results of operations have not been presented individually or in the aggregate for this acquisition because the effects of the acquisition were not material to our Consolidated Financial Statements.
Acquisitions in Fiscal 2008
In June 2008, the Company purchased the business of OATSystems, Inc., a privately held company, for approximately $37.2 million, net of cash acquired of $0.9 million, and including the assumption of $3.2 million of OATSystems, Inc. debt. The transaction was paid in cash. Additionally, we acquired $1.3 million in liabilities.
The financial statements reflect the preliminary allocation of the OATSystems, Inc. purchase price based on estimated fair values at the date of acquisition. This allocation resulted in acquired goodwill of $22.8 million, which is not tax deductible. We also acquired intangibles of $6.1 million consisting of a trade name and proprietary technologies. The trade name is an indefinite-lived intangible asset while the proprietary technologies are finite-lived intangible assets that have a useful life of 4 years. The results from the acquisition date through December 28, 2008 are included in the Shrink Management Solutions segment and were not material to the consolidated financial statements.
During 2009, we recorded working capital adjustments for the OATSystems, Inc. acquisition which increased goodwill by $0.2 million. The working capital adjustments were related to income tax adjustments. As of December 27, 2009, the financial statements reflect the final allocations of the purchase price based on estimated fair values at the date of acquisition.
In January 2008, the Company purchased the business of Security Corporation, Inc., a privately held company, for $7.9 million plus $1.0 million of liabilities acquired. The transaction was paid in cash. The financial statements reflect the final allocation of the purchase price based on estimated fair values at the date of acquisition. This allocation has resulted in acquired goodwill of $1.3 million, which is deductible for tax purposes. We also acquired intangibles of $5.2 million related to customer relationships with a useful life of 10 years. The results from the acquisition date through December 28, 2008 are included in the Shrink Management Solutions segment and were not material to the consolidated financial statements.
Pro forma results of operations have not been presented individually or in the aggregate for these acquisitions, described in “Other Acquisitions in Fiscal 2008”, because the effects of these acquisitions were not material to our consolidated financial statements.
During the first quarter of 2009, a contingent payment of $6.8 million was made related to the Alpha acquisition since revenues for the S3 business exceeded the minimum contingency payment thresholds established in the Alpha asset purchase agreement, with a corresponding increase to goodwill recorded on the acquisition.
During 2009, we recorded working capital adjustments for the SIDEP acquisition which decreased goodwill by $0.1 million. As of December 27, 2009, the financial statements reflect the final allocations of the purchase price based on estimated fair values at the date of acquisition.
Note 3. INVENTORIES
Inventories consist of the following:
(amounts in thousands)
December 26,
December 27,
Raw materials
$ 21,976
$ 16,274
Work-in-process
5,416
5,721
Finished goods
79,582
67,252
Total
$ 106,974
$ 89,247
Note 4. REVENUE EQUIPMENT ON OPERATING LEASE AND PROPERTY, PLANT, AND EQUIPMENT
The major classes are:
(amounts in thousands)
December 26,
December 27,
Revenue equipment on operating lease
Equipment rented to customers
$ 7,389
$ 20,659
Accumulated depreciation
(5,049)
(18,643)
Total revenue equipment on operating lease
$ 2,340
$ 2,016
Property, plant, and equipment
Land
$ 10,416
$ 9,803
Buildings
69,145
67,642
Machinery and equipment
168,253
163,386
Leasehold improvements
17,754
16,170
Construction in progress
15,222
4,532
280,790
261,533
Accumulated depreciation
(159,532)
(143,935)
Total property, plant, and equipment
$ 121,258
$ 117,598
Property, plant, and equipment under capital lease had gross values of $2.1 million and $3.0 million and accumulated depreciation of $1.5 million and $1.0 million, as of December 26, 2010 and December 27, 2009, respectively.
Depreciation expense on our revenue equipment on operating lease and property, plant, and equipment was $21.2 million, $18.9 million, and $18.1 million, for 2010, 2009, and 2008, respectively.
During 2009, we announced that we were in the initial stages of implementing a company-wide ERP system to handle the business and finance processes within our operations and corporate functions. The total amount of internal-use software costs capitalized since the beginning of the ERP implementation as of December 26, 2010 and December 27, 2009 were $13.1 million and $2.8 million, respectively. As of December 26, 2010, $0.4 million was recorded in machinery and equipment related to supporting software packages that were placed in service. The remaining costs of $12.7 million and $2.8 million as of December 26, 2010 and December 27, 2009, respectively, are capitalized as construction-in-progress until such time as the ERP system has been placed in service.
In 2008, we recorded a $1.5 million fixed asset impairment. The charge consisted of $1.1 million related to the write down of a building in France and $0.4 million related to the write down of land and a building in Japan. These impairments were recorded in asset impairments on the consolidated statement of operations.
Note 5. GOODWILL AND OTHER INTANGIBLE ASSETS
We had intangible assets with a net book value of $90.8 million, and $104.7 million as of December 26, 2010 and December 27, 2009, respectively.
The following table reflects the components of intangible assets as of December 26, 2010 and December 27, 2009:
We recorded $12.0 million, $12.5 million, and $12.5 million of amortization expense for 2010, 2009, and 2008, respectively.
During our 2008 annual goodwill and indefinite-lived intangibles impairment test, we determined our indefinite-lived trade mark intangible in our Shrink Management Solutions segment was impaired. As a result we recorded an impairment charge of $0.4 million in the fourth quarter of 2008. This charge was recorded in asset impairments on the Consolidated Statement of Operations.
As a result of changes in business circumstances related to the customer list intangible asset recognized in connection with the SIDEP/Asialco acquisition, we recorded an impairment charge of $2.6 million in the fourth quarter ended December 28, 2008. The impairment charge was recorded in asset impairments in the Shrink Management Solutions segment on the Consolidated Statement of Operations.
Estimated amortization expense for each of the five succeeding years is anticipated to be:
(amounts in thousands)
$ 10,515
$ 9,725
$ 8,577
$ 8,101
$ 7,922
The changes in the carrying amount of goodwill are as follows:
(amounts in thousands)
Shrink
Management
Solutions
Apparel
Labeling
Solutions
Retail
Merchandising
Solutions
Total
Balance as of December 28, 2008
$ 169,493
$ -
$ 66,039
$ 235,532
Acquired during the year
-
4,278
-
4,278
Purchase accounting adjustment
-
-
Translation adjustments
2,102
1,845
3,969
Balance as of December 27, 2009
$ 171,878
$ 4,300
$ 67,884
$ 244,062
Acquired during the year
-
-
Purchase accounting adjustment
-
(1,077)
-
(1,077)
Translation adjustments
(6,554)
(5,798)
(12,127)
Balance as of December 26, 2010
$ 165,324
$ 3,915
$ 62,086
$ 231,325
The following table reflects the components of goodwill as of December 26, 2010 and December 27, 2009:
During fiscal 2010, 2009 and 2008 we made multiple acquisitions which impacted goodwill and intangible assets. Please refer to Note 2 of the Consolidated Financial Statements for more information on these acquisitions, including any impact of purchase accounting adjustments.
We perform an assessment of goodwill by comparing each individual reporting unit’s carrying amount of net assets, including goodwill, to their fair value at least annually during the fourth quarter of each fiscal year and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. In 2010 and 2009, annual assessments did not result in an impairment charge.
During the year ended December 28, 2008, the Company completed step one of its fiscal 2008 annual analysis and test for impairment of goodwill and it was determined that certain goodwill related to the Shrink Management Solutions, Apparel Labeling Solutions and Retail Merchandising Solutions segments were impaired. The second step of the goodwill impairment test was not completed prior to the issuance of the fiscal 2008 financial statements. Therefore, the Company recognized a charge of $59.6 million as a reasonable estimate of the impairment loss in its fiscal 2008 financial statements. The impairment charge was recorded in goodwill impairment on the consolidated statement of operations. The impairment charge was attributed to a combination of a decline in our market capitalization of the Company and a decline in the estimated forecasted discounted cash flows expected by the Company.
During the first quarter of fiscal 2009, the Company completed the second step of its fiscal 2008 annual analysis and test for impairment of goodwill and it was determined that no further adjustment to the estimated impairment recorded at December 28, 2008 was needed.
Determining the fair value of a reporting unit is a matter of judgment and often involves the use of significant estimates and assumptions. The use of different assumptions would increase or decrease estimated discounted future cash flows and could increase or decrease an impairment charge. If the use of these assets or the projections of future cash flows change in the future, we may be required to record additional impairment charges. An erosion of future business results in any of the business units could create impairment in goodwill or other long-lived assets and require a significant charge in future periods.
Note 6. SHORT-TERM BORROWINGS AND CURRENT PORTION OF LONG-TERM DEBT
Short-term borrowings and current portion of long-term debt at December 26, 2010 and at December 27, 2009 consisted of the following:
(amounts in thousands)
December 26,
December 27,
Line of credit (1)
$ 1,808
$ 6,578
Asialco loans
-
3,660
Full-recourse factoring liabilities
13,065
12,089
Term loans
4,950
1,060
Revolving loan facility
-
Current portion of long-term debt
2,016
2,385
Total short-term borrowings and current portion of long-term debt
$ 22,225
$ 25,772
(1)
The weighted average interest rates for 2010 and 2009 were 1.92% and 1.75%, respectively.
On December 30, 2009, we entered into a new Hong Kong banking facility. The banking facility includes a trade finance facility, a revolving loan facility, and a term loan. The maximum availability under the facility is $8.2 million (HKD 63.7 million). The banking facility is secured by all plant, machinery, fittings and equipment. The book value of the collateral as of December 26, 2010 is $11.6 million (HKD 90.0 million). The banking facility is subject to the bank’s right to call the liabilities at any time, and is therefore included in short-term borrowings in the accompanying Consolidated Balance Sheets.
Trade Finance Facility - The trade finance facility is a full-recourse factoring arrangement that has a maximum borrowing limit of $3.2 million (HKD 25.0 million) and totaled $2.6 million (HKD 20.0 million) as of December 26, 2010. The interest rate on this arrangement is HIBOR + 2.5%. The trade finance facility is secured by the related receivables.
Revolving Loan Facility - The revolving loan facility has a maximum borrowing limit of $0.4 million (HKD 3.0 million). The interest rate on this arrangement is Hong Kong Best Lending Rate + 1.0%. As of December 26, 2010, the revolving loan facility is $0.4 million (HKD 3.0 million) and is fully drawn.
Term Loan - On March 18, 2010, the Company borrowed $5.4 million (HKD 42.0 million). The interest rate on this arrangement is HIBOR + 2.5% and matures in March 2015. As of December 26, 2010, $4.6 million (HKD 35.7 million) was outstanding.
Included in Term loans is a $0.4 million (RMB 2.4 million) term loan maturing in May 2012. The term loan is subject to the bank’s right to call the liabilities at any time, and is therefore included in short-term borrowings in the accompanying Consolidated Balance Sheets.
During the first quarter of 2010, our outstanding Asialco loans of $3.7 million (RMB 25 million) were paid down.
In October 2009, the Company entered into a $12.0 million (€8.0 million) full-recourse factoring arrangement. The arrangement is secured by trade receivables. Borrowings bear interest at rates of EURIBOR plus a margin of 3.00%. As of December 26, 2010, the interest rate was 4.03%. As of December 26, 2010, our short-term full-recourse factoring arrangement equaled $10.5 million (€8.0 million) and is included in short-term borrowings in the accompanying Consolidated Balance Sheets. The full-recourse factoring arrangement was extended in December 2010 for a twelve month period.
