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Checkpoint Systems, Inc. (NYSE:CKP)

Q4 2008 Earnings Call

February 26, 2009, 10:00 am ET

Executives

Robert M. Powers Vice President Investor

Robert van der Merwe – President, Chief Executive Officer

Ray Andrews – Senior Vice President, Chief Financial Officer

Analysts

Robert Labick – CJS Securities

Ajit Pai – Thomas Weisel Partners

Richard Waid – Robert W. Baird

Operator

Greeting and welcome to the Checkpoint Systems fourth quarter and year-end 2008 earnings conference call. At this time all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. (Operator Instructions). As a reminder this conference is being recorded.

It’s now my pleasure to introduce your host Bob Powers, Vice President, Investor Relations for Checkpoint Systems. Thank you Mr. Powers you may begin.

Robert Powers

Thank you, [Ryan]. Good morning and welcome to Checkpoint Systems’ fourth quarter and full year 2008 results conference call. On the call from the company are Rob van der Merwe, President, Chairman and Chief Executive Officer, and Ray Andrews, Senior Vice President and Chief Financial Officer.

If you’ve not yet received a copy of this morning’s fourth quarter and full year 2008 results it is available on the company’s website at www.checkpointsystems.com. Click on the Investors tab. Additionally an archived version of this conference call will be available on our website.

Before we begin I would like to remind you that statements made on this conference call reflecting our future plans and strategies are forward-looking statements that are based on current expectations and assumptions. These expectations and assumptions are subject to risks and uncertainties, which could affect our future plans. Checkpoint’s actual results and the timing and occurrence of expected events could differ materially from our plans and expectations due to a number of factors, such as changes in overall economic condition and changes in the legal environment as well as those factors discussed in the earnings release and in our filings with the Securities and Exchange Commission.

Also, please be aware that all information disclosed and discussed in this conference call is as of February 26, 2009. Checkpoint undertakes no duty to update any forward-looking statements to conform their statements to actual results or changes in the company’s expectations.

At this time I would like to turn the call over to Rob van der Merwe. Rob?

Robert van der Merwe

Thanks, Bob. Good morning, everyone. Thanks for joining us today. I will make some comments and then Ray will take you through the financial details before I summarize and we take your questions. It is quite clear now that the unprecedented global financial and the economic downturn hit us hard in the fourth quarter conditionally our strongest quarter were sales and earrings.

And as we reflect on this past quarter while sales result in October were mixed, November and December results notably deteriorated as most customers went into a belt and braces mode curtailing spending as they try to navigate through an exceptionally difficult environment. This resulted in lower sales generally across all our business lines and particularly in Europe.

I respond to these conditions we have taken strong and defective actions to cutback on all discretionary spending, non-customer focus travel and entertainment and we’ve quickly downsized direct labor at manufacturing facilities where volumes are soft. We have also taken action to extract prices decreases from our suppliers particularly for commodities such as aluminum, paper, resins and various chemicals.

Now overall the year ended on a very disappointing mode we were very pleased with the strives we made to better position the company competitively for the future. During 2008, we unveiled a comprehensive new strategy to meet the changing needs of retailers focusing on opportunities we see in the converging fields of shrink management, merchandise tracking and visibility kind of apparel labelling. Specifically, we said for two clear strategic objectives recognized global leader in shrink management and merchandize visibility solutions to the resale and apparel industry, and to be the recognized number two global provider of apparel labelling solutions.

And of course with this vision we also set forth our five-year growth program. During the year we continue to be acquisitive and using our strong balance sheet to acquire OATSystems bringing in-house the leader in the real time RFID Software. And throughout the year we refocused the organization to accelerate innovation. We significantly strengthen the management team and we started a process to clean up the back office to leverage future growth of a lower cost base.

Our focus on procurement and productivity improvement program saved the company over $10 million in 2008 and I expect at least this level of savings to be a realized again in 2009. And this will help any potential margin erosion in 2009. Finally, our focus on improving working capital in the second half of the year resulted in free cash flow levels that exceed the prior year. We expect to see continued improvement in this area in 2009.

Now I would like to leave you with four key messages today. One the extreme currency shift that occurred in the fourth quarter exposed some light weaknesses in our foreign exchange risk management and it corporate that mainly at the local country level. These weaknesses have and are quickly being rectified. I think this learning has made us stronger going forward.

