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Checkpoint Systems (NYSE:CKP)

Q2 2013 Earnings Call

August 06, 2013 8:30 am ET

Executives

Annette Geraghty

George Babich - Chief Executive Officer, President and Director

Jeffrey O. Richard - Chief Financial Officer and Executive Vice President

Analysts

Christopher Kapsch - Topeka Capital Markets Inc., Research Division

Christopher McGinnis - Sidoti & Company, LLC

Jeffrey T. Kessler - Imperial Capital, LLC, Research Division

Operator

Greetings, and welcome to the Checkpoint Systems Second Quarter 2013 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Annette Geraghty, Investor Relations Specialist at Checkpoint Systems. Thank you. Ms. Geraghty, you may now begin.

Annette Geraghty

Thank you, Jesse. Good morning, and welcome to Checkpoint Systems Second Quarter 2013 Conference Call. With me today are George Babich, President and Chief Executive Officer; and Jeff Richard, Executive Vice President and Chief Financial Officer.

Please note that unless otherwise stated, today’s discussion will be on Checkpoint’s continuing operations. Additionally, non-GAAP measures discussed on this call are defined and reconciled with GAAP in statements attached to our earnings release. The release is available on the Investor Relations section of our website.

We remind you that during this call, we may make certain forward-looking statements. These are subject to the forward-looking statement included in today’s earnings release. A replay of this call and written transcript will be made available on our website following the call.

Now I will turn the call over to George Babich. George?

George Babich

Thank you, Annette, and good morning, everyone. Thank you for joining us today. We appreciate you being with us and trust that you've had an opportunity to read our second quarter earnings release issued at about 7:00 this morning.

Well, it's been just over a year since we provided the details of our turnaround plans for Checkpoint. Great deal has been accomplished since then. And today, I'd like to provide a recap during this call, but after we, first, review the second quarter results.

I'll begin the call with an overview of second quarter performance. Then Jeff Richard, our newly -- recently appointed Chief Financial Officer, will walk you through the numbers, provide details on our global restructuring and working capital initiatives. He'll also share with you further detail on our updated guidance for 2013. Following Jeff's presentation, I will provide the 1-year recap, and then, we'll open the call up to your questions.

So looking at the second quarter, we're pleased to report ongoing, steady progress on a number of fronts. Although revenues, as a whole, were down compared with 2012's second quarter, they were in line with our expectations. Demand for Checkpoint's core theft protection solutions remain strong, as consumable systems at Hard Tag @ Source all exceeded our expectations in prior year. Those increases were offset by lower-than-expected, second quarter Alpha revenue, as customers who pull forward, orders in the first quarter pulled back orders in the second. However, year-to-date, we remain ahead of our expectations and prior year with our Alpha business.

However, year-to-date, our ALS business, in addition, was well below last year, as we completed our manufacturing consolidation, customer rationalization, product line refinements and installed a new ERP system in South China during the quarter. Overall, we had expected first half revenue to be below an adjusted prior year. And we're pleased to report first half revenue, approximately 3.5% above an adjusted 2012.

Turning to profitability. Non-GAAP operating income increased by $5.1 million compared with the 2012 second quarter, driven by $6 million reduction in operating expenses, as well as gross profit margin expansions in both SMS and ALS businesses. Unfortunately, foreign currency exchange, transaction and revaluation losses were $1.6 million, worse than the last year's second quarter, and our expectations, due to currency volatility in many emerging markets in which we operate.

Adjusted non-GAAP earnings per diluted share of $0.11, including the $0.05 foreign exchange loss compared with a loss of 16% last year. Clearly, since our organizational realignment 1 year ago, we continue to improve our execution in the markets we serve, while realizing the benefits of continued cost reductions from our expanded global restructuring plan and rigorous cost reduction and expense control.

With respect to our full year guidance, we're pleased to increase our revenue range and to lower our operating expense range. Based upon second quarter results, we've now included the $2.6 million or $0.06 per share first half foreign exchange losses. However, despite absorbing the foreign exchange loss, we are pleased to reaffirm our EPS guidance of $0.65 to $0.75 per share.

Now I'd like to introduce Jeff, who joined Checkpoint on May 28. Jeff's assimilation to our business is going extremely well. He's met with senior finance and operational leaders throughout the company, toured stores and some of our biggest customers and met with some of our shareholders. In the past month, he's had the opportunity to prepare for our annual strategic plan conference, which took place with the Board of Directors last week. As with any new job, there's a great deal to learn, but I believe his induction this past 10 weeks has provided an excellent springboard for him to begin contributing to future growth plans.

With that, I'll turn the call over to Jeff.