In September 2010, $7.2 million (¥600 million) was paid in order to extinguish our existing Japanese local line of credit. The line of credit was included in short-term borrowings in the accompanying Consolidated Balance Sheets. In November 2010, we entered into a new Japanese local line of credit for $1.8 million (¥150 million). As of December 26, 2010, the Japanese local line of credit is $1.8 million (¥150 million) and is fully drawn. The line of credit matures in November 2011.
Note 7. LONG-TERM DEBT
Long-term debt at December 26, 2010 and December 27, 2009 consisted of the following:
(amounts in thousands)
December 26,
December 27,
Senior secured credit facility:
$125 million variable interest rate revolving credit facility maturing in 2014
$ 42,687
$ -
Secured credit facility:
$125 million variable interest rate revolving credit facility maturing in 2012
-
86,745
Senior Secured Notes:
$25 million 4.00% fixed interest rate Series A senior secured notes maturing in 2015
25,000
-
$25 million 4.38% fixed interest rate Series B senior secured notes maturing in 2016
25,000
-
$25 million 4.75% fixed interest rate Series C senior secured notes maturing in 2017
25,000
-
Full-recourse factoring liabilities
1,740
2,432
Other capital leases with maturities through 2015
2,313
4,308
Total (1)
121,740
93,485
Less current portion
2,016
2,385
Total long-term portion
$ 119,724
$ 91,100
(1)
The weighted average interest rates for 2010 and 2009 were 3.9% and 4.6 %, respectively.
Revolving Credit Facility
On July 22, 2010, we entered into an Amended and Restated Senior Secured Credit Facility (the “Senior Secured Credit Facility”) with a syndicate of lenders. The Senior Secured Credit Facility provides us with a $125.0 million four-year senior secured multi-currency revolving credit facility.
The Senior Secured Credit Facility amended and restated the terms of our existing $125.0 million senior secured multi-currency revolving credit agreement (“Secured Credit Facility”). The amendments primarily reflect an extension of the terms of the Secured Credit Facility, reductions in the interest rates charged on the outstanding balances, and favorable changes with regard to the collateral provided under the Senior Secured Credit Facility. Prior to entering into the Senior Secured Credit Facility, $102.2 million of the Secured Credit Facility was paid down during the third quarter of 2010.
The Senior Secured Credit Facility provides for a revolving commitment of up to $125.0 million with a term of four years from the effective date of July 22, 2010. We may borrow, prepay and re-borrow under the Senior Secured Credit Facility as long as the sum of the outstanding principal amounts is less than the aggregate facility availability. The Senior Secured Credit Facility also includes an expansion option that will allow us to request an increase in the Senior Secured Credit Facility of up to an aggregate of $50.0 million, for a potential total commitment of $175.0 million. As of December 26, 2010, we did not elect to request the $50.0 million expansion option.
The Senior Secured Credit Facility contains a $25.0 million sublimit for the issuance of letters of credit of which $1.4 million, issued under the Secured Credit Facility, are outstanding as of December 26, 2010. The Senior Secured Credit Facility also contains a $15.0 million sublimit for swingline loans.
Borrowings under the Senior Secured Credit Facility, other than swingline loans, bear interest at our option of either a spread ranging from 1.25% to 2.50% over the Base Rate (as described below), or a spread ranging from 2.25% to 3.50% over the LIBOR rate, and in each case fluctuating in accordance with changes in our leverage ratio, as defined in the Senior Secured Credit Facility. 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 1.0%. Swingline loans bear interest of (i) a spread ranging from 1.25% to 2.50% over the Base Rate with respect to swingline loans denominated in U.S. dollars, or (ii) a spread ranging from 2.25% to 3.50% over the LIBOR rate for one month U.S. dollar deposits, as of 11:00 a.m., London time. We pay an unused line fee ranging from 0.30% to 0.75% per annum based on the unused portion of the commitment under the Senior Secured Credit Facility.
All obligations of domestic borrowers under the Senior Secured Credit Facility are irrevocably and unconditionally guaranteed on a joint and several basis by our domestic subsidiaries. The obligations of foreign borrowers under the Senior Secured Credit Facility are irrevocably and unconditionally guaranteed on a joint and several basis by certain of our foreign subsidiaries as well as the domestic guarantors. Collateral under the Senior Secured Credit Facility includes a 100% stock pledge of domestic subsidiaries and a 65% stock pledge of all first-tier foreign subsidiaries, excluding our Japanese sales subsidiary.
Pursuant to the terms of the Senior Secured Credit Facility, we are subject to various requirements, including covenants requiring the maintenance of a maximum total leverage ratio of 2.75 and a minimum fixed charge coverage ratio of 1.25. The Senior Secured Credit Facility also contains customary representations and warranties, affirmative and negative covenants, notice provisions and events of default, including change of control, cross-defaults to other debt, and judgment defaults. Upon a default under the Senior Secured Credit Facility, including the non-payment of principal or interest, our obligations under the Senior Secured Credit Facility may be accelerated and the assets securing such obligations may be sold. Certain wholly-owned subsidiaries with respect to the Company are guarantors of our obligations under the Senior Secured Credit Facility. As of December 26, 2010, we were in compliance with all covenants.
As of December 26, 2010, the Company incurred $1.7 million in fees and expenses in connection with the Senior Secured Credit Facility, which are amortized over the term of the Senior Secured Credit Facility to interest expense on the Consolidated Statement of Operations. The remaining unamortized debt issuance costs recognized in connection with the Secured Credit Facility of $2.4 million are amortized over the term of the Senior Secured Credit Facility to interest expense on the Consolidated Statement of Operations.
Senior Secured Notes
Also on July 22, 2010, we entered into a Note Purchase and Private Shelf Agreement (the “Senior Secured Notes Agreement”) with a lender, and certain other purchasers party thereto (together with the lender, the “Purchasers”).
Under the Senior Secured Notes Agreement, we issued to the Purchasers its Series A Senior Secured Notes in an aggregate principal amount of $25.0 million (the “Series A Notes”), its Series B Senior Secured Notes in an aggregate principal amount of $25.0 million (the “Series B Notes”), and its Series C Senior Secured Notes in an aggregate principal amount of $25.0 million (the “Series C Notes”); together with the Series A Notes and the Series B Notes, (the “2010 Notes”). The Series A Notes bear interest at a rate of 4.00% per annum and mature on July 22, 2015. The Series B Notes bear interest at a rate of 4.38% per annum and mature on July 22, 2016. The Series C Notes bear interest at a rate of 4.75% per annum and mature on July 22, 2017. The 2010 Notes are not subject to any scheduled prepayments. The entire outstanding principal amount of each of the 2010 Notes shall become due on their respective maturity date.
The Senior Secured Notes Agreement also provides that for a three-year period ending on July 22, 2013, we may issue, and our lender may, in its sole discretion, purchase, additional fixed-rate senior secured notes (the “Shelf Notes”); together with the 2010 Notes, (the “Notes”), up to an aggregate amount of $50.0 million. The aggregate principal amount of the Shelf Notes issued at any time shall be no less than $5.0 million. The Shelf Notes will have a maturity date of no more than 10 years from the respective maturity date and an average life of no more than 7 years after the date of issue. The Shelf Notes will have such other terms, including principal amount, interest rate and repayment schedule, as agreed with our lender at the time of issuance. As of December 26, 2010, we did not issue additional fixed-rate senior secured notes.
We may prepay the Notes in a minimum principal amount of $1.0 million and in $0.1 million increments thereafter, at 100% of the principal amount so prepaid, plus an amount equal to the excess, if any, of the present value of the remaining scheduled payments of principal and interest on the amount repaid, over the principal amount repaid. Either we or our lender may terminate the private shelf facility with respect to undrawn amounts upon 30 days’ written notice, and our lender may terminate the private shelf facility with respect to undrawn amounts upon the occurrence and/or continuation of an event of default or acceleration of any Note.
All obligations under the Senior Secured Notes are irrevocably and unconditionally guaranteed on a joint and several basis by our domestic subsidiaries. Collateral under the Senior Secured Notes includes a 100% stock pledge of domestic subsidiaries and a 65% stock pledge of all first-tier foreign subsidiaries, excluding our Japanese sales subsidiary.
The Senior Secured Notes Agreement is subject to covenants that are substantially similar to the covenants in the Senior Secured Credit Facility Agreement, including covenants requiring the maintenance of a maximum total leverage ratio of 2.75 and a minimum fixed charge coverage ratio of 1.25. The Senior Secured Notes Agreement also contains representations and warranties, affirmative and negative covenants, notice provisions and events of default, including change of control, cross-defaults to other debt, and judgment defaults that are substantially similar to those contained in the Senior Secured Credit Facility, and those that are customary for similar private placement transactions. Upon a default under the Senior Secured Notes Agreement, including the non-payment of principal or interest, our obligations under the Senior Secured Notes Agreement may be accelerated and the assets securing such obligations may be sold. Certain of our wholly-owned subsidiaries are also guarantors of our obligations under the Notes. As of December 26, 2010, we were in compliance with all covenants.
As of December 26, 2010, the Company incurred $0.2 million in fees and expenses in connection with the Senior Secured Notes, which are amortized over the term of the Notes to interest expense on the consolidated statement of operations.
Full-recourse Factoring Arrangements
In December 2009, we entered into new full-recourse factoring arrangements. The arrangements are secured by trade receivables. The Company received a weighted average of 92.4% of the face amount of receivables that it desired to sell and the bank agreed, at its discretion, to buy. As of December 26, 2010 the factoring arrangements had a balance of $1.7 million (€1.3 million), of which $0.4 million (€0.3 million) was included in the current portion of long-term debt and $1.3 million (€1.0 million) was included in long-term borrowings in the accompanying Consolidated Balance Sheets since the receivables are collectable through 2016.
In connection with the acquisition of Brilliant in August 2009, the Company assumed $8.4 million (HKD 64.8 million) of capital leases. The capital leases mature at various dates through July 2014. As of December 26, 2010, the capital lease balance equals $0.4 million (HKD 2.8 million), of which $0.3 million (HKD 2.5 million) is included in current portion of long-term debt and $35 thousand (HKD 0.3 million) is included in long-term borrowings in the accompanying Consolidated Balance Sheets. As of December 26, 2010, the weighted average interest rate was 4.6%.
During the second quarter of 2009, we recorded a $2.6 million capital lease related to the purchase of software.
The aggregate maturities on all long-term debt (including current portion) are:
(amounts in thousands)
Debt
Capital
Leases
Total
Debt
$ 421
$ 1,595
$ 2,016
68,001
68,039
25,208
25,218
Thereafter
25,053
-
25,053
Total
$ 119,427
$ 2,313
$ 121,740
Note 8. STOCK-BASED COMPENSATION
At December 26, 2010, we had stock-based employee compensation plans as described below. For the years ended December 26, 2010, December 27, 2009, and December 28, 2008, the total compensation expense (included in selling, general, and administrative expense) related to these plans was $8.8 million, $7.1 million, and $7.1 million ($6.4 million, $5.0 million, and $4.9 million, net of tax), respectively.
