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Checkpoint Systems, Inc. (NYSE:CKP)

Q2 2010 Earnings Call

July 29, 2010 2:00 p.m. ET

Executives

Bob Powers - VP, IR

Rob van der Merwe - President & CEO

Ray Andrews - SVP & CFO

Analysts

Bob Labick - CJS Securities

Reik Read - Robert W. Baird

Ajit Pai - Stifel Nicolaus

Chris McGinnis - Sidoti & Company

Jerome Lande - Millbrook Capital

Operator

Greetings and welcome to the Checkpoint Systems Second Quarter 2010 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 is now my pleasure to introduce your host Bob Powers, Vice President of Investor Relations for Checkpoint Systems. Thank you Mr. Powers; you may begin.

Bob Powers

Thank you, Jan. Good afternoon and welcome to Checkpoint System's Second Quarter 2010 Results Conference Call. On the call from the company are Rob van der Merwe, Chairman, President and Chief Executive Officer; and Ray Andrews, Senior Vice President and Chief Financial Officer.

If you have not yet received the copy of this morning's second quarter 2010 results release, it's available on the company's website; click on the Investors tab. Additionally, an archived version of this conference call will be available on our website.

Before we would 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 uncertainty, 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 the global economy and changes in the legal environment, as well as those factors disclosed in the earnings release and in our filings with the Securities and Exchange Commission.

Please be aware that all information disclosed and discussed in this conference call is as of July 29, 2010. Checkpoint undertakes no duty to update any forward-looking statements to conform the 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?

Rob van der Merwe

Thanks Bob, and good morning everyone, or good afternoon. Thanks for joining yesterday. I'll briefly discuss our second quarter results and Ray will then share some more financial detail. And at the conclusion of Ray's comments, I'll make some closing remarks and then we will be happy to take your questions.

First, the improving conditions we started to experience in our core markets late last year continued through the second quarter of 2010. And as we continue to execute according to our plan, we realized another strong quarter of organic growth and our margins have remained strong. We anticipate these favorable trends will continue throughout the year.

Second, although European market conditions remain mixed, we still realized organic growth there of 10%. It should be noted that although the dollar strengthened as compared to the euro, this move had less than a 1% negative impact on total sales in the quarter.

Third, the amended and restated credit agreement and note purchase and private shelf placement that we announced last week, will provide us with more borrowing capacity and flexibility to move forward on our growth strategy, and I think the favorable terms and timing of this transaction reflect our solid performance thus far and our strong balance sheet.

Finally, with having delivered a solid first half, we feel comfortable with the full-year financial goals that we outlined at the beginning of this year. And consistent with that, we've narrowed and updated our guidance for this year, and Ray will provide more details on that shortly.

Commenting briefly on our businesses, those that are dependent on retail CapEx spend and new store openings like EAS Systems Hardware, remained soft as you would expect. That said, our CheckView or CCTV, Burglar and Fire Alarm business in the United States, however had a positive organic growth for the first time in many quarters due to a number of things including our cross-selling initiatives.

Our consumables business is performing extremely well, notably Alpha and also Hard Tag @ Source Solutions. Additionally we also remain very, very pleased with our Apparel Labeling Solutions business as we approach the first year anniversary of that successful acquisition. That's Brilliant Label.

Said another way, our recurring revenue base is increasing very nicely and this is very positive. In conclusion, we are currently pursuing some notable growth prospects in both the United States and in Europe, and I remain very excited about these opportunities. We do however fully realize that markets can change rapidly, both positively and negatively, and as such we continue to remain cautiously optimistic about the balance of this year.

Ray will now take you through the second quarter financial details.

Ray Andrews

Thanks Rob. First let me say that we’ve filed our 10-Q this morning. That will provide additional details beyond the comments I make this afternoon. Revenue for the second quarter of 2010 was $208.2 million, compared to $181.9 million in the second quarter of last year, an increase of 14.4% year-over-year. Revenue included organic growth of 10% driven by the strong performance of our Alpha, EAS consumables and Apparel Labeling Solutions businesses.