Jeffrey O. Richard

Great. Thanks, George. Good morning, everyone. We expect to file our 10-Q later today, which provide additional details beyond my comments this morning. As a reminder, all my references will relate to the second quarter activity from continuing operations, unless I state otherwise. Continuing operations exclude the results of the U.S. and Canada-based CheckView business, which was sold on April 29 of this year.

Revenues from continuing operations decreased 3.1% year-over-year. On a constant-currency basis, revenues decreased 2.5%. Year-over-year differences in foreign currency exchange rates accounted for a 0.6% decrease in revenue. Gross profit margins in the quarter were 40.5% compared with 39.7% last year. I'll provide more detail as I review each segment's results here.

Turning to our first segment. Shrink Management Solutions revenues from continuing operation decreased 0.2% on a constant dollar basis. The decline largely resulted from lower demand for our Alpha solution. In addition, certain domestic customers curtailed ordering of Alpha products, a situation that we believe was temporary, and we expect to return to more normal levels, going forward.

Also contributing to the decrease was an expected decline in our nonstrategic library business, following the expiration of a license agreement in the U.S. and a decline in RFID revenues. Despite the second quarter decline in RFID revenues due primarily to the timing of a significant rollout, we expect revenues in this business to increase in the second half and continue on their forecasted path for strong growth in 2013, as certain current pilots convert to installation contracts, and certain installation contracts expand to additional stores.

These decreases were partially offset by increased EAS label revenues in the U.S., Europe and International Americas, as a result of new protection programs with new and existing customers as well as increased EAS systems revenues, primarily driven by growth in the U.S., Asia and International Americas, resulting in significant market share advances. Hard Tag @ Source revenues in the U.S. also increased, as a result of higher volumes from both new and existing customers.

Gross profit margins for the segment was 45% compared to 44.6% last year. The increase was principally due to manufacturing efficiences, notably in EAS consumables and Alpha business. EAS consumables margins increased due to favorable manufacturing variances in 2013, as well as an elimination of cost incurred in shutting down certain EAS label manufacturing operations in the second quarter 2012.

Alpha margins increased due to product mix, offset, in part, by increased inventory costs. Partially offsetting the overall segment improvement were lower margins in EAS systems due to increased field service cost in product mix, resulting from a significant systems rollout in Europe.

Now moving onto Apparel Labeling Solutions. The segment revenues decreased 7.4% on a constant dollar basis. Sales volumes declined in the U.S. and Europe, as well as International Americas, where we closed operations in 2012 and was largely due to streamlining of operations under Project LEAN. Gross profit margin for the segment was 30.1% compared to 28.8% last year. This 130-basis point uptick results from the actions under Project LEAN to restructure and rightsize our manufacturing footprint, most notably, from improved efficiencies and inventory management.

And onto our third segment, Retail Merchandising Solutions. Segment revenues declined 3.4% on a constant dollar basis. The decrease is primarily related to the movement of a portion of this business to a distributor model and continued decline in the use of handheld labeling solutions for our retail price marking. Gross profit margin for the segment was 40.3% for the quarter compared to 41% last year. The decrease primarily relates to the movement of a portion of this business to the distributor model.

Now turning to SG&A expenses. Expenses for the quarter were $56.9 million compared to $65.2 million last year. Foreign exchange effects reduced SG&A expenses by $0.2 million. Wide-ranging actions taken under the enhanced Global Restructuring Plan reduced expenses by an incremental $8.6 million over previous cost reductions that were realized in the second quarter of 2012.

Further decreases in SG&A expenses were due to CEO transition cost recorded in our second quarter 2012, without comparable expenses in 2013. Reductions in bad debt expense in external legal and accounting services, as well as less amortization expense in 2013 -- due to fully amortized intangible assets. Offsetting these decreases were increases in long-term incentive compensation, costs associated with the CFO transition, increased marketing efforts, performance incentive compensation and external tax services.

Now I'm going to provide an update on our restructuring program. We continue to expect that the Expanded Global Restructuring Plan, which includes Project LEAN and the SG&A restructuring plan, will generate approximately $102 million in annual savings in cost of goods sold and SG&A expenses when the plans are fully implemented by the end of 2013. These restructuring initiatives lowered costs in the second quarter by additional $14.5 million, when compared with reductions achieved through the second quarter of 2012 with $8.6 million attributed -- attributable to SG&A cost reduction actions. To date, $78 million of the cost reductions have been realized, of which, $55.5 million reduced SG&A expenses.