Our strategy number 2 our strategy to build the core shrink management and merchandise visibility business is even more valid now as shrinkage increases. We are aggressively pursuing new meaningful innovation solution with selected top customers which we believe will position us as the innovation leader in our space going forward. And this is a very exciting dynamic.

Many retailers who are leader in innovation and who enjoy world-class level to shrink are continuing to investing in Checkpoint solutions notwithstanding the recession. We lead the field in providing shrink solutions to drug retailers here in the U.S and in hypermarkets and supermarkets in Europe. These are solid verticals that are exhibiting resilient despite the global downturn. These leaders are continuing to expand through acquisitions for example Longs Drug or geographic expansion into Eastern Europe and China regardless of the current economic situation as well.

So there are aspects of our R&D spending with where we are leading with innovation that we will continue to protect going forward. In the middle of this year at the latest I expect factual confirmation as the anecdotal evidence we see a rising shrink levels and this will surely attract the attention of retail decision makers resulting in more aggressive action being taken by some of our customer to bring shrink back under control.

This lag is similar to what as occurred in previous downturn at least in the U.S. from what we can determine. The priorities in our core security business include taking more market share, and protecting margin by reducing costs and improvement productivity. You recall that part of the restructuring program we announced in August 2008 with design to reduce EAS label production cost and this program is on track.

Three, our apparel labelling solution strategy is focused on reducing costs through the previously announced 2008 restructuring program, improving operational efficiency where outsourcing and capacity constraints has led to margin pressure and to build management capability which we are doing very aggressively. We’ve committed to this second leg of our strategy. We have post on progressing towards making meaningful acquisitions in this area in the first half of 2009, but plan to resume the strategy of acquisitions their offset assuming market dynamics to settle down.

Said another away, we remain committed to the two core strategies that we outlined late last year including the assignment of the 10% operating income return by 2011, and striving for 12% by 2013. Or we are driving hard to reduce inventories and better manage receivables. This more aggressive activity benefitted us over the last six months of 2008 and I fully expect this trend of improving working capital levels to continue throughout 2009.

Now it’s important to note that management objectives are also fully aligned and focused on protecting margins and boosting liquidity in 2009. Finally, going forward we will continue to provide you with annual guidance despite the volatility and the changing retail market conditions. We will continue to keep you fully informed of our progress and keep you updated as the conditions we face and what we are doing about it. We do plan to further reduce costs, details of these new programs will not be shared today, but I fully expect to be able to do so when we released first quarter results in a few months time.

I will comment on the first quarter 2009 results thus far after Ray provides his financial overview and before we open up the call for questions. I will now hand over the call to Ray he will take you through the fourth quarter and full year financial results and some more information regarding our outlook for 2009. Thank you Ray.

Ray Andrews

Thanks Rob. Revenue for the fourth quarter was $237.3 million compared to $262.7 million in the fourth quarter of last year, a 9.7% decline in year-over-year. The weaker than expected global economic and retail conditions that we experienced in the fourth quarter were the key factor in our top line results. Foreign exchange had a negative impact on revenue of approximately $11.2 million or 4.3% of the decline in the fourth quarter of 2008.

Revenue from acquired businesses provided approximately 11.8% of sales growth in the quarter including the Alpha, Sidep and Asialco businesses we acquired in November of 2007 and the OATSystems business we acquired in June 2008.

We saw a 17.2% organic decline versus the fourth quarter of last year primarily due to softness in EAS systems and labels in Europe and our CCTV store monitoring business in the U.S. which is now using the trade name CheckView.

Gross profit margins in the quarter were 40.5% compared to 40.8% in the fourth quarter of last year. Our fourth quarter 2008 gross margins were positively impacted by margin improvements in the EAS systems along with a positive impact from the Alpha acquisition.

However these improvements were more than offset by a decline in the quarter in EAS labels, Check-Net apparel labelling and library gross margins.

Now I will review the results for the segments and the geographies.