Stock Plans
On April 29, 2004, the shareholders approved the Checkpoint Systems, Inc. 2004 Omnibus Incentive Compensation Plan (2004 Plan). The initial shares available under the 2004 Plan were approximately 3,500,000, which represent the shares that were available at that time under the 1992 Stock Option Plan (1992 Plan). All cancellations and forfeitures related to share units outstanding under the 1992 Plan will be added back to the shares available for grant under the 2004 Plan. No further awards will be issued under the 1992 Plan. The 2004 Plan is designed to provide incentives to employees, non-employee directors, and independent contractors through the award of stock options, stock appreciation rights, stock units, phantom shares, dividend equivalent rights and cash awards. The Compensation Committee (Committee) of our Board of Directors administers the 2004 Plan and determines the terms and conditions of each award. Stock options issued under the 2004 Plan primarily vest over a three-year period and expire not more than 10 years from date of grant. Restricted stock units vest over three to five year periods from date of grant. On June 3, 2009, at the 2009 Annual Meeting of Shareholders of Checkpoint Systems, Inc., the shareholders of the Company approved the Checkpoint Systems, Inc. Amended and Restated 2004 Omnibus Incentive Compensation Plan, Effective Date: February 17, 2009 (the “Omnibus Incentive Plan”), which was amended and restated to extend the term of the Omnibus Incentive Plan by an additional five years and to re-approve the performance goals set forth under the Omnibus Incentive Plan. The 2004 Plan was further amended on June 2, 2010, at the 2010 Annual Meeting of Shareholders of Checkpoint Systems, Inc., when our shareholders approved the Checkpoint Systems, Inc. Amended and Restated 2004 Omnibus Incentive Compensation Plan (the “Plan”), which was amended and restated to:
·
increase the number of shares of the Company’s common stock reserved for issuance under the Plan by 3,250,000 shares to an aggregate of 6,687,956 shares;
·
revise the “repricing” provision such that the new provision will provide that, except in respect of certain corporate transactions, the terms of outstanding awards may not be amended to (i) reduce the exercise price of outstanding stock options or stock appreciation rights (“SARs”), or (ii) cancel, exchange, substitute, buy out or surrender outstanding options or SARs in exchange for cash, other awards, stock options or SARs with an exercise price that is less than the exercise price of the original stock options or SARs (as applicable) without shareholder approval;
·
impose a limitation on certain shares of the Company’s common stock from again being made available for issuance under the Plan such that the following shares of the Company’s common stock may not again be made available for issuance: (i) shares of common stock not issued or delivered as a result of the net settlement of an outstanding SAR or stock option, (ii) shares of common stock used to pay the exercise price or withholding taxes related to an outstanding award, or (iii) shares of common stock repurchased on the open market with the proceeds of the stock option exercise price;
·
establish a minimum exercise price with respect to stock options or SARs to be granted under the Plan such that no stock option or SAR may be granted under the Plan with a per share exercise price that is less than 100% of the fair market value of one share of the Company’s common stock on the date of grant; and
·
establish a limitation against the payment of any cash dividend or dividend equivalent right (“DER”) with respect to awards that vest based upon the attainment of one or more performance measures such that no awards granted under the Plan based upon the attainment of one or more performance measures will be entitled to receive payment of any cash dividends or DERs with respect to such awards unless and until such awards vest.
As of December 26, 2010, there were 3,810,428 shares available for grant under the 2004 Plan.
Our 1992 Stock Option Plan (1992 Plan) allowed us to grant either Incentive Stock Options (ISOs) or Non-Incentive Stock Options (NSOs) to purchase up to 16,000,000 shares of common stock. Only employees were eligible to receive ISOs and both employees and non-employee directors of the Company were eligible to receive NSOs. On February 17, 2004, the Plan was amended to allow an independent consultant to receive NSOs. All ISOs under the 1992 Plan expire not more than ten years (plus six months in the case of NSOs) from the date of grant. Both ISOs and NSOs require a purchase price of not less than 100% of the fair market value of the stock at the date of grant. As of December 26, 2010, there were no shares available for grant under the 1992 Plan.
On December 27, 2007, we adopted a stand alone inducement stock option plan authorizing the issuance of options to purchase up to 270,000 shares of our common stock, which were granted to the newly elected President and CEO of the Company in connection with his hire. The non-qualified stock options provide for three vesting instances: 60% on December 31, 2010; 20% on December 31, 2011; and 20% on December 31, 2012. The options also have a market condition. The market condition specifies that any unvested tranche will vest immediately as soon as the Company’s stock price exceeds 200% of the December 27, 2007, strike price of $22.71. In addition, there were 230,000 shares issued out of our Omnibus Incentive Compensation Plan with similar vesting and market based criteria as described above.
To determine the fair value of stock options with market conditions we used the Monte Carlo simulation lattice model using the following assumptions: (i) expected volatility of 37.04%, (ii) risk-free rate of 4.1%, (iii) expected term of 10 years, and (iv) an expected dividend yield of zero. The weighted average fair value of the stock options with market conditions was $12.43 per share.
During fiscal 2005, we initiated a Long-Term Incentive Plan (LTIP). Under this plan, restricted stock units (RSUs) were awarded to eligible executives. During fiscal 2006, we expanded the scope of the LTIP. Under the expanded plan, RSUs were awarded to eligible key employees. The number of shares for these units varies based on the Company’s cash flow. These units cliff vest at the end of fiscal 2008. During fiscal 2007, 34,996 units vested at a grant price of $28.89 per share in accordance with the former CEO’s retirement plan. At December 28, 2008, the Company did not achieve the cash flow targets required by the plan and as a result no remaining RSUs were earned under this plan. During fiscal 2008, $2.0 million of previously recognized compensation cost was reversed related to the 2006 LTIP.
The LTIP plan was further expanded during fiscal 2007. Under the 2007 LTIP plan, RSUs were awarded to eligible key employees. The number of shares for these units varies based on the Company’s revenue and earnings per share. These units cliff vest at the end of fiscal 2009. As of December 30, 2007, 20,000 units vested at a grant price of $23.91 per share in accordance with the former CEO’s retirement plan. At December 28, 2008, we reversed $1.7 million of previously recognized compensation cost since it was determined that the Company would not achieve the revenue and earnings per share targets set for in the 2007 LTIP plan during fiscal 2009. At December 27, 2009, the Company did not achieve the targets required by the plan and as a result no remaining RSUs were earned under this plan.
On December 4, 2007, RSUs were awarded to certain key employees of the Company’s Alpha Security Products Division as part of the LTIP plan. The number of shares for these units varies based on the Company’s Alpha product revenues. These units had the potential to vest 33% per year, over a three-year period ending at the end of fiscal 2010. The weighted average price for these RSUs was $21.84 per share. At December 26, 2010, we reversed $0.6 million of previously recognized compensation cost since it was determined that the Company did not achieve the revenue targets set forth in the plan. Accordingly, no remaining RSUs were earned under this plan.
On February 17, 2009, RSUs were awarded to certain key employees of the Company as part of the LTIP 2009 plan. The number of shares for these units varies based on the Company achieving specific relative performance goals versus a pool of peer companies during the January 2009 to December 2011 performance period. The final value of these units will be determined by the number of shares earned. The value of these units is charged to compensation expense on a straight-line basis over the vesting period with periodic adjustments to account for changes in anticipated award amounts and estimated forfeitures rates. The weighted average price for these RSUs was $8.12 per share. For fiscal year 2010, $0.3 million was charged to compensation expense. As of December 26, 2010, total unamortized compensation expense for this grant was $0.3 million. As of December 26, 2010, the maximum achievable RSUs outstanding under this plan are 180,102 units. These RSUs reduce the shares available to grant under the 2004 Plan.
On February 12, 2010, RSUs were awarded to certain key employees of the Company as part of the LTIP 2010 plan. The number of shares for these units varies based on the Company achieving specific relative performance goals versus a pool of peer companies during the January 2010 to December 2012 performance period. The final value of these units will be determined by the number of shares earned. The value of these units is charged to compensation expense on a straight-line basis over the vesting period with periodic adjustments to account for changes in anticipated award amounts and estimated forfeitures rates. The weighted average price for these RSUs was $15.83 per share. Additional RSUs related to the LTIP 2010 plan were awarded on February 22, 2010, and March 11, 2010, with a weighted average price of $17.06 and $21.76 per share, respectively. For fiscal year 2010, $0.4 million was charged to compensation expense. As of December 26, 2010, total unamortized compensation expense for this grant was $1.1 million. As of December 26, 2010, the maximum achievable RSUs outstanding under this plan are 191,450 units. These RSUs reduce the shares available to grant under the 2004 Plan.
Stock Options
Option activity under the principal option plans as of December 26, 2010 and changes during the year then ended were as follows:
Number of
Shares
Weighted-
Average
Exercise
Price
Weighted-
Average
Remaining
Contractual
Term
(in years)
Aggregate
Intrinsic
Value
(in thousands)
Outstanding at December 27, 2009
3,047,897
$ 18.07
5.69
$ 4,420
Granted
188,375
17.32
Exercised
(447,717)
11.41
Forfeited or expired
(42,759)
17.92
Outstanding at December 26, 2010
2,745,796
$ 19.11
5.32
$ 8,731
Vested and expected to vest at December 26, 2010
2,692,210
$ 19.13
5.26
$ 8,532
Exercisable at December 26, 2010
1,815,148
$ 19.02
4.12
$ 6,092
The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between the Company’s closing stock price on the last trading day of fiscal 2010 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on December 26, 2010. This amount changes based on the fair market value of the Company’s stock. The total intrinsic value of options exercised for the years ended December 26, 2010, December 27, 2009, and December 28, 2008, was $4.3 million, $19 thousand, and $8.2 million, respectively.
As of December 26, 2010, $1.7 million of total unrecognized compensation cost related to stock options is expected to be recognized over a weighted-average period of 1.7 years.
Tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options are classified as financing cash flows. Cash received from option exercises and purchases under the ESPP for the year ended December 26 2010 was $6.0 million. The actual tax benefit realized for the tax deduction from option exercises of the share-based payment units totaled $1.3 million and $0.4 million for the fiscal years ended December 26, 2010 and December 27, 2009. We have applied the “Short-cut” method in calculating the historical windfall tax benefits. All tax short falls will be applied against this windfall before being charged to earnings.
Restricted Stock Units
We issue service-based restricted stock units with vesting periods of three to five years. These awards are valued using their intrinsic value on the date of grant. The compensation expense is recognized straight-line over the vesting term.
Nonvested service-based restricted stock units as of December 26, 2010 and changes during the year ended December 26, 2010 were as follows:
Number of
Shares
Weighted-
Average
Vest Date
(in years)
Weighted-
Average
Grant Date
Fair Value
Nonvested at December 27, 2009
613,964
1.07
$ 39.24
Granted
216,417
$ 17.61
Vested
(171,173)
$ 19.13
Forfeited
(28,964)
$ 17.27
Nonvested at December 26, 2010
630,244
0.81
$ 50.26
Vested and expected to vest at December 26, 2010
589,595
0.79
Vested at December 26, 2010
54,425
-
The total fair value of restricted stock awards vested during 2010 was $3.3 million as compared to $1.5 million during 2009. As of December 26, 2010, there was $2.7 million unrecognized stock-based compensation expense related to nonvested restricted stock units. That cost is expected to be recognized over a weighted-average period of 1.6 years.
Other Compensation Arrangements
During fiscal 2010, we initiated a plan in which time-vested cash unit awards were granted to eligible employees. The time-vested cash unit awards under this plan vest one-third each year over three years from the date of grant. As of December 26, 2010, the total value of the plans equal $0.7 million, of which $0.2 million was expensed in 2010. The associated liability is included in Accrued Compensation and Related Taxes in the accompanying Consolidated Balance Sheets.
Note 9. SUPPLEMENTAL CASH FLOW INFORMATION
Cash payments in 2010, 2009, and 2008, included payments for interest of $3.6 million, $6.3 million, and $5.2 million, and income taxes of $22.4 million, $8.7 million, and $17.0 million, respectively.