Restructuring expenses in our second quarter were $1.6 million. To date, the Expanded Global Restructuring Plan has recorded $69.6 million in expenses, including $46.1 million in severance and other employee-related charges; $8.5 million in other restructuring costs; as well as $15 million in noncash asset impairments associated with facilities, rationalizations and closures. These programs will impact approximately 2,500 positions with 2,482 positions eliminated through the end of the second quarter this year.

While we are firmly committed to achieving the overall savings targets, the expanded global restructuring plan has a wide-ranging scope, in which some details may change as we execute specific programs. Delivering the $102 million in savings is now expected to cost between $70 million to $73 million, down approximately $2 million from previous estimates.

Now turning to GAAP income taxes. The effective tax rate for the second quarter of 2013 was 37.4%, as compared to a negative 6.5% for the second quarter of 2012. The second quarter of 2013 effective tax rate was high due primarily to the mix of income among subsidiaries. The 2013 rate was also impacted by losses incurred in countries with valuation allowances that did not result in a tax benefit, causing the overall tax expense as a percentage of income to increase.

The second quarter of 2013, we accounted for the U.S. operations by applying an estimated annual effective rate methodology. We determined that if the U.S. operations are included in the estimated annual tax rate, small changes in estimated pretax earnings will no longer result in significant fluctuations in the tax rate. The effective tax rate for the second quarter 2012 was negative, as we adjusted our U.S. operations out of our estimated annual effective tax rate calculation and applied a discrete method. The second quarter 2012 effective tax rate also included the impact of applying the discrete method to the first quarter of 2012, as well as the impacts of the mix of income among subsidiaries and goodwill impairment charges that did not receive an income tax benefit.

Now turning to non-GAAP earnings per share. Non-GAAP diluted earnings per share for the second quarter 2013 were $0.11 versus a loss of $0.16 in the same period in 2012. Foreign currency transaction and revaluation losses for the second quarter of 2013 were $2 million, reducing our EPS approximately $0.05 in the quarter. This unfavorable variance is primarily attributed to intra-period currency fluctuations in our operations in several emerging markets, where central banks prohibit participation in our intercompany netting system. In a word, it's either impossible or cost-prohibitive to effectively hedge current -- certain of these foreign exchange exposures.

Now moving on to cash flow and our debt covenant. Cash flow provided by operations was $3.8 million in the quarter. Capital expenditures were $1.9 million and free cash flow was $1.9 million.

In the second quarter of 2012, we implemented new working capital initiatives that expected to generate $50 million to $60 million in improvements by June of this year. The initiatives focused on the following: improving forecasting, product management and supply chain processes to reduce inventory levels facilitated by our new business structure; improve customer to cash process execution to improve collections and reduce accounts receivable balances; and more effective management of vendor payment terms in a manner that is favorable to the company. When compared to the end of second quarter 2012, accounts receivables, inventories and payables generated a combined improvement in cash flows of $75.8 million, including an $11.5 million improvement in the second quarter of 2013, significantly exceeding our goal.

Now regarding our debt covenant. We finished the second quarter well within our amended financial covenant ratios. The total leverage ratio of total debt to trailing 12-month adjusted EBITDA was 2.41, which was well below the 2.75 limit defined in the July 2012 debt amendment. The fixed charge coverage ratio of trailing 12-month adjusted EBITDA less capital expenditures to consolidated interest expense plus scheduled debt payments was 3.42, which was well above the 1.25 minimum defined in the debt amendment. We expect to remain in compliance with the amended debt covenants throughout the year.

And last, a recap of our CheckView business. We completed the sale of the North America CheckView business to Platinum Equity on April 29. Details are provided in the 8-K that were filed on May 2. The financial results of this business for the second quarter 2013 until the sale concluded were revenues of $3.5 million and an operating loss of $1.4 million. These results reported as discontinued ops, in addition to our loss on the sale of this business of $13 million.

Now I'll provide the update on the 2013 guidance. Based on our assessment of current market conditions, and assuming continuation of current foreign exchange rates, Checkpoint is updating certain components of the guidance for 2013. This guidance does not include the impact of acquisitions, divestitures, restructuring and onetime or unusual charges resulting from debt refinancing, litigation, certain tax reserves and gains or losses generated by nonroutine operating matters, which we may record during the year.

Projected income taxes for the year can be impacted by changes in the mix of pretax income and losses, as well as valuation allowances in the countries in which we operate, which we can also -- which can also impact our earnings. Net revenues are expected to be in the range of $685 million to $700 million. Prior guidance was $675 million to $695 million. The gross profit margins are expected to be in a range of 40.9% to 41.6%. Prior guidance was 41.2% to 42.2%. Operating expenses are expected to be in the range of $233 million to $239 million, with prior guidance being $233 million and $243 million.