Our Shrink Management Solution segment generated revenue of $153 million in the fourth quarter of 2008 or 65% of total company revenue. Revenue in the fourth quarter of 2007 was $163.1 million. This represents a year-over-year decline of 3% on a constant dollar basis. The growth in this segment was lead by the Alpha acquisition, which on a constant dollar basis contributed $27.9 million in revenue in the fourth quarter 2008 compared to a $11.9 million that was generated in 2007 after acquisition of our business on November 1 of that year.

Alpha produced its typical fourth quarter although results were someone damping by the pullback and retails spending. The organic revenue decline in shrink management solution was primarily the result of global economic conditions with [premier] productions and retail capital spending and new store openings in the quarter.

This had a significant impact of global EAS system particularly in Europe as well as on our U.S. CheckView CCTV store monitoring business. The impact in EAS system once mitigated to some extent by efforts to sell new solutions through existing customers and increase market share by generating interest in our Evolve platform.

Gross profit margin for Shrink Management Solution segment was 41.2% compared to 39% in the same quarter in 2007. Increases in EAS systems and Alpha gross profit margins were key contributors. EAS systems gross margin improvement is primarily due to favorable product mix and sourcing.

Our intelligent label segment reported revenue of $62.2 million for the fourth quarter or 26% of total company revenue. Revenue in the fourth quarter of 2007 was $73 million. This represents a decrease in revenue of 10% on a constant dollar basis. Weak economic conditions throughout Europe were the key factors in the decline in EAS labels revenue.

Library revenues also declined due to the January 2008 transition to the 3M distributor agreement when compared to direct sales in 2007. This was partially offset by Check-Net apparel labelling revenue, which grew $1.1 million compared to the fourth quarter of 2007 with market share gains offsetting the impact of the weak apparel retail marketplace.

The gross profit margin and Intelligent Label segment was 36.1% compared to 41.8% in the comparable quarter over a year ago. EAS labels gross profit margins continue be impacted by manufacturing variances primarily attributable to reduced volumes that impacted capacity utilizations. Production issues in Puerto Rico continue to be factor although to a lesser extent in earlier in year.

We have intensified manufacturing management's focus on improving production performance in the yields. Check-Net apparels label and gross margins also decline primarily due to operational issues in our Hong Kong primarily due to operational issues in our Hong Kong and U.K. facilities will be an aggressively addressed on our new global and regional apparel labelling leadership.

Library gross profit margins also decline due to the shift in direct sale model to sale through 3M distribution agreement. Our retail merchandising segment reported revenue of $22.1 million for the quarter or 9% of total company revenue. Revenue in the fourth quarter of 2007 was $26.5 million. This represents a decrease in revenue of 7.4% from the prior year on a constant dollar basis.

Lot of the decrease comes from our hand-held labelling systems business with our retail display system business declining to its more expense. The gross profit margin in retail merchandising segment was 47.7% for the fourth quarter of 2008 comparing to 48.4% for the same quarter in 2007.

Moving on to the geographies, European operations reported revenue of $117.8 million for the fourth quarter or 50% of total company revenue. Revenue in the fourth quarter of 2007 it was $134.4 million.

Europe revenue declined 5.3% on a constant dollar basis over the prior year primarily attributable to impact the weak economic conditions in the region. U.S. operations reported revenue of $79.3 million or 33% of total company revenue. Revenue in the fourth quarter of 2007 was $83.7 million. This represents a 5.3% decline in revenue when compared to fourth quarter of 2007 with decline in CheckViews CCTVs store monitoring, library and the EAS systems revenue partially offset by year-over-year increases in Alpha and Check-Net apparel labelling results.

The Asia Pacific region reported revenue of $31 million or 13% of total Company revenue. Revenue in the fourth quarter 2007 was $32.4 million. This represents the 4.3% constant dollar revenue decline when compared to fourth quarter of 2007, which is primarily attributable to reduce EAS label revenue in the region.

International Americas region reported revenue of $9.2 million or 4% of total company revenue. Revenue in the fourth quarter of 2007 was $12 million. The region reported a 10.5% decline in revenue on a constant dollar basis, primarily due to reduce sales of EAS systems. During the fourth quarter we spent $6.3 million or 2.7% of revenue on research and development, up from the $5 million that we spent R&D in the fourth quarter of 2007.