Revenue was negatively impacted by 0. 9% due to foreign currency which was primarily result of the strengthening of the dollar versus the euro during the second quarter. The August 2009 acquisition of Brilliant Label contributed 5.3% to revenue growth. Gross profit margins in the quarter were 43.6%, compared to 42.7% in the second quarter of 2009. I'll provide more details on this as I review results for the segments.

Our Shrink Management Solutions segment reported revenue of $143.8 million in the second quarter of 2010, or 69% of total company revenue. This represents a year-over-year increase of 11.5% on a constant dollar basis. The revenue increase in Shrink Management Solutions was primarily the result of strong growth in our Alpha business in all geographies and strong growth in the EAS consumables, which was primarily attributably to Hard Tag @ Source program sales in Europe.

Note that the CheckView business had positive organic growth to the first time since the second quarter of 2008. These positive results were partially offset by a decline in our EAS systems business which continues to be impacted by constraints and retail capital spending and new store openings.

The gross profit margins for the Shrink Management Solutions segment was 45%, compared to 40.1% in the second quarter of 2009. Higher gross profit margins in our EAS consumables business were partially offset by lower margins in our EAS systems and Alpha businesses. The decline in EAS systems margins was primarily due to an increase in field service cost in 2010. The decline in Alpha margins is attributable to particularly strong margin performance to the mix in the second quarter of 2009.

Our Apparel Labeling Solutions segment reported revenue of $48.2 million in the second quarter of 2010, or 23% of total company revenue, including $9.7 million from Brilliant Label, which was acquired in August of 2009.

On a constant dollar basis, the year-over-year increase in organic revenue was 13.3%. This growth resulted from our ongoing efforts to broaden our customer base, and leverage the expansion to our product line that resulted from the Brilliant Label acquisition. Gross profit margin for the Apparel Labeling Solutions segment was 38%, compared to 39.4% in the second quarter of 2009. Gross margins in this segment declined primarily due to changes in our product mix including the impact of lower margin products from Brilliant Label.

Our Retail Merchandising Solutions segment reported revenue of $16.2 million in the second quarter of 2010, or 8% of total company revenue. This represents a year-over-year decrease in revenue of 6.8% on a constant dollar basis. The primary markets for retail display business in Northern and Central Europe continued to be impacted by weaker economic conditions and our hand-held labeling systems business was impacted by shifts in market demand.

Gross profit margin for the Retail Merchandising Solutions segment was 47.7% for the second quarter of 2010, compared to 46.4% for the same quarter in 2009.

Selling, general and administrative expenses for the second quarter of 2010 were $70.2 million, or 34% of revenue, compared to 61.6 million, or 34% of revenue in 2009. Foreign exchange effects reduced SG&A expenses by approximately $900,000 and the Brilliant Label acquisition added 2 million to SG&A. On a cost in dollar basis, the remaining $7.5 million dollar increase is primarily due to increased sales and marketing expense resulting from the year-over-year growth in revenue as well as the impact in 2009 from the temporary global payroll reduction and furlough program that was in place from April through December of last year.

SG&A expense was also impacted by expenditures to support our investment and improved information technology, including the move to a common ERP platform beginning in North America in 2011, coupled with our plan to improve business processes and backlog efficiencies.

As I have noted previously, the implementation of the common ERP platform is expected to take place over a four-year time period. In late 2009, through 2010, we have focused on the front end work of defining the standard global business processes that will be the foundation to realization of cost savings improved information availability. We'll begin to realize business savings when we implement the system and processes in North America in early 2011.

However, due to depreciation expense from the capital investment, the cost of continuing consulting support for supplement implementations in Europe and Asia, we will not realize a net benefit in 2011. We expect to realize a net benefit in 2012 and then full benefits beginning in 2013.

Research and development expenses for the second quarter were $5.2 million or 2.5% of revenue, compared to $4.8 million or 2.6% of revenue in the second quarter of 2009. Restructuring expenses for the second quarter of 2010 were $1.2 million and are attributable to the previously announced manufacturing restructuring and selling, general and administrative restructuring plans.

Our selling, general and administrative restructuring plan continues to be defined as we identify additional operational efficiencies. We expect to provide more detail on this by year-end.

Interest expense for the second quarter of 2010 totaled $1.4 million and was partially offset by interest income of $698,000. Interest expense for the balance of 2010 will be impacted by the update to the debt structure that we announced last week.