Non-cash investing and financing activities are excluded from the Consolidated Statement of Cash Flows. During the third quarter of 2009 we transferred $5.6 million (HKD 43.0 million) of acquired Brilliant properties and relieved the associated liability to the former Brilliant owner. This transaction was a non-cash transaction and is excluded from our Consolidated Statement of Cash Flows as of December 27, 2009.
Excluded from the Consolidated Statement of Cash Flows for the years ended December 26, 2010 and December 27, 2009 are $0.4 million and $2.8 million, respectively, of new capital lease obligations and related capitalized assets.
Business Acquisitions
(amounts in thousands)
December 26,
December 27,
December 28,
Fair value of tangible assets acquired, less cash acquired
$ 33
$ 52,275
$ 12,492
Goodwill and identified intangible assets
5,929
44,246
Liabilities assumed
-
(32,669)
(17,109)
Payment obligation
(200)
-
-
Cash paid for acquisitions
$ 300
$ 25,535
$ 39,629
Note 10. STOCKHOLDERS’ EQUITY
In October 2006, our Board of Directors approved a share repurchase program that allowed for the purchase of up to 2 million shares of the Company’s common stock. During the first six months of 2008, the Company repurchased 2 million shares of its common stock at an average cost of $25.42, spending a total of $50.9 million. This completed the repurchase of shares under the Company’s repurchase authorization that was put in place during the fourth quarter of 2006. Common stock obtained by the Company through the repurchase program has been added to our treasury stock holdings.
In March 1997, our Board of Directors adopted a new Shareholder’s Rights Plan (1997 Plan). The Rights under the 1997 Plan attached to the common shares of the Company as of March 24, 1997. The Rights are designed to ensure all Company shareholders fair and equal treatment in the event of a proposed takeover of the Company, and to guard against partial tender offers and other abusive tactics to gain control of the Company without paying all shareholders a fair price.
The Rights are exercisable only as a result of certain actions of an acquiring person. Initially, upon payment of the exercise price (currently $100.00), each Right will be exercisable for one share of common stock. Upon the occurrence of certain events each Right will entitle its holder (other than the acquiring person) to purchase a number of our or an acquiring person’s common shares having a market value of twice the Right’s exercise price. On December 22, 2009, the Company amended the 1997 Plan to accelerate the final expiration date of the outstanding Rights from March 10, 2017 to December 24, 2009.
The components of accumulated other comprehensive income at December 26, 2010 and at December 27, 2009 are as follows:
(amounts in thousands)
Actuarial losses on pension plans, net of tax
$ (4,146)
$ (844)
Derivative hedge contracts, net of tax
(302)
Foreign currency translation adjustment
14,491
29,749
Total
$ 10,722
$ 28,603
Note 11. EARNINGS PER SHARE
For fiscal years 2010, 2009, and 2008, basic earnings per share are based on net earnings divided by the weighted average number of shares outstanding during the period. The following data shows the amounts used in computing earnings per share and the effect on net earnings from continuing operations and the weighted average number of shares of dilutive potential common stock:
(amounts in thousands, except per share data)
December 26,
December 27,
December 28,
Basic earnings (loss) attributable to Checkpoint Systems, Inc. available to common stockholders
$ 27,371
$ 26,142
$ (29,805)
Diluted earnings (loss) attributable to Checkpoint Systems, Inc. available to common stockholders
$ 27,371
$ 26,142
$ (29,805)
Shares:
Weighted average number of common shares outstanding
39,483
38,909
39,071
Shares issuable under deferred compensation agreements
Basic weighted average number of common shares outstanding
39,935
39,305
39,408
Common shares assumed upon exercise of stock options and awards
-
Shares issuable under deferred compensation arrangements
-
Dilutive weighted average number of common shares outstanding
40,445
39,552
39,408
Basic earnings (loss) attributable to Checkpoint Systems, Inc. per share
$ .69
$ .67
$ (.76)
Diluted earnings (loss) attributable to Checkpoint Systems, Inc. per share
$ .68
$ .66
$ (.76)
Anti-dilutive potential common shares are not included in our earnings per share calculation. The Long-term Incentive Plan restricted stock units were excluded from our calculation due to the performance of vesting criteria not being met.
The number of anti-dilutive common share equivalents for the years ended December 26, 2010, December 27, 2009, and December 28, 2008 were as follows:
(amounts in thousands)
December 26,
December 27,
December 28,
Weighted average common share equivalents associated with anti-dilutive stock options and restricted stock units excluded from the computation of diluted EPS(1) :
1,516
2,507
2,151
(1)
Adjustments for stock options and awards of 518 shares and deferred compensation arrangements of 22 shares were anti-dilutive in fiscal 2008 and therefore excluded from the earnings per share calculation due to our net loss for the year.
Note 12. INCOME TAXES
The domestic and foreign components of earnings from continuing operations before income taxes and minority interest are:
(amounts in thousands)
Domestic
$ (22,184)
$ (20,473)
$ (16,448)
Foreign
59,207
56,458
(12,761)
Total
$ 37,023
$ 35,985
$ (29,209)
Provision for income taxes:
(amounts in thousands)
Currently payable
Federal
$ 234
$ (2,565)
$ 36
State
(41)
Puerto Rico
(3,950)
Foreign
15,891
20,555
11,826
Total currently payable
12,217
17,994
12,117
Deferred
Federal
(4,818)
(11,042)
(4,315)
State
4,320
Puerto Rico
(707)
Foreign
(1,245)
1,848
(8,053)
Total deferred
(2,450)
(7,704)
(11,398)
Total provision
$ 9,767
$ 10,290
$ 719
Adjustments to prior period amounts in the table above have been made to conform to current period presentation.
Deferred tax assets/liabilities at December 26, 2010 and December 27, 2009 consist of:
(amounts in thousands)
December 26,
December 27,
Inventory
$ 4,817
$ 4,613
Accounts receivable
1,296
2,449
Capitalized research and development costs
13,582
9,265
Net operating loss and foreign tax credit carryforwards
57,809
59,770
Restructuring
1,633
Deferred revenue
(105)
Pension
6,724
5,957
Warranty
1,469
1,381
Deferred compensation
2,306
3,483
Stock based compensation
6,740
5,064
Depreciation
2,501
Other
11,927
8,955
Valuation allowance
(37,808)
(32,739)
Deferred tax assets
72,891
70,425
Intangibles
10,447
10,978
Withholding tax liabilities
Deferred tax liabilities
11,392
11,923
Net deferred tax assets
$ 61,499
$ 58,502
Adjustments to prior period amounts in the table above have been made to conform to current period presentation.
At December 26, 2010, the Company had $34.4 million of net operating loss carryforwards (tax effected) in certain non-U.S. jurisdictions. Of these, $27.7 million have no expiration, and the remaining $6.7 million will expire in future years through 2017. In the U.S., there were approximately $7.5 million of federal and $6.8 million of state net operating loss carryforwards, which will expire in future years through 2030. Of the $7.5 million of federal net operating loss carryforward, $6.8 million is subject to IRC § 382 limitations. In addition, in the U.S., a $3.5 million (gross) windfall benefit on stock compensation occurred in 2010 that the Company has not recorded to APIC or increased its related net operating loss carryforward.
At December 26, 2010, the Company had U.S. foreign tax credit carryforwards of $8.4 million with expiration dates ranging from 2015 to 2020. Realization is dependent on generating sufficient taxable income prior to expiration of the foreign tax credit and loss carryforwards. Although realization is not assured, management believes it is more likely than not that the net deferred position will be realized.
In accordance with ASC 740, “Accounting for Income Taxes”, we evaluate our deferred income taxes quarterly to determine if valuation allowances are required or should be adjusted. ASC 740 requires that companies assess whether valuation allowances should be established against their deferred tax assets based on all available evidence, both positive and negative, using a “more likely than not” standard. In the assessment for a valuation allowance, appropriate consideration is given to all positive and negative evidence related to the realization of the deferred tax assets. This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the duration of statutory carryforward periods, the Company's experience with loss carryforwards not expiring and tax planning alternatives. The Company operates and derives income across multiple jurisdictions. As the geographic footprint of the business changes, we may encounter losses in jurisdictions that have been historically profitable, and as a result might require additional valuation allowances to be recorded against certain deferred tax asset balances. At December 26, 2010 and December 27, 2009, the Company had net deferred tax assets of $61.5 million and $58.5 million, respectively.
During 2010, negative evidence arose in the form of cumulative losses in two material jurisdictions with net deferred tax assets of $41.8 million and $9.3 million, respectively. The Company considered all available evidence and was able to conclude on a more likely than not basis that the effects of our commitment to specific tax planning actions provided a sufficient amount of positive evidence to support the continued benefit of the jurisdiction’s deferred tax assets. The Company is committed to implementing tax planning actions in jurisdictions that experience losses, when deemed appropriate, in order to realize deferred tax assets prior to their expiration. When tax planning actions are implemented, they often impact the Company’s effective tax rate. We will include the effect of tax planning actions on the effective tax rate in the quarter of implementation.
In June 2008, the Company purchased the stock of OATSystems, Inc. Upon finalizing purchase accounting in 2009, we established an opening net deferred tax asset of $8.2 million of which $7.7 million related to a federal net operating loss carryforward. The federal net operating loss carryforward is subject to IRC § 382 limitations, however we feel that it is more likely than not the loss will be utilized in the carryforward period. In addition, OATSystems had a deferred tax asset of $1.5 million related to state net operating loss carryforwards on which a full valuation allowance has been provided.
In July 2009, the Company purchased the stock of Brilliant Label Manufacturing Ltd., a China-based manufacturer of paper, fabric and woven tags and labels. As of December 27, 2009, we had established a preliminary opening net deferred tax liability of $3.7 million. In addition, we had established $2.6 million of income tax liabilities related to uncertain tax positions for Brilliant in pre-acquisition tax years. During the second quarter of 2010, we finalized our purchase accounting related to income taxes for the Brilliant acquisition, and as a result we recorded a decrease to our deferred tax liability and an increase to our accrual for uncertain tax positions (tax contingencies) of $1.3 million and $0.2 million, respectively. As of the second quarter of 2010, the financial statements reflected the final allocations of the purchase price based on the estimated fair values at the date of acquisition.
At December 26, 2010, unremitted earnings of subsidiaries outside the United States totaling $84.4 million were deemed to be permanently reinvested. No deferred tax liability has been recognized with regards to the remittance of such earnings. It is not practical to estimate the income tax liability that might be incurred if such earnings were remitted to the United States.