The acquisitions of Alpha and OATSystems were the main contributors to the increased year-over-year R&D expense. Selling, general and administrative expenses for the fourth quarter were $73.2 million or 30.9% of revenue as compared to $79 million or 30.1% of revenue in the prior year. Foreign exchange decreased SG&A expense by approximately 3.9 million compared to the prior year.

On the constant dollar basis the remaining $1.9 million in SG&A expense primarily due to the results of efforts to control expense in addition to the reversal core foreign expense related to our management compensation plan. This will partially offset by approximately $4.5 million of SG&A expenses generated by the business as we acquired since November 1 of 2007.

We conducted our annual goodwill impairment test as of the fourth quarter, in performing this assessment we determined the goodwill associated with the intelligent label segment and the international Americas and Asia Pacific goodwill reporting units of the retail merchandising segment is impaired.

We’ve recorded an estimated goodwill impairment charge to the $59.6 million which includes all of the $51.8 million in goodwill attributable to the intelligent label segment. We will complete the impairment assessment in the first quarter of 2009. We believe that the bulk of the impairment expense has been recognized. The impairment is largely attributable to the weak economic conditions we are currently experiencing which are projected to impact our financial results and cash flows particularly in 2009.

Our projections incorporate actions being taken by Checkpoint in 2009 to improve future operating performance and working capital levels. The expectation to economic conditions were improve in 2010 and reflect our continued commitment to the strategy and resulting targeting for financial performance in 2011 and 13 that we communicated at the analyst day in November 2008.

We also reported litigation settlement expense of 5.7 million in the fourth quarter 2008 related to a patent infringement counter suit as a result of Checkpoint being liable to the legal fees of the other party. We’ve accrued amount of the judgment although we plan to appeal this ruling. In the fourth quarter of 2008, we’ve reported an asset impairment expense totaling $4.1 million this included an impairment charge of $2.6 million related to the customer relationship intangible assets recorded as a result of Asialco acquisition.

This drive is primarily the result of the decision by customer to Asialco who are regional competitors to Checkpoint to pursue alternative sources of our supply for RF labels after the acquisition of Asialco by Checkpoint. We also recorded a $1.1 million impairment charge attributable to the write-down of the building, the company - in France and a $400,000 impairment of indefinite trademarks associated with the goodwill impairment reported in our intelligent label segment.

In the fourth quarter of 2008 we’ve recorded restructuring expense of $2 million primarily resulting from the manufacturing of supply chain restructuring program to accelerate profitable growth in our Check-Net apparel labeling business an incremental on proving EAS systems and labelling business that was announced earlier this year. We’ve remain on track for annualized savings of approximately $6 million when the program is complete in 2010.

Interest expense of $1.8 million was partially offset by interest income of just under $700,000 for the quarter. In the fourth quarter of 2008 we’ve recorded a foreign exchange loss of $7 million in large part of exposure the currency payers that fall significant and unprecedented volatility during the quarter. In some cases exceeding 20%. Movement in the U.K. pound versus the euro was the main contributor to the loss.

Even issued to actions to expand our foreign currency risk management assessment and have already taken action to mitigate our exposure to volatility in the U.K. pound versus the euro. Our effective income tax rate for the year is 15.7% this excludes the impact of the write-off of goodwill and the impact of a net $2.8 million valuation allowance release.

Primary reason for the reduction in the effective tax rate is a greater than expect proportional income in lower tax jurisdictions. Our cash balance at the end of the year was $132.2 million and working capital was $282.8 million. Current and long-term debt totaled $145.3 million resulting in net debt of $13.1 million. During the fourth quarter we generated $50.2 million in cash flow from operations compared to $38.2 million in the fourth quarter of 2007.

Cash flow from operations for the full year was $77.2 million, the decline in revenue we experienced in the quarter couple were increased focused on management accounts receivable credit risk exposure with main contributor goes upon cash flow for the quarter. Our day sales outstanding were 75 days and day sales in inventory were 78 days at the end of the fourth quarter. Our capital expenditures were $2.9 million. We continue to be with join on maintaining liquidity during this challenging economic environment, we’ve been working to reduce liquidity risk by reducing cash expenditures in areas that will not adversely impact this strategy that we have outlined, and by focussing on improvements in working capital.