Income taxes for the second quarter of 2010 were $2.9 million or 24.3% of earnings before income taxes. Our income tax rate each quarter is impacted by the mix of taxable income among the 30 countries in which we operate, whose rates vary significantly. The income tax rate is also impacted by the timing of reserved releases.

The unrestricted cash balance at the end of the second quarter of 2010 was $162.7 million, and working capital was $259.1 million. Current and long-term debt totaled $122.9 million. Unrestricted cash net of debt was $39.8 million.

Cash flow provided by operations during the second quarter of 2010 was $13.6 million compared to cash flow provided by operations of $8 million in the second quarter of last year.

Our day sales outstanding were 64 days, and our days in inventory were 100 days at the end of the second quarter. Our capital expenditures in the second quarter of 2010 were $5.8 million. We continue to forecast approximately $32 million in capital expenditures for the full year, with the increase over 2009 attributable, to expansion and relocation of the apparel labeling solutions capacity, as well as our investment in information technology.

The weighted average number of shares outstanding on a fully diluted basis for the second quarter of 2010 was 40.5 million shares.

Now, I'll comment on our outlook for 2010. Our outlook for this year is based on our evaluation of country and regional marketing conditions that are derived from forecasts, and supporting information gathered from our operating units around the world. Our outlook is based on the assumption that current exchange rates will continue.

Over the past year, economic conditions and the impact on the retail marketplace have been highly dynamic and subject to unpredictable changes. The events could occur in the reminder of 2010 to create further unpredictable changes that are non-anticipated in our outlook, such as the significant increases in commodity prices, or significant changes in currency exchange rates.

With respect to foreign currency exchange rates, Checkpoint collectively purchases currency forward exchange contracts to reduce the risk of currency fluctuations on short-term intercompany receivables and payables, where it is economically efficient to do so.

We also entered into foreign exchange contracts to reduce our exposure to forecast in our company euro denominated revenues. Checkpoint's largest overall exposure is the relationship of the dollar to the euro. Based on the natural hedge that existed in our business within the euro zone where we manufacture and sell within the Euro zone.

Coupled with our intercompany hedging programs, the impact to the bottom-line to changes in the dollar-euro relationship is not significant. Generally a $0.05 change in the exchange rate will impact the bottom-line by roughly $0.02 or $0.03. Please note that due to our broad geographic reached to our many other currency peers that may impact the bottom-line.

We are now reading the outlook that we provided at the time of our previous earnings release on. For 2010, we expect annual revenues at current exchange rates to be in the range of $830 to $860 million. Our outlook reflects the full-year impact of the August 2009 Brilliant Label acquisition. As previously noted, we expect Brilliant Label to generate approximately $40 million in revenues.

For 2010, we expect non-GAAP diluted earnings per share attributable to Checkpoint System Inc. to be in the range of $1.05 to $1.17. For 2010, we expect non-GAAP operating income margins to be in the range of 6.9% to 7.4%. We expect the leverage gain from forecast revenue growth as well as continued activities to manage our cost to more than offset the operating margin impact, bending the temporary global payroll reduction and furlough program that we had in place last year.

In addition, we are striving to limit to growth in operating expenses to those expenditures that support future revenue growth and improved efficiency of the business.

For 2010, we expect non-GAAP annualized tax rates in the range of 18 to 20%. The release of income tax reserves over the balance for the year is expected of a significant impact on taxes recorded in the second half of the year.

For 2010, we expect free cash flow to be in the range of $30 million to $40 million. Free cash flow in 2010 has been impacted by $12 million in customer payments received in 2009 for products to be delivered in 2010 as well as expected growth in working capital to support our forecast revenue growth.

Free cash flow were also impacted by projected capital expenditures of approximately $32 million. Depreciation and amortization expense is expected to be approximately $35 million in 2010 with the increase over 2009 driven by the Brilliant Label acquisition.

Now, I'll turn the call back over to Rob.

Rob van der Merwe

Thanks Ray. So, to summarize I was very pleased with the second quarter results and our execution remains good. We remain cautiously optimistic that sequential revenue improvements will continue through the third and fourth quarters of 2010, and that would result in sequential operating margin growth.