A reconciliation of the tax provision at the statutory U.S. Federal income tax rate with the tax provision at the effective income tax rate follows:
(amounts in thousands)
Tax provision at the statutory Federal income tax rate
$ 12,958
$ 12,595
$ (10,222)
Non-deductible goodwill
-
-
20,994
Non-deductible permanent items
1,533
1,302
1,258
State and local income taxes, net of Federal benefit
4,363
Foreign losses for which no tax benefit recognized
1,408
2,077
3,122
Foreign rate differentials
(7,233)
(9,305)
(13,356)
Tax settlements
(47)
(20)
Potential tax contingencies
(3,488)
(72)
1,214
Change in valuation allowance
-
3,515
(4,334)
Stock based compensation
Other
(168)
(1,060)
(22)
Tax provision at the effective tax rate
$ 9,767
$ 10,290
$ 719
Adjustments to prior period amounts in the table above have been made to conform to current period presentation.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
(amounts in thousands)
December 26,
December 27,
December 28,
Gross unrecognized tax benefits at beginning of year
$ 14,884
$ 12,520
$ 12,714
Increases in tax positions for prior years
1,161
2,502
-
Decreases in tax positions for prior years
-
(1,684)
(966)
Increases in tax positions for current year
1,229
1,442
1,843
Settlements
(928)
-
(965)
Acquisition reserves
2,631
-
Lapse in statute of limitations
(3,740)
(2,527)
(106)
Gross unrecognized tax benefits at end of year
$ 12,846
$ 14,884
$ 12,520
The total amount of gross unrecognized tax benefits that, if recognized, would affect the effective tax rate was $12.8 million and $14.9 million at December 26, 2010 and December 27, 2009, respectively. Penalties and tax-related interest expense are reported as a component of income tax expense. During fiscal years ending 2010, 2009 and 2008, we recognized interest and penalties of ($2.8) million, $0.4 million, and $0.8 million, respectively in the statement of operations. At December 26, 2010 and December 27, 2009, the Company has accrued interest and penalties related to unrecognized tax benefits of $3.6 million and $6.4 million, respectively.
We file income tax returns in the U.S. and in various states, local and foreign jurisdictions. We are routinely examined by tax authorities in these jurisdictions. It is possible that these examinations may be resolved within the next twelve months. Due to the potential for resolution of Federal, state and foreign examinations, and the expiration of various statutes of limitation, it is reasonably possible that the gross unrecognized tax benefits balance may change within the next twelve months by a range of $3.3 million to $5.2 million.
We are currently under audit in the following major jurisdictions: United States 2007 - 2008, Germany 2002 - 2005, Finland 2008 - 2009, Sweden 2007 - 2009, Poland 2008, and the United Kingdom 2007 - 2008.
Note 13. EMPLOYEE BENEFIT PLANS
Under our defined contribution savings plans, eligible employees may make basic (up to 6% of an employee’s earnings) and supplemental contributions. We match in cash 50% of the participant’s basic contributions. Company contributions vest to participants in increasing percentages over one to five years of service. Our contributions under the plans approximated $1.3 million, $1.1 million, and $1.2 million, in 2010, 2009, and 2008, respectively.
Generally, all employees in the U.S. may participate in our U.S. Savings Plan. All full-time employees of the Puerto Rico subsidiary who have completed three months of service may participate in our Puerto Rico Savings Plan.
During fiscal 2005, we initiated a 423(b) Employee Stock Purchase Plan (ESPP), which was adopted by the shareholders at the Annual Shareholder Meeting on April 29, 2004. This plan replaces the non-qualified Employee Stock Purchase Plan. Under the provisions of the 423(b) plan, eligible employees may contribute from 1% to 25% of their base compensation to purchase shares of our common stock at 85 percent of the fair market value on the offering date or the exercise date of the offering period, whichever is lower.
On June 3, 2009, at the 2009 Annual Meeting of Shareholders of Checkpoint, our shareholders amended the ESPP in order to increase the number of shares of the Company’s common stock reserved for issuance under the ESPP by 400,000 shares to an aggregate of 650,000 shares. Our expense for this plan in fiscal 2010, 2009 and 2008 was $0.6 million, $0.6 million, and $0.4 million, respectively. As of December 26, 2010, there were 240,482 shares authorized and available to be issued. During fiscal year 2010, 102,769 shares were issued under this plan as compared to 132,165 shares in 2009 and 51,315 shares in 2008.
We maintain deferred compensation plans for executives and non-employee directors. The executive deferred compensation plan allows certain executives to defer portions of their salary and bonus (up to 50% and 100%, respectively) into a deferred stock account. All deferrals in this plan are matched 25% by the Company. The match vests in thirds at each calendar year end for three years following the match. For executives over the age of 55 years old, the matching contribution vests immediately. The settlement of this deferred stock account is required by the plan to be made only in Company common stock. The deferral shares held in the deferred compensation plan are considered outstanding for purposes of calculating basic and diluted earnings per share. The unvested match is considered in the calculation of diluted earnings per share. Our match into the deferred stock account under the executive plan for fiscal years 2010, 2009, and 2008 were approximately $0.4 million, $0.3 million, and $0.3 million, respectively. The match will be expensed ratably over a three year vesting period for executives under 55 years old and immediate for those older than 55 years.
The director deferred compensation plan allows non-employee directors to defer their compensation into a deferred stock account. All deferrals in this plan are matched 25% by the Company. The match vests immediately. The settlement of this deferred stock account is required by the plan to be made only in Company common stock. The deferral shares held in the deferred compensation plan are considered outstanding for purposes of calculating basic and diluted earnings per share. Our match into the deferred stock account under the director’s plan approximated $46 thousand, $0.1 million, and $0.1 million for fiscal years 2010, 2009, and 2008, respectively.
Pension Plans
We maintain several defined benefit pension plans, principally in Europe. The plans covered approximately 6% of the total workforce at December 26, 2010. The benefits accrue according to the length of service, age, and remuneration of the employee. We recognize the funded status of our defined benefit postretirement plans in the Company’s statement of financial position.
The amounts recognized in accumulated other comprehensive income at December 26, 2010, and December 27, 2009, consist of:
(amounts in thousands)
December 26,
December 27,
Transition obligation
$ 198
$ 351
Prior service costs
Actuarial losses
7,358
2,806
Total
7,572
3,178
Deferred tax
(3,426)
(2,334)
Net
$ 4,146
$ 844
The amounts included in accumulated other comprehensive income at December 26, 2010 and expected to be recognized in net periodic pension cost during the year ended December 25, 2011 is as follows:
(amounts in thousands)
December 25,
Transition obligation
$ 122
Prior service costs
Actuarial loss
Total
$ 172
The Company expects to make contributions of $4.7 million during the year ended December 25, 2011.
The pension plans included the following net cost components:
(amounts in thousands)
Service cost
$ 855
$ 1,020
$ 1,088
Interest cost
4,331
4,643
4,623
Expected return on plan assets
(60)
(67)
(72)
Amortization of actuarial gain
(24)
(10)
(44)
Amortization of transition obligation
Amortization of prior service costs
Net periodic pension cost
5,228
5,719
5,734
Settlement gain
-
-
(37)
Total pension expense
$ 5,228
$ 5,719
$ 5,697
The table below sets forth the funded status of our plans and amounts recognized in the accompanying Consolidated Balance Sheets.
(amounts in thousands)
December 26,
December 27,
Change in benefit obligation
Net benefit obligation at beginning of year
$ 83,634
$ 83,478
Service cost
1,020
Interest cost
4,331
4,643
Actuarial loss (gain)
4,344
(3,147)
Gross benefits paid
(4,487)
(4,449)
Foreign currency exchange rate changes
(7,451)
2,089
Net benefit obligation at end of year
$ 81,226
$ 83,634
Change in plan assets
Fair value of plan assets at beginning of year
$ 1,400
$ 1,550
Actual return on assets
(432)
(383)
Employer contributions
5,117
4,648
Gross benefits paid
(4,487)
(4,449)
Foreign currency exchange rate changes
(126)
Fair value of plan assets at end of year
$ 1,472
$ 1,400
Reconciliation of funded status
Funded status at end of year
$ (79,754)
$ (82,234)
(amounts in thousands)
December 26,
December 27,
Amounts recognized in accrued benefit consist of:
Accrued pensions - current
$ 4,358
$ 4,613
Accrued pensions
75,396
77,621
Net amount recognized at end of year
$ 79,754
$ 82,234
Other comprehensive income attributable to change in additional minimum liability recognition
$ -
$ -
Accumulated benefit obligation at end of year
$ 77,361
$ 79,949
The following table sets forth additional fiscal year-ended information for pension plans for which the accumulated benefit is in excess of plan assets:
(amounts in thousands)
December 26,
December 27,
Projected benefit obligation
$ 81,226
$ 83,634
Accumulated benefit obligation
$ 77,361
$ 79,949
Fair value of plan assets
$ 1,472
$ 1,400
The weighted average rate assumptions used in determining pension costs and the projected benefit obligation are as follows:
December 26,
December 27,
Weighted average assumptions for year-end benefit obligations:
Discount rate (1)
5.27
%
5.77
%
Expected rate of increase in future compensation levels
2.52
%
2.52
%
Weighted average assumptions for net periodic benefit cost development:
Discount rate (1)
5.77
%
5.75
%
Expected rate of return on plan assets
4.00
%
3.75
%
Expected rate of increase in future compensation levels
2.52
%
2.77
%
Measurement Date:
December 31, 2010
December 31, 2009
(1)
Represents the weighted average rate for all pension plans.
In developing the discount rate assumption for each country, we use a yield curve approach. The yield curve is based on the AA rated bonds underlying the Barclays Capital corporate bond index. The weighted average discount rate was 5.27% in 2010 and 5.77% in 2009. We calculate the weighted average duration of the plans in each country, then select the discount rate from the appropriate yield curve which best corresponds to the plans' liability profile.
The majority of our pension plans are unfunded plans. The expected rate of the return was developed using the historical rate of returns of the foreign government bonds currently held. This resulted in the selection of the 4.00% long-term rate of return on asset assumption. For funded plans, all assets are held in foreign government bonds.
The benefits expected to be paid over the next five years and the five aggregated years after:
(amounts in thousands)
$ 4,359
$ 4,474
$ 4,602
$ 4,707
$ 4,886
2016 through 2020
$ 25,482
The following table provides a summary of the fair value of the Company’s pension plan assets at December 26, 2010 utilizing the fair value hierarchy discussed in Note 14:
(amounts in thousands)
Total Fair
Value
Measurement
December 26,
Quoted
Prices
In Active
Markets for
Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Global insurance assets
$ 1,472
$ -
$ -
$ 1,472
Total assets
$ 1,472
$ -
$ -
$ 1,472
All investments consist of fixed-income global insurance. The investment objective of fixed-income funds is to maximize investment return while preserving investment principal.
Additional information pertaining to the changes in the fair value of the pension plan assets classified as Level 3 for the year ended December 26, 2010 is presented below:
(amounts in thousands)
Balance as of
December 27,
Actual Return
on Plan Assets,
Relating to
Assets Still
Held at the
Reporting Date
Actual Return
on Plan Assets,
Relating to
Assets Sold
During the
Period
Purchases,
Sales and
Settlements
Transfer
into / (out of)
Level 3
Change due to
Exchange Rate
Changes
Balance as of
December 26,
Asset Category
Global insurance assets
$ 1,400
$ 228
$ (126)
$ 96
$ -
$ (126)
$ 1,472
Total Level 3 Assets
$ 1,400
$ 228
$ (126)
$ 96
$ -
$ (126)
$ 1,472
Note 14. FAIR VALUE MEASUREMENT, FINANCIAL INSTRUMENTS AND RISK MANAGEMENT
Fair Value Measurement
We utilize the market approach to measure fair value for our financial assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.
Our financial assets and liabilities are measured using a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on inputs to valuation techniques that are used to measure fair value that are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources while unobservable inputs reflect a reporting entity’s pricing based upon their own market assumptions. The fair value hierarchy consists of the following three levels:
Level 1
Inputs are quoted prices in active markets for identical assets or liabilities.
Level 2
Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market-corroborated inputs which are derived principally from or corroborated by observable market data.
Level 3
Inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable.
Because the Company’s derivatives are not listed on an exchange, the Company values these instruments using a valuation model with pricing inputs that are observable in the market or that can be derived principally from or corroborated by observable market data. The Company’s methodology also incorporates the impact of both the Company’s and the counterparty’s credit standing.