We have been working with our banking partners on renewal of our revolving credit facility and expect renewals will be completed in the first half of this year at market terms company with our solid balance sheet in our history or positive cash flow. The weighted average number of shares outstanding on a fully diluted basis was $30 million shares for the fourth quarter of 2008 or $39.4 million for the full year.

Now I will comment on our outlook for 2009. My outlook for this year is based on our evaluation of country and regional market condition and drive for forecast in supporting information that we gather from our operating units around the world. My outlook is based on the assumption of the current market condition will not change significantly for the reminder of the year and the current exchange rates will continue.

Over the past year economic condition our impact on a retail marketplace highly dynamic and subject to unpredictable changes. Events could occur in 2009 will create further unpredictable change and are not anticipated in my outlook. We are projecting annual revenues of current exchange rates on 780 to $820 million. This represents the organic decline in mid-single digit on constant currency.

Operating margin projections excluding restructuring expense are in the range of 5 to 6%. For the full year 2009 non-GAAP diluted net earnings per share from continuing operations are projected to be $0.55 to $0.85. Checkpoint has been subject to seasonality into results in the greater portion of the revenue in earnings second half of the year we expected the effects of the weaker economic and retail environment we experience at the end of 2008 will continue to 2009 and result and seasonal effects on revenue in earnings were even more weighted to the second half the year then we normally experience.

Our annualized tax rate is currently forecast to be 22%, nor free cash flow for the year is expected to be in the range of 40 to $50 million well projections include capital expenditures of $16 million and depreciation and amortization is expected to be approximately $29 million.

Now I will turn the call back over to Rob.

Robert van der Merwe

Thank you, Ray. In summary then we had a serious of one off-charges in the fourth quarter that we’ve believe will not reoccur in 2009, the benefits are better are focussed on best practice processes clarified accountability but the stronger management team that is aligned around the strategies will show up in our results.

Now strategy remains in tact there is no change to our long-term stated – and strategies including and operating income return of sales of at least 10% by 2011. The impairment primarily taken in the eye labels area is not a signal that you should interpret. We fully expect continue to see improvement in our cash flow our position this year and we will resume accretive strategic acquisitions want some semblance of normal sea returns to the marketplace hopefully by mid year.

Now with respect to the 2009 first quarter move visibility has obviously not yet returns to the market. The first quarter is normally are seasonally weaker quarter. We then build slow momentum from their sequentially each quarter and I expect this profile as you heart from Ray to repeat itself in 2009.

Can a page from which we have establish on 2009 forecast includes the fourth quarter experience and what we have seen that’s for in the first quarter of 2009. January was very weak. However February has improved versus January and is now tracking to our internal revenue forecast which is excellent news. It is not enough and not enough evidence at this stage it would make me comfortable. The March is normally the strongest month in the quarter and we will therefore been an important milestone in confirming our projection area where I except to see very early science of our recovery with our projects. Not only except a high value merchandise rising but this is we have pay backs of fast and we typically convert it’s a very high proportion of pilot tests. So far this year our pilot tests population is at high as it was at this time in 2008. Now for help January was very, very slow, at February to started to seen mixed results. What did you suggest therefore that as soon as executive management loosens up on spending. Last paper, fast payback projects, alpha we will gain funding which we will see we believe in the case of the Alpha. There was at Ray we will now in the call of that and take questions.

Question-and-Answer Session

Operator

(Operator Instruction) Our first question comes from the line of Reik Read with Robert W. Baird.

Reik Read – Robert W. Baird & Co.

Hi, good morning. Ray, you had touched on the R&D being up year-over-year but I noticed it was also almost 20% sequentially. Can you talk a little bit about why that boosted so much in the fourth quarter?

Ray Andrews

We’ve been focusing our R&D efforts on areas that we think have a key opportunity and that portfolio management and focus on those opportunities are what were driving increased spending.

Reik Read – Robert W. Baird & Co.

But there is no specific program that’s close to coming out that would have driven that at just a normal thing?

Ray Andrews

Okay, you think as a pretty large expense nothing like that with nature although Alpha in particular has a six-month cycle with their launches, so that maybe an factor here.

Reik Read – Robert W. Baird & Co.

Okay, and then could you guys provide maybe a little bit more detail on the retail weakness on - in terms of the type of retailer and Rob I think in your comments, you talked a little bit about the hypermarkets and the pharma markets but maybe if you could expand a little bit on that and then also could you talk about how much you think is coming from just simply reduced spending versus store closures at this point.