We continue to implement programs to grow our core businesses, and also plans to eliminate non-valued added costs. So, with that Jane we'll take some questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Bob Labick with CJS Securities. Please proceed with your question.

Bob Labick - CJS Securities

Good afternoon, congratulations on a nice quarter.

Rob van der Merwe

Thanks.

Ray Andrews

Thanks.

Bob Labick - CJS Securities

A couple of questions. First obviously in the news there has been a lot about RFID item marking and how it maybe heating or coming sooner. Could you without speaking about any program specifically, could you just broadly talk about the process of implementation for a retailer and what are Checkpoint's touch points in potential item marking for a retailer.

Rob van der Merwe

Okay Bob, it's a phased introduction starting with pilot work in one or two stores, typically with the technology and change program is proven out to be and the return on investment model is confirmed and at the point it starts to migrate into either from more stores or more categories or more countries and that process could take -- the first stage of pilot could take three months, six months depending on the business even up to a year; in the second stage, where multiple units and multiple categories can go into year two and year three.

So it's very much dependent on the particular retailer. It's also dependent on whether they are introducing more comprehensive solutions or simplistic inventory management to eliminate out of stocks type solutions, the later being easier than the former. Now in Alpha where we do pilots, obviously that was much, much faster and the conversions are much faster. The bigger insulations I would think could even take three to four years on the very, very large retailers.

Our participation touches all areas from source to store, again depending on the retailer and we participate directly or indirectly with partners along the supply chain. In the case where there is an EAS type solution there is some hardware in the rest of it. It's typically a recurring type revenue business, some softwares, some partnerships involved.

Bob Labick - CJS Securities

Okay, great. Thank you for that overview. Looking more specifically at Checkpoint now, you had a very strong quarter particularly in the gross profit area and particularly in security of 45%. Was that a function of processes put in place of mix or how do you look at that gross profit in the quarter and going forward?

Ray Andrews

I think a big contributor to the profit in this quarter was mix but also a factor is our ongoing programs to streamline operations and reduce cost. So we would expect and I guess Rob mentioned, we'd expect our margins to be in this range for the balance of this year.

Bob Labick - CJS Securities

Okay great. One more and I'll get back in queue. Part of your longer term goals to get to various operating margin levels include potential acquisition. Does the center changes for taxes out of capital gains or carried interest of anything like that impact the targets out there for you or are the targets your seeking not affected by those tax changes and how is the environment looking in general.

Ray Andrews

I think on the tax front, that not a big factor in the targets we're looking for. We're really looking those that provide right business fit for our growth strategy and provide synergies for our business in particular and our approach has been looking for top line synergies, not necessarily areas where get we get cost synergies in a big restructuring activity.

Rob van der Merwe

Now the other part of the question candidates are for acquisition are out there. It's feasible. The pricing is acceptable. It is part of the pathway to the operating income goal that we shared with you, can't to talk too much about acquisitions at this point, suffice it to say that our balance sheet now is restructured that we can move forward pretty quickly if that occurs.

Bob Labick - CJS Securities

Hey great, thank you very much.

Operator

Thank you. Our next question comes from the line of Reik Read with Robert W. Baird. Please proceed with your question.

Reik Read - Robert W. Baird

Hey how are you guys? Just going back to the CapEx front Rob with your customers, can you talk a little about what drove the improvement in CCT business, is it one time or there some actual spending improvement and then maybe a similar question is done in the antenna side is it didn't sound like you saw a lot of improvement, but is that still seeing weaker, or are you seeing at least some level of stability there?

Ray Andrews

CapEx is returning, but very, very slowly. That would be kind of in line with new store openings and so on. The antenna, the systems antenna business is very, very soft as a result. What we saw in the burglar and fire alarm business in North America was the result of a cross-selling initiative that is in been initiated across the company.

And as we talked to you before, we had this legacy business that never really worked together in a specific account that that is in the process of changing, and we're seeing some success as a result.

Reik Read - Robert W. Baird

So you simply go introduced to more opportunities?

Ray Andrews

Well, yeah, exactly.