The following table represents our assets and liabilities measured at fair value on a recurring basis as of December 26, 2010 and December 27, 2009 and the basis for that measurement:
(amounts in thousands)
Total Fair
Value
Measurement
December 26,
Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Foreign currency forward exchange contracts
$ 27
$ -
$ 27
$ -
Foreign currency revenue forecast contracts
-
-
Total assets
$ 965
$ -
$ 965
$ -
Foreign currency forward exchange contracts
$ 20
$ -
$ 20
$ -
Foreign currency revenue forecast contracts
-
-
Interest rate swap
-
-
-
-
Total liabilities
$ 298
$ -
$ 298
$ -
(amounts in thousands)
Total Fair
Value
Measurement
December 27,
Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Foreign currency forward exchange contracts
$ 56
$ -
$ 56
$ -
Foreign currency revenue forecast contracts
-
-
Total assets
$ 359
$ -
$ 359
$ -
Foreign currency forward exchange contracts
$ 191
$ -
$ 191
$ -
Foreign currency revenue forecast contracts
-
-
Interest rate swap
-
-
Total liabilities
$ 494
$ -
$ 494
$ -
The following table provides a summary of the activity associated with all of our designated cash flow hedges (interest rate and foreign currency) reflected in accumulated other comprehensive income for the years ended December 26, 2010 and December 27, 2009:
(amounts in thousands)
December 26,
December 27,
Beginning balance, net of tax
$ (302)
$ 880
Changes in fair value gain, net of tax
1,841
Reclass to earnings, net of tax
(1,162)
(1,659)
Ending balance, net of tax
$ 377
$ (302)
We believe that the fair values of our current assets and current liabilities (cash, restricted cash, accounts receivable, accounts payable, and other current liabilities) approximate their reported carrying amounts. The carrying values and the estimated fair values of non-current financial assets and liabilities that qualify as financial instruments and are not measured at fair value on a recurring basis at December 26, 2010 and December 27, 2009 are summarized in the following table:
(1)
The carrying amounts are reported on the balance sheet under the indicated captions.
Long-term debt is carried at the original offering price, less any payments of principal. Rates currently available to us for long-term borrowings with similar terms and remaining maturities are used to estimate the fair value of existing borrowings as the present value of expected cash flows. The Senior Secured Credit Facility’s maturity date is in the year 2014 and the Senior Secured Notes mature in the years 2015 through 2017.
Financial Instruments and Risk Management
We manufacture products in the USA, the Caribbean, Europe, and the Asia Pacific region for both the local marketplace and for export to our foreign subsidiaries. The foreign 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 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.
Our major market risk exposures are movements in foreign currency and interest rates. We have historically not used financial instruments to minimize our exposure to currency fluctuations on our net investments in and cash flows derived from our foreign subsidiaries. We have used third-party borrowings in foreign currencies to hedge a portion of our net investments in and cash flows derived from our foreign subsidiaries. A reduction in our third party foreign currency borrowings will result in an increase of foreign currency fluctuations on our net investments in and cash flows derived from our foreign subsidiaries.
We enter into forward exchange contracts to reduce the risks of currency fluctuations on short-term inter-company receivables and payables. These contracts are entered into with major financial institutions, thereby minimizing the risk of credit loss. We will consider using interest rate derivatives to manage interest rate risks when there is a disproportionate ratio of floating and fixed-rate debt. We do not hold or issue derivative financial instruments for speculative or trading purposes. We are subject to other foreign exchange market risk exposure resulting from anticipated non-financial instrument foreign currency cash flows which are difficult to reasonably predict, and have therefore not been included in the table of fair values. All listed items described are non-trading.
The following table presents the fair values of derivative instruments included within the Consolidated Balance Sheets as of December 26, 2010 and December 27, 2009:
The following tables present the amounts affecting the Consolidated Statement of Operations for the years ended December 26, 2010, December 27, 2009, and December 28, 2008
We selectively purchase currency forward exchange contracts to reduce the risks of currency fluctuations on short-term inter-company receivables and payables. These contracts guarantee a predetermined exchange rate at the time the contract is purchased. This allows us to shift the effect of positive or negative currency fluctuations to a third party. Transaction gains or losses resulting from these contracts are recognized at the end of each reporting period. We use the fair value method of accounting, recording realized and unrealized gains and losses on these contracts. These gains and losses are included in other gain (loss), net on our Consolidated Statements of Operations. As of December 26, 2010, we had currency forward exchange contracts with notional amounts totaling approximately $11.7 million. The fair values of the forward exchange contracts were reflected as a $27 thousand asset and $20 thousand liability and are included in other current assets and other current liabilities in the accompanying balance sheets. The contracts are in the various local currencies covering primarily our operations in the USA, the Caribbean, and Western Europe. Historically, we have not purchased currency forward exchange contracts where it is not economically efficient, specifically for our operations in South America and Asia, with the exception of Japan.
Beginning in the second quarter of 2008, we entered into various foreign currency contracts to reduce our exposure to forecasted Euro-denominated inter-company revenues. These contracts were designated as cash flow hedges. The foreign currency contracts mature at various dates from January 2011 to December 2011. The purpose of these cash flow hedges is to eliminate the currency risk associated with Euro-denominated forecasted inter-company revenues due to changes in exchange rates. These cash flow hedging instruments are marked to market and the changes are recorded in other comprehensive income. Amounts recorded in other comprehensive income are recognized in cost of goods sold as the inventory is sold to external parties. Any hedge ineffectiveness is charged to other gain (loss), net on our Consolidated Statements of Operations. As of December 26, 2010, the fair value of these cash flow hedges were reflected as a $0.9 million asset and a $0.3 million liability and are included in other current assets and other current liabilities in the accompanying Consolidated Balance Sheets. The total notional amount of these hedges is $33.3 million (€24.8 million) and the unrealized gain recorded in other comprehensive income was $0.4 million (net of taxes of $0.2 million), of which the full amount is expected to be reclassified to earnings over the next twelve months. During the year ended December 26, 2010, a $1.2 million benefit related to these foreign currency hedges was recorded to cost of goods sold as the inventory was sold to external parties. The Company recognized a $9 thousand loss during the year ended December 26, 2010 for hedge ineffectiveness.
During the first quarter of 2008, we entered into an interest rate swap agreement with a notional amount of $40 million. The purpose of this interest rate swap agreement was to hedge potential changes to our cash flows due to the variable interest nature of our senior unsecured credit facility. The interest rate swap was designated as a cash flow hedge. This cash flow hedging instrument was marked to market and the changes are recorded in other comprehensive income. The interest rate swap matured on February 18, 2010.
Aggregate foreign currency transaction losses in 2010, 2009, and 2008, were $2.7 million, $0.4 million, and $9.2 million, respectively, and are included in other (loss) gain, net on the Consolidated Statements of Operations.
Additionally, there were no deferrals of gains or losses on currency forward exchange contracts at December 26, 2010.
Note 15. PROVISION FOR RESTRUCTURING
Restructuring expense for the periods ended December 26, 2010, December 27, 2009, and December 28, 2008 were as follows:
(amounts in thousands)
December 26,
December 27,
December 28,
SG&A Restructuring Plan
Severance and other employee-related charges
$ 6,993
$ 2,828
$ -
Manufacturing Restructuring Plan
Severance and other employee-related charges
1,481
Consulting fees
-
-
Other exit costs
-
-
2005 Restructuring Plan
Severance and other employee-related charges
-
1,149
4,563
Lease termination costs
-
(57)
-
Acquisition integration costs
-
-
2003 Restructuring Plan
Severance and other employee-related charges
-
-
(253)
Lease termination costs
-
-
Total
$ 8,211
$ 5,401
$ 6,442
Restructuring accrual activity for the periods ended December 26, 2010, and December 27, 2009, were as follows:
(amounts in thousands)
Fiscal 2010
Accrual at
Beginning of
Year
Charged to
Earnings
Charge
Reversed to
Earnings
Cash
Payments
Other
Exchange
Rate
Changes
Accrual at
12/26/2010
SG&A Restructuring Plan
Severance and other employee-related charges
$ 2,810
$ 7,732
$ (739)
$ (3,005)
$ -
$ (138)
$ 6,660
Manufacturing Restructuring Plan
Severance and other employee-related charges
1,481
1,203
(562)
(1,339)
-
(64)
Other exit costs(1)
-
-
(541)
-
Total
$ 4,291
$ 9,512
$ (1,301)
$ (4,885)
$ 107
$ (202)
$ 7,522
(1)
During 2010, lease termination and other exit costs of $0.6 million were recorded due to the closing of a manufacturing facility, which were partially offset by a deferred rent charge of $0.1 million previously incurred in prior periods for the manufacturing facility.
(amounts in thousands)
Fiscal 2009
Accrual at
Beginning of
Year
Charged to
Earnings
Charge
Reversed to
Earnings
Cash
Payments
Other
Exchange
Rate
Changes
Accrual at
12/27/2009
SG&A Restructuring Plan
Severance and other employee-related charges
$ -
$ 2,828
$ -
$ (103)
$ -
$ 85
$ 2,810
Manufacturing Restructuring Plan
Severance and other employee-related charges
1,614
(133)
(676)
-
1,481
Total
$ 652
$ 4,442
$ (133)
$ (779)
$ -
$ 109
$ 4,291
SG&A Restructuring Plan
During 2009, we initiated a 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 subsequent phases initiated during 2010. The remaining phases of the plan are expected to be substantially complete by the end of 2011.
As of December 26, 2010, the net charge to earnings of $7.0 million represents the current year activity related to the SG&A Restructuring Plan. The anticipated total costs related to the plan are expected to approximate $20 million to $25 million, of which $9.8 million have been incurred. The total number of employees currently affected by the SG&A Restructuring Plan were 198, of which 79 have been terminated. Termination benefits are planned to be paid one month to 24 months after termination.
Manufacturing Restructuring Plan
In August 2008, we announced a manufacturing and supply chain restructuring program designed to accelerate profitable growth in our Apparel Labeling Solutions (ALS) business, formerly Check-Net®, and to support incremental improvements in our EAS systems and labels businesses. For the year ended December 26, 2010, there was a net charge to earnings of $1.2 million recorded in connection with the Manufacturing Restructuring Plan. The charge was composed of severance accruals and other exit costs associated with the closing of manufacturing facilities.
The total number of employees currently affected by the Manufacturing Restructuring Plan were 418, of which 371 have been terminated. As of December 26, 2010 the implementation of the Manufacturing Restructuring Plan is substantially complete, with total costs incurred of $4.2 million. Termination benefits are planned to be paid one month to 24 months after termination.
2005 Restructuring Plan
During 2009, a net charge of $1.1 million was recorded in connection with the 2005 Restructuring Plan. The charge was composed of severance accruals and related costs, partially offset by the release of a lease termination liability.
2003 Restructuring Plan
During 2008, we reversed $0.3 million of previously accrued severance and incurred $0.1 million of lease termination costs related to the 2003 Restructuring Plan.
Note 16. COMMITMENTS AND CONTINGENCIES
We lease certain production facilities, offices, distribution centers, and equipment. Rental expense for all operating leases approximated $16.9 million, $18.4 million, and $15.1 million, in 2010, 2009, and 2008, respectively.