Robert van der Merwe

Hi Reik, we’re expose to very broad spectrum of retail from auto to music, power, food, hyper, drug, mass [merch] and in Europe. I would say that obviously apparel has taken a pretty hard knock probably more so than – then most others. We’ve seen mixed results in the other areas electronics and the like. Supermarkets are holding pretty well but here and in Europe hyper has held up well in Europe and leading players, companies, retails that are actually leading in their categories have continued with their expansion plans into Eastern Europe into China and places like that, so new store openings in drug here, new store openings in Eastern Europe and in China, so those players has continued unabated for the leaders. We just try and interpret your second question. We’re exposed very broadly to the downturn, I mean no matter of what business we’re in, I mean with the exception of contractual business or fixed dates for example, new store openings as I mentioned in the drug vertigo or in Europe where we’ve a very high visibility. Those programs are on track. We saw cancellation of CapEx right across the Board even for fast pay back propositions. I think retail has really frozen up somewhat in panic until later get visibility of holdings, the end of year turned out and the beginning of this year and we’re working our way through that. The recurring EAS label business that links to systems and where systems are churned easily is an automatically occurring business and we’ve seen that held up very well. European, and particularly in North America, in Europe the systems deals are typically more deal-by-deal bids. Some of our EAS label businesses is source tagging, which is done with companies like Procter and Gamble and others and there has been quite a bit of competition there. It is a deal-by-deal business as those manufacturers have looked to get their cost down. The fully integrated tag business, we talked about is an automatic recurring business and that’s held up pretty well. Service for us is relatively stable, particularly when linked to installations and there is a hike predictable, a peak predictably around that. I mentioned Alpha tests, we do convert a lot of tests with a very high level of confidence, but we’ve seen CapEx expenditure and all forms of expenditure, now being curtailed and effectively what happened is that even for $100 or $200 retail is a four step decision making process up one or two levels within their organization making that much more difficult for expenditure to occur. The OAT business is highly predictable, and within CCTV although we are somewhat dependent on new store openings, some aspect of the burglar and fire alarm business where we do 24-hour core service for them that’s a repeat contractual based business and that’s fairly stable.

Reik Read – Robert W. Baird & Co.

Thank you, for that detail real helpful. Just one follow-up. Given that you said that the months ending the year were quite weak in January started off quite weak and you’ve mentioned that some of your businesses has held up well and in fact some of that the retail customers that our leader are expanding. What’s kind of the major offset there? Is it just store consolidation within Western Europe? That’s the problem plus a whole reduction in CapEx.

Ray Andrews

I think the inventory coming out of the system I think the pace that the order cycles are getting shorter. I think there is actually rationalization going on. So there is an inventory aspect that will work its way through here and inventories are cleared. I think retail is going to be a little cautious going into the month ahead and the season and then their confidence will boost thereafter. It’s clearly retail space coming up and in our case I think there is somewhat of an offset there as you correctly point out.

Reik Read – Robert W. Baird & Co.

Okay.

Ray Andrews

Particularly here in North America.

Reik Read – Robert W. Baird & Co.

Great thank you guys.

Robert van der Merwe

All right.

Operator

Our next question comes from the line Bob Labick with CJS Securities.

Robert Labick – CJS Securities

Good morning.

Ray Andrews

Good morning, Bob.

Robert Labick – CJS Securities

Hi. A couple of questions. First I wanted to ask if you could expand a little bit on the outlook in ’09 as it relates to the organic pressure or maybe you talk about Q4 a little bit towards ’09 and how much of your organic pressure was volume related versus price and I know it is going to be different by segments but just broadly speak for those two points please?

Ray Andrews

Yeah I think we’ve looked several of our businesses and the conclusion we’ve come with is in general, the volume issues are – it’s more volume than price on the organic decline.

Robert Labick – CJS Securities

Okay, great. And then so how should we think about that as it relates to I guess gross profit or SG&A in ’09. Obviously with volumes down you’re going to have some pressure on the EBIT line. Is there room to that out more from SG&A organically or gross profit be hit more or less SG&A be fixed more to get to that EBIT?