Non-GAAP operating income is expected to be $47 million to $52 million, with prior guidance at $45 million to $50 million. Full year non-GAAP effective income tax rate is expected to be approximately 26% to 28%. Prior guidance was 27% to 29%. Non-GAAP diluted net earnings per share attributed to Checkpoint Systems are expected to be in the range of $0.65 to $0.75, which is unchanged from the prior guidance.

Free cash flow. Cash flow from operations, less CapEx, is expected to be in the range of $50 million to $60 million, which is also unchanged from prior guidance. And depreciation and amortization is expected to be in the range of $29 million to $30 million. And capital expenditures are expected to be approximately $12 million to $17 million for the full year. Previous guidance for CapEx was approximately $19 million.

Now I'll turn it back over to George.

George Babich

All right. Thanks, Jeff. So what I'd like to do now is recap the last 12 months, just to give you a sense of the magnitude of what was accomplished, how we view the year in retrospect and, most importantly, where we go from here.

Overall, this first year was marked by steady progress in meeting 2 significant objectives: achieving substantial sustainable cost savings; and reducing working capital outlay. These goals were accomplished through our program of global restructuring and organizational change. I know most of the listeners on the call today are familiar with what took place, but I'd like to walk through the scorecard, nonetheless, for the benefit of new investors.

So we -- first, we aligned our customer-facing organizations by line of business and streamlined our global field service. Second, we fundamentally restructured our ALS business to support our redefined merchandise availability strategy. Third, we transitioned certain businesses in Europe to an indirect selling model. Fourth, we sold 2 nonstrategic businesses, the Banking Security Systems Integration business and our U.S. and Canadian CheckView business. Fifth, we consolidated corporate functions to be appropriately sized to support the businesses. Sixth, we instituted rigorous expense control. Seventh, we began a process to improve productivity throughout the organization. And eighth, we tightened cash management practices worldwide to significantly increase free cash flow.

I'm pleased to report that we achieved all of the foregoing, exceeding the $50 million to $60 million working capital improvement goal by $21 million or 38%. And we fully expect to deliver the targeted $102 million in cost savings by the end of 2013.

Looking ahead to the next 12 months, our focus will be on improving processes and execution throughout the organization. In addition, we'll be accelerating our innovation efforts, and we will be focusing on optimizing talent and capabilities to ensure that we are the best contender in the marketplace we serve.

Operator, I'd like to open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is coming from the line of Chris Kapsch with Topeka Capital Markets.

Christopher Kapsch - Topeka Capital Markets Inc., Research Division

I have a question about the ALS business, with the gross margins that's just over 30%. As you complete the sort of rationalization of that manufacturing footprint, and also rationalizing low profit -- low-margin customers, I'm just wondering how you see a more normalized gross margin for that business as it stabilize, and as you fully capture your cost savings on a go-forward basis?

George Babich

Okay. Chris, this is George. I'll take a shot at that. Yes, as I said a year ago, I think you'll find, not only in the comments on the call, but also in the press release, the changes that we were about to undergo in the ALS business were, by far, the most far-reaching, most complex and had, obviously, a lot of risk to them. So we expected to have -- to see some volatility in our performance as you do that. As Jeff mentioned, we've reduced approximately 2,400 positions, a vast majority of them in that business -- in the manufacturing side of that business. We've consolidated 8 facilities in South China down to, basically, 2 facilities at this point. There's been a lot of moving pieces, so the margin, it continues to be a little bit unsteady. And that business, in general, the margin, can fluctuate quarter to quarter as you get in and out of the peak selling season. So we can have full absorption in our manufacturing facilities for 6 or 8 months out of the year and then significant under-absorption in other months. And the only reason I'm just reminding you, and I think you know this and others, and before I answer the question, is that there is a lot of -- there are a lot of moving pieces just in our restructuring, as well as inherent in the business. Having said that, the objective for us in that business is certainly to be in the mid-30% range, when we get this thing fully stabilized, up and running, all the consolidations, customer rationalizations, product refinements, all of these things behind us, ERP systems, everything else. That's where we would expect the full year numbers to be. We currently have plants that are running in excess of 40%. We have other plants where we have opportunities that are dragging us down. So it continues to be a little bit more volatile than I think it will be 12 months from now. And, certainly, we would expect to be in the mid-30s at that point on a full year basis though.