Future minimum payments for operating leases and capital leases having non-cancelable terms in excess of one year at December 26, 2010 are:
(amounts in thousands)
Capital
Leases
Operating
Leases
Total
$ 1,671
$ 15,379
$ 17,050
10,328
10,816
6,119
6,328
3,329
3,369
Thereafter
-
Total minimum lease payments
2,418
$ 35,978
$ 38,396
Less: amounts representing interest
Present value of minimum lease payments
$ 2,313
Contingencies
We are involved in certain legal and regulatory actions, all of which have arisen in the ordinary course of business. Management believes that the ultimate resolution of such matters is unlikely to have a material adverse effect on our consolidated results of operations and/or financial condition, except as described below.
Matter related to All-Tag Security S.A., et al
We originally filed suit on May 1, 2001, alleging that the disposable, deactivatable radio frequency security tag manufactured by All-Tag Security S.A. and All-Tag Security Americas, Inc.’s (jointly “All-Tag”) and sold by Sensormatic Electronics Corporation (Sensormatic) infringed on a U.S. Patent No. 4,876,555 (Patent) owned by us. On April 22, 2004, the United States District Court for the Eastern District of Pennsylvania granted summary judgment to defendants All-Tag and Sensormatic on the ground that our Patent was invalid for incorrect inventorship. We appealed this decision. On June 20, 2005, we won an appeal when the Federal Circuit reversed the grant of summary judgment and remanded the case to the District Court for further proceedings. On January 29, 2007 the case went to trial, and on February 13, 2007, a jury found in favor of the defendants on infringement, the validity of the Patent and the enforceability of the Patent. On June 20, 2008, the Court entered judgment in favor of defendants based on the jury’s infringement and enforceability findings. On February 10, 2009, the Court granted defendants’ motions for attorneys’ fees designating the case as an exceptional case and awarding an unspecified portion of defendants’ attorneys’ fees under 35 U.S.C. § 285. Defendants are seeking approximately $5.7 million plus interest. We recognized this amount during the fourth fiscal quarter ended December 28, 2008 in litigation settlements on the consolidated statement of operations. On March 6, 2009, we filed objections to the defendants’ bill of attorneys’ fees. Those objections are still pending before the Court. We intend to appeal any specified award of legal fees.
Other Settlements
During 2009, we recorded $1.3 million of litigation expense related to the settlement of a dispute with a consultant for $0.9 million and the acquisition of a patent related to our Alpha business for $0.4 million. We purchased the patent for $1.7 million related to our Alpha business. A portion of this purchase price was attributable to use prior to the date of acquisition and as a result we recorded $0.4 million in litigation expense and $1.3 million in intangibles.
Note 17. CONCENTRATION OF CREDIT RISK
Our foreign subsidiaries, along with many foreign distributors, provide diversified international sales thus minimizing credit risk to one or a few distributors. Our sales are well diversified among numerous retailers in the apparel, drug, home entertainment, mass merchandise, music, shoe, supermarket, and video markets. We perform ongoing credit evaluations of our customers’ financial condition and generally require no collateral from our customers.
Note 18. BUSINESS SEGMENTS AND GEOGRAPHIC INFORMATION
Historically, we have reported our results of operations into three segments: Shrink Management Solutions, Intelligent Labels, and Retail Merchandising. During the first quarter of 2009, resulting from a change in our management structure, we began reporting our segments into three new segments: Shrink Management Solutions, Apparel Labeling Solutions, and Retail Merchandising Solutions. Fiscal year 2008 has been conformed to reflect the segment change. Shrink Management Solutions now includes results of our EAS labels and library business. Apparel Labeling Solutions, formerly referred to as Check-Net®, includes tag and label solutions sold to apparel manufacturers and retailers, which leverage our graphic and design expertise, strategically located service bureaus, and our Check-Net® e-commerce capabilities. Our apparel labeling services coupled with our EAS and RFID capabilities provide a combination of apparel branding and identification with loss prevention and supply chain visibility. There were no changes to the Retail Merchandising Segment.
Historically, we have reported RF and EM Hard Tags as part of the SMS EAS Systems product line. During the first quarter of 2010, we began reporting our RF and EM Hard Tags as part of the Alpha product line. This change results in all hard tags for in-store application being recorded in the same product line as the Alpha hard tags. Because both product lines are reported within the Shrink Management Solutions segment, the change in classification does not impact segment reporting. The years ended 2009 and 2008 have been conformed to reflect the product line change within the SMS segment.
Our reportable business segments are strategic business units that offer distinctive products and services that are marketed through different channels. We have three reportable business segments:
i.
Shrink Management Solutions - includes electronic article surveillance (EAS) systems, EAS consumables, Alpha, CheckView®, and radio frequency identification (RFID) tags and labels.
ii.
Apparel Labeling Solutions - includes our web-enabled apparel labeling solutions platform 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, and apparel branding tags.
iii.
Retail Merchandising Solutions - includes hand-held labeling systems (HLS) and retail display systems (RDS).
The accounting policies of the segments are the same as those described in the summary of significant accounting policies.
The business segment information set forth below is that viewed by the chief operating decision maker:
(A)
Business Segments
(amounts in thousands)
Business segment net revenue:
Shrink Management Solutions
$ 589,569
$ 553,700
$ 687,352
Apparel Labeling Solutions
172,937
141,910
135,350
Retail Merchandising Solutions
71,992
77,108
94,380
Total
$ 834,498
$ 772,718
$ 917,082
Business segment gross profit:
Shrink Management Solutions
$ 249,914
$ 242,096
$ 284,428
Apparel Labeling Solutions
61,805
52,543
47,008
Retail Merchandising Solutions
34,929
36,645
46,663
Total gross profit
346,648
331,284
378,099
Operating expenses
304,000(1)
289,704(2)
395,276(3)
Interest (expense) income, net
(3,389)
(5,415)
(3,108)
Other gain (loss), net
(2,237)
(180)
(8,924)
Earnings (loss) from continuing operations before income taxes
$ 37,022
$ 35,985
$ (29,209)
Business segment total assets:
Shrink Management Solutions
$ 707,663
$ 730,969
Apparel Labeling Solutions
191,092
159,184
Retail Merchandising Solutions
136,518
134,080
Total
$ 1,035,273
$ 1,024,233
(1)
Includes a $8.2 million restructuring charge and a $0.8 million selling, general and administrative charge related to an adjustment to an acquisition related liability pertaining to the period prior to the acquisition date.
(2)
Includes a $5.4 million restructuring charge and a $1.3 million litigation settlement charge.
(3)
Includes a $59.6 million goodwill impairment charge, $6.4 million restructuring charge, a $6.2 million litigation settlement charge, a $3.0 million intangible asset impairment charge, a $1.5 million fixed asset impairment charge, and a $1.0 million gain from the sale of our Czech subsidiary.
Geographic Information
Operating results are prepared on a “country of domicile” basis, meaning that net revenues are included in the geographic area where the selling entity is located. Assets are included in the geographic area in which the producing entities are located. A direct sale from the U.S. to an unaffiliated customer in South America is reported as a sale in the U.S. Inter-area sales between our locations are made at transfer prices that approximate market price and have been eliminated from consolidated net revenues. International Americas is defined as all countries in North and South America, excluding the United States Puerto Rico, and Dominican Republic.
The following table shows net revenues, and other financial information by geographic area for the years 2010, 2009, and 2008:
(amounts in thousands)
United States,
Puerto Rico, &
Dominican Republic
Europe
International
Americas
Asia
Pacific
Total
Net revenues from unaffiliated customers
$ 288,282
(1)
$ 352,347
$ 41,868
$ 152,001
$ 834,498
Long-lived assets
$ 41,274
(2)
$ 17,815
$ 2,280
$ 62,229
(3)
$ 123,598
Net revenues from unaffiliated customers
$ 264,773
(4)
$ 362,639
(5)
$ 30,289
$ 115,017
$ 772,718
Long-lived assets
$ 35,347
(6)
$ 19,432
$ 1,789
$ 63,046
(7)
$ 119,614
Net revenues from unaffiliated customers
$ 319,929
(8)
$ 438,011
(9)
$ 35,433
$ 123,709
$ 917,082
(1)
Includes net revenue from the United States of $288.3 million.
(2)
Includes long-lived assets from the United States and Puerto Rico of $23.7 million and $15.2 million, respectively.
(3)
Includes long-lived assets from China, Hong Kong, and Japan of $28.8 million, $15.9 million and $15.4 million, respectively.
(4)
Includes net revenue from the United States of $264.8 million.
(5)
Includes net revenue from Germany of $84.2 million.
(6)
Includes long-lived assets from the United States and Puerto Rico of $17.7 million and $16.5 million, respectively.
(7)
Includes long-lived assets from China, Hong Kong, and Japan of $30.9 million, $15.9 million and $13.7 million, respectively.
(8)
Includes net revenue from the United States of $319.6 million.
(9)
Includes net revenue from Germany of $96.3 million.
Note 19. QUARTERLY INFORMATION (UNAUDITED)
(1)
Includes a $0.5 million restructuring charge (net of tax).
(2)
Includes a $0.9 million restructuring charge (net of tax).
(3)
Includes a $0.6 million restructuring charge (net of tax) and a $4.3 million valuation allowance adjustment.
(4)
Includes a $4.2 million restructuring charge (net of tax). Also includes a $1.7 million tax charge and a $0.8 million selling, general and administrative charge (net of tax) related to adjustments to acquisition related liabilities pertaining to the period prior to the acquisition date.
(5)
Includes a $0.3 million restructuring charge (net of tax) and a $0.8 litigation settlement expense (net of tax).
(6)
Includes a $0.4 million restructuring charge (net of tax).
(7)
Includes a $0.2 million restructuring charge (net of tax) and a $3.6 million valuation allowance adjustment.
(8)
Includes a $3.1 million restructuring charge (net of tax) and a $1.7 million valuation allowance adjustment. Included in fourth quarter 2009 income tax expense is a benefit of $1.3 million related to the settlement of a tax matter in an overseas jurisdiction for which the assessment was received in the third quarter of 2009.
Note 20. SUBSEQUENT EVENTS
On January 28, 2011, the Company entered into a Master Purchase Agreement (“Master Purchase Agreement”) by and among the Company and Shore to Shore, Inc. (“STS”), Shanghai WH Printing Co. Ltd., Wing Hung (Dongguan) Printing Co., Ltd., Wing Hung Printing Co., Ltd., Adapt Identification (China) Garment Accessories Trading Co., Ltd., Lau Shun Keung aka John Lau, Yeung Mei Kuen, Lau Shun Man, Lau Shun Wah, Howard J. Kurdin and Lau Wing Ting aka Shirley Lau (collectively, the “Owners”).
The Master Purchase Agreement outlines the general terms and conditions pursuant to which the Company agreed to acquire from the Owners, through the acquisition of equity and/or assets by the Company and/or certain of its subsidiaries (collectively, “Purchasers”), a retail apparel and footwear product identification business which designs, manufactures and sells tags and labels, hang tags, price tickets, printed paper tags, pressure sensitive products, woven labels, leather and leather-like labels, heat transfer labels and brand protection and EAS solutions/labels which may or may not contain RFID tags, chips or inlays (the “Global Business”).
Pursuant to the Master Purchase Agreement, the Owners and the applicable Purchaser will complete the steps necessary for Purchasers collectively to acquire the assets or stock of various U.S. and foreign entities that constitute the Global Business, excluding specified assets. With respect to an acquisition of assets, the applicable Purchaser will also assume specified liabilities. The Master Purchase Agreement sets forth customary indemnification obligations of the parties that will apply to each of these transactions that are contemplated by the Master Purchase Agreement, which will occur simultaneously unless otherwise agreed by the parties.