Reik Read - Robert W. Baird

And then just ask you to talk a little bit about apparel trends broadly. Can you just talk a little about why the Hard Tag @ Source Europe was good as it was in and what is that it looked to be like, and it seems like there is also some rising and market cost in the apparel world, and just wondering if that has in any impact on how those sales will translate?

Ray Andrews

I can't, I mean the Hard Tag @ Source initiative for us is been very successful. It's still in its early stages. It's a very profitable business. It includes a recycling where we refurbish and then place the tags back into circulation for those particular retailers, and so in that sense it's very attractive. The tag is placed on the government at source and it requires another labor therefore throughout the supply chain through to the store because it's placed very carefully on the government eliminating labor and store. So, I would expect that this business to remain relatively strong throughout the year. It was pioneered in the U.S. and in Europe. I think in this quarter, we saw a strongest, stronger performance in Europe. That doesn't mean to say that weren't changing the quarters ahead.

Reik Read - Robert W. Baird

And just given that comment I mean what are your expectations in the back half for Europe is, is that something where its relatively stable or their programs that give that a plus or minus one way or the other?

Ray Andrews

Now in a parallel, I'll say it's a very, very mixed, but there clearly is a pipeline that needs to be refilled after retailers reacted very strongly last year to the economic situation. That the inventory in the system if you will is not at a sustainable level even today probably and some other companies that have put those statistic out there which I've fully endorsed, I think we are seeing that too. So, there is a pipeline fill that is probably providing a bit of a near-term kick, that said retailers are coming back mid-year and through the end of the year with new programs now and cautiously starting to move back into a more normalized mode.

And in Europe, I would say that's very mixed, it depends on -- not so much to country it depends on the retailer and whether they're performing well or not, it's the old story, like there are winners and losers and you just hope that you've got a sufficient mix of the winners in your portfolio and I think we're fortunate that we do.

But it's tentative at this point, in our case, we are fortunate in one respect and that is that we're making acquisitions, there are synergistic sale to be gained, there's an opportunity to take market share which is a timing situation in a market that's in the process of consolidating. So, it's difficult for me to lay that on the back of an economic or sharper type trend, it's more us taking advantage of dynamics and in the market at this particular time.

Reik Read - Robert W. Baird

Okay and then just one last set of questions, back on the RFID front, is do you guys see any near-term impact on the tagging business and most of this would be a pass through for you I just want to understand if that becomes material enough because that the volumes are more than what that means, your press is suggesting and then I guess the second question would be give you a chance to comment on merchandise visibility solution that you have and I wouldn't expect that to impact in 2010, but maybe if you could talk about where the interest level is and what you think 2011 might bring for that type of a solution?

Rob van der Merwe

Yes, I understood the question on the first part, I don't see any material impact on our business at this stage, I think it's upside opportunity for us. There could be some mix issues but the numbers are not yet material. I see most of that traction commencing in 2011 and to the degree that it doesn't and whether it sustain itself or not remains to be seen. So, certainly there's a big scramble in the industry to put capacity together or seek capacity to play the game and in this case of the one retailer that has announced its initiative.

We expect to participate but there are going to be many players participating in that. On merchandize visibility business is gaining traction, very, very pleased with that and we too have series of pilots in place, that span a number of the areas you know from shrink management all the way through the inventory. But at this point, I can't say too much more about that I think perhaps some news later this year and certainly if there's anything material coming out of that we'll let you know.

Reik Read - Robert W. Baird

Okay, great. Thank you for the comments.

Rob van der Merwe

Thanks.

Operator

Our next question comes from the line of Ajit Pai with Stifel Nicolaus. Please proceed with your question.

Ajit Pai - Stifel Nicolaus

Yes, good afternoon.

Rob van der Merwe

Hi Ajit.

Ajit Pai - Stifel Nicolaus

A couple of quick question, one is just the CapEx, of 32 million, it's quite a step-up, I just want to understand some of the SAP initiatives you've talked about whether those you are capitalizing all of that or some of that being expensed and then also what are the others sort of initiatives that are going to be using in the step-up in CapEx?

Ray Andrews

Okay, on the SAP side, Ajit, the accounting rules are such that when you're doing an early design that has to be expensive for we've seen in the first half of the year. And as you start taking that design and professionally flip in the switches and that safely configuring SAP, the operational and rolling out that part of the program, that part of U.S. GAAP accounting is capitalized. So, that's about half of the uptick in the 9 to $10 million range.