Christopher Kapsch - Topeka Capital Markets Inc., Research Division

Okay. And then I also had a question on the RFID business. The notion of doubling of that business albeit from a relatively small level for the full year, talking about doubling. I'm just wondering how confident are you on that? Do you have like RFPs that are out there that you're hoping to win? Or do you have contracts in plan with installations, RFID adoptions that are definitely going to happen? And I just wondered if you can talk about the expected margin profile of the RFID business as that ramps. And then maybe talk about, by business, is it also through SMS, or if there's some ALS benefit as well?

George Babich

Okay. Let me see if I can recall all of those elements. But let's start, I guess, with the first question on revenue. We're very confident at this point that we will, in fact, at least double the RFID business this year. Because we have -- as I mentioned 6 months ago, we have a major European retailer that we are ramping up in the second half of this year. So that's a signed contract with that major European retailer. So that was in the plan for the year and why we expected full year revenue to be up, despite the first half being down, that was our plan. Although we've done better than that, was because of the RFID business ramping up in the second half. In addition, we also have secured a North American -- substantial North American retailers, RFID business, for chain-wide rollout that will enable us to forecast with confidence that we can, in fact, at least double the business year-over-year. In addition, as I've mentioned before, we have 20-some tests ongoing around the world, where we are either a proof-of-concept, beginning stages of RFID, or we're in a more of a test mode with them. And we continue to work those. They do take some time. But sequencing them into 2014 looks -- certainly does look like we're on track to continue the growth in RFID through 2014 as well, as expected. So that's on the revenue side. On the margin side, the business is really, in a lot of ways, 2 separate businesses. We have the high-margin business where the software, the hardware that we provide with our antennas and our other readers that we have with our Wirama technology, as well as our field service and installation capabilities, to provide what the retailer needs for the installation and project management. Those are all high-margin elements of the business. And they are accretive to our legacy SMS business, if you will, or expected to be, going forward. Offsetting that, to some degree is the other labels. The labels themselves, the RFID labels, as you know, Chris, standardized labels, we don't really have any differentiation other than our ability to over print on the labels. But the actual inlay itself, standardized, it's a commodity. So those labels, we expect to be kind of average ALS margin business going forward. So when you blend the 2 together, the overall business is, certainly, it's our expectation to be accretive to our legacy EAS business. It's likely accretive. And we'll continue to look for ways to make it even more accretive through the addition of data analytics -- predictive data analytics as necessary, or if possible, and in other services that we can provide to retailers that add more value. So from a margin standpoint and a revenue standpoint, today, our RFID business is reported in the SMS business, okay? To your last question -- I think your last question. Beginning in the third quarter, we will do 2 things. We'll rename the SMS business to MAS. SMS or Shrink Management Solutions, it was a legacy terminology. Beginning in the third quarter, it will become MAS, which is Merchandise Availability Solutions. So it encompasses loss prevention, EAS products and services that are legacy business. It prevents products from being sold and, therefore, makes the merchandise available for sale, as well as our RFID business, which we refer to as Merchandise Visibility, MV, which, obviously, helps retailers with inventory management and increasing sales. So in the future, you'll see MAS as the acronym, Merchandise Availability Solutions. It will not include the labels. The labels are becoming a bigger part of the overall business. So beginning in the third quarter, all of the labels that we produced through our print shops to support the Merchandise Availability Business will be reported in our ALS business. So, hopefully, that all made sense. And, hopefully, I answered your 3 questions.

Operator

Our next question is coming from the line of Chris McGinnis with Sidoti & Company.

Christopher McGinnis - Sidoti & Company, LLC

I guess, just a couple of things. One, I think if I -- it went through quick and someone didn't pick up, so I apologize if I missed anything. But on the Alpha, you saw a decline, but you feel confident you're going to see growth. Can you maybe walk us through your confidence in that?

George Babich

Yes, Chris. In Q1, if you remember, we exceeded our expectations from a revenue standpoint pretty nicely. And I mentioned in Q1 that we had -- broader sense, we had delays in our Tesco rollout from Q4 that benefited us in Q1. And we had pull up of revenue from the second quarter into the first quarter in our Leedal [ph] rollout in Europe, as well as in our Alpha business, where we -- in North America, where we significantly exceeded our expectations. And I think what happened in Q2 is because of the pull forward in Q1 of the Alpha from major retailers, Walmart, Target, that sort of thing, there was just kind of a pullback in Q2 relative to our expectations. But through the first half, we are on plan and right where we expect to be with the Alpha business, and have very good visibility at this point, relative to the second half of the year. So we feel good that it was just a shift between Q1, Q2 and like our business overall, as you know, it can be lumpy, depending on when retailers write the POs or don't write the POs. So that -- I think that's just -- that's the case with Alpha.