The aggregate initial purchase price to be paid by the Purchasers to the respective Owners for the Global Business is $67.95 million less any debt of the selling entity that the Purchasers are required to discharge at closing, subject to adjustment based upon the aggregate net working capital of the Global Business at closing. The purchase price is payable in cash in United States Dollars or an equivalent amount in Euros or Hong Kong Dollars, or a combination thereof at closing. A portion of the purchase price to be paid at closing will be deposited into escrow.
The purchase price is subject to increase, based upon the Global Business’s performance for the calendar year ended December 31, 2010, pursuant to which the Purchasers may pay an additional $6.25 million up to a maximum additional purchase price of $12.50 million. In addition, a $1.23 million payment will be made by the Purchasers for transitional consulting services. The purchase price will be further increased by an additional $6.25 million, contingent upon the successful migration of specified business accounts of the Global Business.
The closing of the transactions contemplated by the Master Purchase Agreement is conditioned upon: (i) the completion of each applicable Purchaser’s acquisition of selected assets from the Owners; (ii) the completion by the Company of its due diligence to its satisfaction; (iii) evidence that all consents necessary in connection with the transaction having been obtained; (iv) receipt of opinions of Owners’ counsel acceptable to Purchaser with respect to aspects of the transaction; (v) the execution and delivery of ancillary documentation relating to transition services and employment matters; and (vi) customary closing conditions.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There are no changes or disagreements to report under this item.
Item 9A.
Item 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a - 15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective as of December 26, 2010.
Management’s Annual Report On Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. With the participation of our Chief Executive Officer and Chief Financial Officer, management conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 26, 2010 based on the Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that our internal control over financial reporting was effective as of December 26, 2010.
Our independent registered public accounting firm, PricewaterhouseCoopers LLP, has issued an audit report on the effectiveness of our internal control over financial reporting, which appears in Item 8 of this report.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal controls over financial reporting that occurred during our fourth fiscal quarter of 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. OTHER INFORMATION
None.
PART III
Item 10.
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this Item (except for the information regarding executive officers called for by Item 401 of Regulation S-K, which is included in Part I hereof in accordance with General Instruction G (3)) is hereby incorporated by reference to the Registrant’s Definitive Proxy Statement for its Annual Meeting of Shareholders presently scheduled to be held on June 8, 2011, which management expects to file with the SEC within 120 days of the end of the Registrant’s fiscal year.
We have posted the Code of Ethics, the Governance Guidelines and each of the Committee Charters on our website at www.checkpointsystems.com, and will post on our website any amendments to, or waivers from, the Code of Ethics applicable to any of its directors or executive officers. The foregoing information will also be available in print upon request.
Item 11.
Item 11. EXECUTIVE COMPENSATION
The information required by this Item is hereby incorporated by reference to the Registrant’s Definitive Proxy Statement for its Annual Meeting of Shareholders presently scheduled to be held on June 8, 2011, which management expects to file with the SEC within 120 days of the end of the Registrant’s fiscal year.
Note that the section of our Definitive Proxy Statement entitled “Compensation Committee Report” pursuant to Regulation S-K Item 407 (e)(5) is not deemed “soliciting material” or “filed” as part of this report.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is hereby incorporated by reference to the Registrant’s Definitive Proxy Statement for its Annual Meeting of Shareholders presently scheduled to be held on June 8, 2011, which management expects to file with the SEC within 120 days of the end of the Registrant’s fiscal year.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is hereby incorporated by reference to the Registrant’s Definitive Proxy Statement for its Annual Meeting of Shareholders presently scheduled to be held on June 8, 2011, which management expects to file with the SEC within 120 days of the end of the Registrant’s fiscal year.
Item 14.
Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this Item is hereby incorporated by reference to the Registrant’s Definitive Proxy Statement for its Annual Meeting of Shareholders presently scheduled to be held on June 8, 2011, which management expects to file with the SEC within 120 days of the end of the Registrant’s fiscal year.
PART IV
Item 15.
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
All other schedules are omitted either because they are not applicable, not required, or because the required information is included in the financial statements or notes thereto:
1.
The following consolidated financial statements of Checkpoint Systems, Inc. were included in Item 8
Consolidated Balance Sheets as of December 26, 2010 and December 27, 2009
Consolidated Statements of Operations for each of the years in the three-year period ended December 26, 2010
Consolidated Statements of Equity for each of the years in the three-year period ended December 26, 2010
Consolidated Statements of Comprehensive Income (Loss) for each of the years in the three-year period ended December 26, 2010
Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 26, 2010
Notes to Consolidated Financial Statements
36-58
2.
The following consolidated financial statements schedules of Checkpoint Systems, Inc. are included
Financial Statement Schedule, Schedule II - Valuation and Qualifying Accounts
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized in Philadelphia, Pennsylvania, on February 22, 2011.
CHECKPOINT SYSTEMS, INC.
/s/ Robert P. van der Merwe
Chairman of the Board of Directors,
President and Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated.
SIGNATURE
TITLE
DATE
/s/ Robert P. van der Merwe
Chairman of the Board of Directors, President and
Chief Executive Officer
February 22, 2011
/s/ Raymond D. Andrews
Senior Vice President and Chief Financial Officer
February 22, 2011
/s/ William S. Antle, III
Director
February 22, 2011
/s/ George Babich, Jr.
Director
February 22, 2011
/s/ Harald Einsmann
Director
February 22, 2011
/s/ R. Keith Elliott
Director
February 22, 2011
/s/ Julie S. England
Director
February 22, 2011
/s/ Jack W. Partridge
Director
February 22, 2011
/s/ Sally Pearson
Director
February 22, 2011
/s/ Robert N. Wildrick
Director
February 22, 2011
3. Exhibits
Exhibit 3.1
Articles of Incorporation, as amended, are hereby incorporated by reference to Item 14(a), Exhibit 3(i) of the Registrant’s 1990 Form 10-K, filed with the SEC on March 14, 1991.
Exhibit 3.2
By-Laws, as Amended and Restated, are hereby incorporated by reference Item 5.03, Exhibit 3.2 of the Registrant’s Current Report on Form 8-K filed with the SEC on August 4, 2010.
Exhibit 3.3
Articles of Amendment to the Articles of Incorporation are hereby incorporated by reference to Item 5.03, Exhibit 3.1 of the Registrant’s Current Report on Form 8-K filed with the SEC on December 28, 2007.
Exhibit 4.1
Note Purchase and Private Shelf Agreement, dated as of July 22, 2010, between the Company and Prudential Investment Management, Inc., and Other Purchasers party thereto is hereby incorporated by reference to Item 1.01(b), Exhibit 4.1 of the Registrant’s Current Report on Form 8-K filed with the SEC on July 23, 2010.
Exhibit 10.1*
Amended and Restated Stock Option Plan (1992) is hereby incorporated by reference to Registrant’s Form 10-K for 1997 filed with the SEC on March 23, 1998.
Exhibit 10.2
Consulting and Deferred Compensation Agreement with Albert E. Wolf, are incorporated by reference to Item(a), Exhibit 10(c) of the Registrant’s 1994 Form 10-K.
Exhibit 10.3
Amended and Restated Credit Agreement, dated as of July 22, 2010, among the Company, Checkpoint Manufacturing Japan Co., Ltd., and CP International Systems C.V., as foreign borrowers, certain other domestic and foreign subsidiaries of the Company, as domestic guarantors and foreign guarantors, the various lenders party thereto from time to time, Wells Fargo Bank, National Association, as Administrative Agent, Citizens Bank of Pennsylvania as Syndication Agent, and Wells Fargo Securities, LLC and Citizens Bank of Pennsylvania, as Joint Lead Arrangers and Joint Bookrunners is hereby incorporated by reference to Item 1.01(a), Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed with the SEC on July 23, 2010.
Exhibit 10.4*
Employment Agreement with Per Harold Levin is incorporated by reference to Item 6(a), Exhibit 10.4 of the Registrant’s Form 10-Q filed on May 13, 2004.
Exhibit 10.5*
Amendment to Employment Agreement with Per Harold Levin is incorporated by reference to Item 6(a), Exhibit 10.5 of the Registrant’s Form 10-Q filed on May 13, 2004.
Exhibit 10.6*
Employment Agreement with John R. Van Zile is Incorporated by reference to Item 6(a), Exhibit 10.7 of the Registrant’s Form 10-Q filed on May 13, 2004.
Exhibit 10.7*
Employment Agreement by and between Robert P. van der Merwe and Checkpoint Systems, Inc. dated December 27, 2007 is incorporated by reference to Registrant’s Form 10-K for 2007 filed with the SEC on February 28, 2008.
Exhibit 10.8*
First Amendment to Employment Agreement by and between Robert P. van der Merwe and Checkpoint Systems, Inc. dated March 17, 2010 is incorporated by reference to Registrant’s Form 8-K, filed with the SEC on March 22, 2010.
Exhibit 10.9*
Employment Agreement by and between S. James Wrigley and Checkpoint Systems, Inc. dated March 11, 2011 is incorporated by reference to Registrant’s Form 10-Q, filed with the SEC on May 4, 2010.
Exhibit 10.10*
Amended and Restated Checkpoint Systems, Inc. 423 Employee Stock Purchase Plan, is hereby incorporated by reference from Appendix A to Checkpoint System, Inc.’s definitive proxy statement for the 2009 Annual Meeting of Shareholders filed with the Securities and Exchange Commission on April 27, 2009 and as Exhibit 10.1 to the Registrant’s Form 8-K, filed with the SEC on June 8, 2009.
Exhibit 10.11*
Checkpoint Systems, Inc. Amended and Restated 2004 Omnibus Incentive Compensation Plan is hereby incorporated by reference from Appendix A to Checkpoint Systems, Inc.’s definitive proxy statement for the 2010 Annual Meeting of Shareholders filed with the Securities and Exchange Commission on April 26, 2010 and as Exhibit 10.1 to the Registrant’s Form 8-K, filed with the SEC on June 8, 2010.
Exhibit 12
Ratio of Earnings to Fixed Charges.
Exhibit 21
Subsidiaries of Registrant.
Exhibit 23
Consent of Independent Registered Public Accounting Firm.
Exhibit 31.1
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act, as enacted by Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2
Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act, as enacted by Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32
Certification of the Chief Executive Officer and the Chief Financial Officer pursuant to 18 United States Code Section 1350, as enacted by Section 906 of the Sarbanes-Oxley Act of 2002.
* Management contract or compensatory plan or arrangement.
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
Allowance for Doubtful Accounts
(amounts in thousands)
Year
Balance at
Beginning
of Year
Additions
Through
Acquisition
Charged to
Costs and
Expenses
Deductions
(Write-Offs and
Recoveries, net)
Balance at
End of Year
$ 14,524
$ -
$ 123
$ (4,175)
$ 10,472
$ 18,414
$ 370
$ (545)
$ (3,715)
$ 14,524
$ 15,839
$ 27
$ 5,783
$ (3,235)
$ 18,414
Schedule II - Deferred Tax Valuation Allowance
(amounts in thousands)
Year
Balance at
Beginning
of Year
Additions
Through
Acquisition
Allowance
Recorded on
Current Year
Losses
Release of
Allowance on
Current Year
Utilization
Release of
Allowance on
Losses
Expired or
Revalued
Balance at
End of Year
$ 32,739
$ -
$ 5,315
$ -
$ (246)
$ 37,808
$ 22,717
$ -
$ 4,104
$ 3,514
$ 2,404
$ 32,739
$ 27,572
$ 1,449
$ 3,122
$ (697)
$ (8,729)
$ 22,717