Ray Andrews

We are looking on all fronts, so we have some opportunities in our cost of goods sold area that we are pursuing, one of the things that’s going to help us this year is the fact that some of the key commodity prices are down over some – these levels I saw last year. Aluminum, being an example and then and also on manufacturing efficiencies a thick focus as I mentioned. And then in the SG&A front, we are looking on all areas. Rob mentioned some of them as ways to constrain SG&A cost. Not only help our earning situation but also as the key driver in insuring that we where we to want to be in liquidity front as the way to conserve cash.

Robert Labick – CJS Securities

Okay. And then as it relates to just overall general inventory destocking, how is that impact to you? Is it mostly on the labeling side or where is the impact there and where do you feel that your customers are in that cycle?

Ray Andrews

Well I think apparel labelling is where we see it and we see the order cycles getting shorter and the volume - the actual order quantity is getting shorter - smaller but apparel is a sure significant hit I think certainly in the last six months

Robert van der Merwe

And if that both apparel labelling and we see a same second mark labels as well.

Ray Andrews

And RS labels.

Robert Labick – CJS Securities

Okay and then you haven’t talked Evolve too much obviously on the call. Could you just give us an update on the Evolve pilots that are out there, the sentiment and obviously given the economic environment, what’s happening there? Has anyone suggested getting out of pilot mode or you getting new pilots? Or what are your thoughts on Evolve for ’09?

Ray Andrews

Now in fact on the country we have more going in. We’ll let another 1000 stores just on one customer. We got an order from recently in 2009. It’s still a relatively small proportion of our total in-stores versus liberty but it’s an increasing proportion of our mix going forward. I don’t know that we’ve given those numbers now but we haven’t Bob right.

Robert van der Merwe

No.

Ray Andrews

When it becomes meaningful Bob will give you more details, but it is an increasing proportion of our mix, it’s a defensive and offensive move with certainly doing some very existing work with customers that are using the full potential events to gain more visibility as to what’s going on in shrink management, customer traffic patterns and stop loading to help them get their cost down and higher hit rates in the store. And that actually is very exciting . So, that’s on track we are putting more in, it’s expanding does see any slowdown in that phase.

Robert Labick – CJS Securities

Great thank you very much.

Ray Andrews

Thanks.

Operator

Our next question comes from the line of Ajit Pai with Thomas Weisel Partners.

Ajit Pai – Thomas Weisel Partners

Yeah, good morning. Couple of quick questions I think the first one I just looking at your gross margins. If you look at your 2008 gross margins it’s the lowest that you’ve had in decades right now I think pieced out decade. So, I think in the color that you’ve provided you said that lot of fee the impact of the top line especially in your guidance is moderated with volumes and pricing. So, could you give us some color is to why, how we should look at the gross margin going into ’09 and then beyond in 2010, and is there any reason why the gross margin declining trend shouldn’t stop at some point?

Ray Andrews

Couple of initiatives that we’re focused on, one particularly if I mention in apparel labelling solutions that scenario where our margins have been low or we certainly want to assume and so that’s a considerable area focused through the new management team with employees there. And then mix is been a factor I think in the decline we’ve seen here in 2008. So there is some exchanges that that will have an effect on margins. Couple of things that we saw in 2008 that will not be there in 2007, we had a royalty expense $3.7 million in 2008 that refer to cards on radio frequency, systems and label that have expired, the royalty agreement. So, that will help improve our cards this coming year. And also we’ve had some purchase accounting related charges for earlier in the year that also are not here in 2009 projection.

Ajit Pai – Thomas Weisel Partners

Right, but on the pricing perspective you’re not seeing, are you seeing any shifts? Are you seeing any improvement in pricing power or not really?

Ray Andrews

I wouldn’t say improvement, we’re not seeing the deterioration to date we have it in the reviews we done in for example of apparel labelling although more can be coming more competitive. I think the area where we have seen pricing pressures in the low-end of the RF label business.

Ajit Pai – Thomas Weisel Partners

Right, but for the guidance that you are giving for ’09 in terms of operating margins most of the given the fact that you expect revenues to be down so much. It’s fair to assume that most of the sort of relative margin improvement regarding for the drop in volume is going to be coming from cost cutting rather than any sort of improvement in pricing across the board. Is that fair?