Christopher McGinnis - Sidoti & Company, LLC

Sure, that works. I appreciate that. I guess, just a quick question on the impact of the license of the library. Can you just -- I guess, on a dollar amount?

George Babich

Yes. Just -- we mentioned this in Q1 and maybe even in Q4, when we released earnings. Just so that you understand that we had a license with 3M, and that license expired. And so we're walking away from, if you will, that revenue that was reported in 2012, obviously, isn't there in 2013. It's, I think, in the quarter, maybe a couple million dollars in North America. We still have a little bit of library revenue, but the 3M piece is kind of an adjustment year-over-year, because -- as we walked away from that business.

Christopher McGinnis - Sidoti & Company, LLC

Sure. And I guess, just one last question, and I'll jump back in queue. But just on the guidance going forward on the gross margin, bringing that down, can you just walk us through that? What's impacting that? And the driver -- or imagine, maybe it's just to do with product release, and I guess, that would be the...

George Babich

Yes, a couple of things. First of all, the significant -- the significance of the systems' rollouts that took place in the first and second quarter, some of which was not anticipated with the Tesco piece flowing out of 2012 into 2013. In both cases, we took lower margins on those systems implementations and installations, with the revenue -- the higher-margin revenue coming at a way of contractually the labels business, which we'll get over the next several years. So that's a piece of why it came down. Another piece is that the ALS business, we're having -- not quite meeting our objectives. So to some degree, that's impacting the overall performance of the company's margins. And I'd say, the third thing is that the Merchandise Visibility, our RFID business, we are getting more RFID labels this year than we had anticipated. So when we look at, again, what the margins are for ALS, and that sort of business, that has a -- that puts downward pressure on our overall margins. So it's a combination of those things. But our gross profit with revenue -- for the second quarter in a row, the guidance being increased on revenue, we continue to gain market share, which is incredibly important, while we're -- have some pressure on the margins, overall gross profit is there. And then as we roll forward into 2014, 2015, we should see the benefits of that. So we are slightly ahead of, as I said, about 3.5% in the first half. Our revenue expectations was that we would be slightly down, so that's encouraging. Our margins, I told you, would be 200% to 300% favorable this year. We're running at about 130 points or so favorable to prior year, so there's a little bit of give and take in those numbers but, overall, the gross profit dollars are in line with what we thought. And as you know, the SG&A is coming in lower. The big surprise for us, obviously -- we saw it coming, but the big surprise relative to our guidance is really the foreign exchange being $0.06, foreign exchange loss that we did not anticipate, have not been in prior guidance. And so I'm pleased now that the team was able to respond, not only on a gross profit line, but on OpEx to be able to overcome that $0.06, and for us to be able to reaffirm our EPS guidance.

Operator

Our next question is coming from the line of Jeff Kessler with Imperial Capital.

Jeffrey T. Kessler - Imperial Capital, LLC, Research Division

Firstly, just a follow-up on ForEx. Realizing that it's almost impossible to predict, given that you have a number of cross currencies, can you give us some idea of what you were looking at in terms of ForEx for the second half of the year, given your experience in the first half of the year?

Jeffrey O. Richard

This is Jeff, I'll take that. We can't predict foreign currency, obviously. So what we do is we just say, we don't know. And so, we keep it flat. We're not projecting any deterioration or bring back of FX going forward.

Jeffrey T. Kessler - Imperial Capital, LLC, Research Division

All right. Second question is your gross margins were impacted a bit in the first half of the year by installations. Granted those installations are due to positive effects and the hopeful improvement in margin on the recurring tag business, can you give some idea of what you believe you've done in terms of either market share, or if you want to call it branding, market awareness at Checkpoint, whatever you want to call it, particularly, in Europe where these wins seem to be coming? And how you believe that will help you competitively going forward?

George Babich

Sure, Jeff. George again. Well, obviously, we announced last September that we won the Tesco chain-wide rollout. That was a swap out from the centramatic systems worldwide for Tesco. So that's, obviously, a market share gain for us, and obviously, an important one than being the sized retailer they are in the world, #2 or #3, depending how you look at it. And the reasons for it fall into a couple of buckets: One is they are, obviously, very interested in lowering their overall cost and their shrinkage and that sort of thing. Our tags, really, we feel, and they felt have a competitive advantage with our competitors with respect to the our ability to use them in source tagging, which is something that they want to do in a significant way to reduce the manual process of tagging the products, so that was a big factor. Another one is the lower cost of operating our systems. Our systems operated at about 75%, 80% less energy. And they've used a lot of antennas. If you've seen a Tesco stores, they you put antennas at the end of every checkout aisle, not just at the front door. That was very important to them as well. And, certainly, the transition from RF to RFID was a major factor in that decision. So from a -- from a market standpoint, we think that, that speaks loudly about being able to accomplish the swap out and some of the reasons for the swap out. And they have been very -- they've been very accommodating in helping us market that with other customers, not only in Europe but throughout the world quite frankly. The other one -- the other major rollout was Lidl, and Lidl was a market share gain as well. Lidl was hard discount. That's -- but we refer to it here in the states as kind of a Family Dollar, Dollar General, the dollar stores. And with the economy being what it is in Europe and they pressure on the consumer -- they've been moving down in the value chain, if you will. And these were unprotected, complete whitespace opportunity is in that hard discount space. We won Lidl -- did the chain-wide rollout of Lidl. Obviously, not only a market share gain but an opportunity for us to market that in Europe. For the rest of that hard discount chain vertical, because those -- the other competitors are not protected either, so in many cases, and I've had this from my experience, you know it from your experience, once your competitor puts in the EAS systems, same thing happened to me in my prior life, is our competitor did it, and all of the thieves kind of started coming to our stores. That's what, certainly, typically, takes place -- took place here in the U.S., with the drugstores, as well, where there's across the street from one another. So we think there's market opportunities in Europe in that vertical, overall, for the next couple of years. So for us, those were great opportunities. We've been able to use the customers -- to help with major customers. Other parts of the world who would come to visit them and hear their story, so we think it's a tremendous opportunity. We've also had some success here in North America. So nothing that we've publicly announced, similar to we have with Tesco. But -- so we're -- having -- continuing to gain market share. As I mentioned before, we believe that we have converted about 87,000 stores over the last dozen years or so. 45,000 of those stores, we took from our competitors. And we haven't lost a significant chain -- or a significant opportunity through the competitive process to our competitors over that period of time.

Jeffrey T. Kessler - Imperial Capital, LLC, Research Division

All right. One final quick question. That is you have been -- you, not you, but the company, for the last 15, 20 years, has been talking about trying to get the percentage of source tags up, whatever, that percentage is. In some years, you've given that percentage, and in other years you've basically not talked about the percentage. But regardless, getting source tagging at the point of manufacturing is important. What is -- what can you tell us about what is going on in terms of getting a combination or separate antitheft and RFID tags in at-the-source level? In other words, the addition of RFID provides another wrinkle in terms of source tagging, it also provides an opportunity?

George Babich

I think you're probably aware of the brands that currently provide RFID tags in the -- many of the retailers. But as far as our business and working with CPGs and other manufacturers and the retailers to try to get source tagging going. As I said, we are working diligently with Tesco to get that going. We think it'll have a spillover effect once the CPG starts source tagging. And they have an inventory of product that has been source tagged that other retailers now will realize the benefits from that and begin to increase that percentage of our business. But it is a long sales process. It's a long -- it 's a different kind of -- process as far as working with CPGs than it is with retailers. We have to work on both simultaneously. We think it'll continue to be the direction that they go. Everything I hear from retailers is that's what they would prefer. But it does take coordination of everyone. So I can't tell you, specifically, the amount that we have right now, source tag, but it continues to be an opportunity for us. You probably saw the study, the TUV study that came out about a month ago that show that our labels at the point of source tagging, have a defective rate of about 1%, and our competitors' labels at the point of source tagging, because of the high-speed application process, have a defective rate of up to 30%. So we have a significant technological advantage with our labels. And it's something that we're going to continue to pursue vigorously and take advantage of that technical advantage that we have.

Operator

Our next question is a follow-up question coming from the line of Chris McGinnis with Sidoti & Company.

Christopher McGinnis - Sidoti & Company, LLC

George, I just wanted to ask you about, maybe, just when you look at your pilot portfolio on the RFID side, and can you just maybe give us a rough sense of the percentage of maybe where -- what the stages are? So maybe, articles 20 to 25, whatever that number is, how many are in the beginning stage? Can you walk us through that a little bit, or give us, at least, a little more detail on that?