Ray Andrews

Yes I think that’s fair.

Ajit Pai – Thomas Weisel Partners

Okay. And then looking at your balance sheet you’ve generated lot of cash especially in this particular quarter, and you’ve talk about sort of your credit facility sort of getting that renegotiated. Can you give us some color as to how you are thinking about that process, what kind of size that you’re looking out over their, and I don’t why trade does and issue fix debt rate right now.

Ray Andrews

I’m sorry I think it’s late further question.

Ajit Pai – Thomas Weisel Partners

Which is instead of credit facility have you consider some kind of fixed instrument?

Ray Andrews

We think to look at the pricing for fixed instruments for a company like us just prohibited right now. So, we’re looking at removing our revolver, we want to give us some extra room and in terms of, we’re looking at moment for year revolver and when we come out of this current economic situation we’re in today we want to be positioned to take advantage of acquisition act opportunities that kept with our strategy.

Ajit Pai – Thomas Weisel Partners

So how would you privatize uses of cash right now?

Ray Andrews

Right now uses of cash in privatized towards and we want to maintain cash and earn some cash. So, we’re focussed on the first half of the year, until we see the economic conditions changing. The other use of cash is to make sure, we continue to fund those activities that will help us grow once the economic conditions turned around.

Ajit Pai – Thomas Weisel Partners

Got it, thank you.

Ray Andrews

Thanks Andrews.

Operator

Our next question comes from the line of Rick Waid with our Robert W. Baird.

Ray Andrews

Hi Mike.

Richard Waid – Robert W. Baird

Hey I just want to followup on evolve for a second. Can you give us a sense for how many installations need to occur before it does become material?

Robert van der Merwe

Yeah. It is a good question. I’ll give to you in terms of timing as in our buying, when we launched the new range we said 18 months just start getting it and I’ve said by late this year those installation should be meaningful. The liberty-installed base is very, very, very significant across the world. So maybe later this year, I don’t want to give those numbers on that and I don’t want share that details with competitor.

Richard Waid – Robert W. Baird

Sure. Fair enough I understand. And then can you just give us a sense in understand that because this is a long cycle opportunity you’re really kind of in the midst of understanding what the customers want. Is this the situation where it is buy and larger replacing existing Checkpoint Systems or do you have a clear evidence that’s you’re displacing someone else?

Robert van der Merwe

We are picking up market share there is no question, when we plan to continue that, it's not a complete turn in other words because of the complexity required to plug-in to the IT systems and provide analytics within customer basis. This move typically will only be a proportion of the total for sometime and then we will start together this team. So in the near-term it's not a clean trend in other way.

Richard Waid – Robert W. Baird

Okay. And then just going back to the R&D side of things that you talked about just as normal course is where that the R&D checkout and there is nothing special in that. Does that mean if it probably adds this back down in the first quarter?

Robert van der Merwe

No actually if you look at our projections and we’re continually assessing this, we setup an innovation council looks that are up our R&D spend and constant with the business and make sure it's optimized. But we are projecting and R&D spent this coming year in the range of mid-20s it's actually the fourth quarter run rate.

Richard Waid – Robert W. Baird

Okay. And then just Ray on the cash I mean that the free cash flow was close to $50 million I think the cash goes is only up about $40 million. What's that and the debt was up so where did the rest of that go?

Ray Andrews

I think where the free cash flow was, it doesn’t working capital sale revenue was up over the previous quarter. So part of it's concern in that regard. I think that's probably the key factor, overall our free cash flow number is actually feasible where we thought it will be able to come and the revenue decline was the contributing factor.

Richard Waid – Robert W. Baird

Yeah okay, okay thank you.

Operator

(Operator Instructions) Seeing, as there are no further questions. I would like to turn the call back to management for any concluding remarks.

Robert van der Merwe

Thanks Ray, and thank you everybody. We will keep you inform, we’re excited about our prospects and not with standing the short-term situation we face here, we’ve got some exciting projects that are moving through the R&D area. And we’ll navigate this thing with confidence stick to the strategy and look forward to talking to you on the next call. Thank you very much.

Operator

Ladies and Gentlemen, this concludes today’s teleconference. Thank you for your participation.

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Source: Checkpoint Systems, Inc. Q4 2008 Earnings Call Transcript
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