George Babich

What I can say is that we haven't launched test of -- kind of proof-of-concept significant number this year. So we're working with those proof-of-concepts that have moved to the next phase of test. And we're doing it. We're working in -- here in North America, in Europe and in Asia. So they moved, it's really hard to tell you, Chris, because they move at different cases. All of a sudden, it catches fire within the organization. There is a pretty long sales cycle, because you're not working just with loss prevention folks like we do with our EAS test, but you're working with loss prevention and IT and procurement, the whole supply chain, so -- in operations folks, as well. So the whole process takes a little longer, and then, some of them will kind of see the light and jump more quickly to the next step. So I can't really give you a percentage off the top of my head, the numbers that are in various stages. And it really wouldn't be all that meaningful, because it's really the pace at which they move. One thing I'd mentioned to you previously is it is a challenge, when you get 1,000-plus store chain, who wants to adopt RFID, and then you have another one, like we have this year. And now, we have 2,000, 3,000 stores that we're trying to do the installation, the training, software, hardware, operational training and all these sorts of things. So there is a kind of a limitation on how much we can actually handle. So the pace in rate now, I am comfortable with. It's moving along in a way that we can handle it. We can provide the service to the customer that they're looking for. We can substantially grow our business. And if we get the sense that 2 or 3 are going to want to go at the same time, and there's going to be thousands of stores that we have to install in the second half of next year, we'll probably -- we're talking to you about the fact that we're going to load in a little bit more OpEx in the beginning of the year in anticipation of that, so -- but right now, I can't -- I really can't give you much more granularity on it, Chris.

Christopher McGinnis - Sidoti & Company, LLC

I appreciate it. And then just last, Jeff, I know -- it's your first -- I think, this is your first call. Can you just maybe -- I know it's been a short period you're there. But just with your background, obviously, it fits well with the position of CKPs. And now, can you just walk through maybe what you've seen, maybe some of the areas of that you think you could work on?

Jeffrey O. Richard

Sure. Yes, so it's been a good run so far. What I like at a company like Checkpoint. I look at it on the way in. And certainly, I solidify these thoughts. Checkpoint has a great name. I always look for a company that has a strong brand. And maybe at the barge of night, most people don't know what Checkpoint is, but in this industry, Checkpoint has a significant name. And then the other thing is technology, so we have technology. George mentioned, even verified by a third party. When you hear stuff like that, we have an advantage. And then it's a matter of how do we get to market. And so we're not starting from behind, we're starting as a leader. So that's, obviously, -- I'm looking for -- we're looking to have a company that is kind of #1, #2 in the space, that has some technology, that has brand. And so that we tick all the boxes here, So we've got a good thing to start with. In the company, we've gone through some tough times here in the last couple of years. When you think about phasing. I think George has mentioned this to you. I see the same thing. You had to go through the last 18 months to get this company back rightsized. And those were some difficult decisions to make, whenever you cut out 2,500 people out of a business, I mean, that's a significant amount of people coming out. And to have the strength of the company that it has today after all of those actions is quite amazing. But we're not going to cut out another 2,500 employees, or we're going to get -- we'll be in the bone marrow, at that point. So that's not going to happen. But what we're going to do is move to that second phase. And the second phase is where I see a lot of opportunity. And to your point, my background kind of fits it perfectly. It's really just looking at the processes, operational excellence type Six Sigma Lean stuff. There's a lot of opportunity here. I see a lot of it's been untouched. And so I'm excited about digging in. We have 3 Six Sigma Lean projects started already. And as I kind of jotted down, I have a list of probably about 15, 20 more. And so we're going to train our team members throughout the company, throughout the world on concepts on how to do things smarter and better. And I think you'll see a culture change here with different limbs on the business, particularly, when we look at profitability, I think there's significant upside in managing the business from a more profitable -- profitability wins. When we look at customer profitability, we look at business line profitability. All that is coming at a much more granular level. And to really support our business leaders to be able to manage our business a lot better when they have that kind of data. Today, they don't have that kind of data to really make exceptional, profitable decisions. Obviously, we're profitable, we're doing a good job. But we have a long way to go to -- down that path to get better. So all I said is I am excited about being here. There's a lot of upside, and so I look forward to talking with you guys in the future about it.

Operator

Mr. Babich, there are no further questions at this time. I would like to turn the floor back over to for any concluding comment.

George Babich

Okay, thank you. And in closing, I think it's important here that I -- for me to say that I really -- I want to thank the entire worldwide Checkpoint team for their dedication in supporting our turnaround for the past year. In almost all cases, it was probably the most demanding year of our careers. But because of the team's perseverance, we met, and in many cases, exceeded our goals.

Today, our organizational commitment worldwide to -- our organization is committed to 3 very important pillars that are at the center of all we aspire to be as a company. First, to be the best customer advocate in the markets we serve. Second, to be the most innovative market leader in the markets we serve from a technology standpoint. And third, to be personally accountable, at all times, with all constituents.

As we move into year 2 of our turnaround, I look forward to working with each member of the team and every one of you on the call. Thank you. Have a great day, and I look forward to speaking to you next quarter.

Operator

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may now disconnect your lines at this time. Thank you for your participation.

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