The other side of it is, our programs related to the restructuring program we announced in 2008, tail end of that and that is moving portions of our Apparel Labeling manufacturing operations out of high-cost countries into Asia and relocating equipment and actually acquiring new equipment to make that happen.

Ajit Pai - Stifel Nicolaus

Got it. And then, just looking at your RFID revenues, I think in your queue, you actually talk about it being down, year-over-year. Why is your business down when the rest of the industry seems to be talking about some pretty incredible growth that seems to accelerating?

Rob van der Merwe

Its de minimis I wouldn't read into that at all in terms of what's passing through our business or through other third party providers. The opportunity that you are hearing about and that we're all talking about in the industry is, I think, probably going to be really commencing next year. So, the small number is washing around now, Ajit, probably not even worth commenting on. I'd ignore them.

Ray Andrews

Yeah other than some of that RFID revenue last year was in a program that was RFID related but not the type that is being talked about being a rolled out now in the future.

Ajit Pai - Stifel Nicolaus

Got it. And then just looking at your Alpha product range, the growth rates seem to have been tremendous for those over the past year. And it seems to be getting to be a larger business. How long do you think the runway for the current growth rate is, like to giving, it's just the tip of the iceberg? Your penetration levels are very low in the markets that you are targeting with the product or do you think that you already, fairly well sort of penetrated and the growth rates will start decelerating quite rapidly?

Rob van der Merwe

No. We don't expect any slowdown in Alpha for a couple of reasons. One, we are creating new categories as you've seen in the mass merchandiser channels and the others are following. That's quite a long runway to that. We have a cross selling initiative where we are agnostic with Alpha. We're introducing our other businesses through them into new accounts. So, either they are penetrating more or getting more share wallet.

And then we're also developing our business in Europe where the Alpha business was started in United States and became very strong here. That process has been underway for a couple of years now in Europe and we are starting to get traction. So, the growth opportunity to bring Europe up to the size of the North American businesses is very, very significant. So, there is a runway of some years here.

Ajit Pai - Stifel Nicolaus

Got it, and then the last question would be, just looking at the Brilliant acquisition, could you give us some color as to while you mentioned that it was successful, Could you give us some kind of measurable metric about how you are measuring your success over there? And in Asia itself, do you see that as an area where you EAS system is also on the system side, not the consumable side? Could start growing quite nicely or you think, the price points are still too high to penetrate Asia broadly?

Ray Andrews

Well, lets start with the last question first. In Asia, we are growing with Western retailers that are expanding in the region and we're doing particularly well on the EAS system side. We're developing the local market. We'll need to look at slightly modified products and solutions at a lower price point for those local markets, as opposed to re-export or dealing with the western retailers that are moving into those regions, including the Japanese that are moving into China. So, that's differentiated approach is under way and I think most companies are going to have to address that.

Ray Andrews

Okay and yeah I think on the Brilliant Label side success, we have certainly operational revenue targets for Brilliant, we also expected to get synergies out of the acquisition which we have seen by having a full product line now, it has opened doors for us. That's dialed into our overall objectives for the Apparel Labeling Solutions segment and one thing I've noted with this part of the business is, first you got to get certified once you open that door for sales, then nominated and then you get part of the recurring revenue stream with the customer and that takes sometime, so we're seeing that kind of -- we're starting to see that ramp up in our revenues.

Ajit Pai - Stifel Nicolaus

It's that just beginning now or did that start, did that begun earlier?

Ray Andrews

I'd say that happened, in some cases within weeks. I would say hours that was acquiring Green Label.

Rob van der Merwe

But its takes -- the ramp up itself as I would say we are going to see more of that now probably in the second half of the year?

The reason we are exited about is that the promises around the synergies are now staring to emerge and I'd say they more second half 2010 then they were first half.

Ajit Pai - Stifel Nicolaus

Got it, okay thank you so much and congratulations on a solid quarter.

Operator

Thank you, our next question comes from Chris McGinnis with Sidoti & Company. Please proceed with your question.

Chris McGinnis - Sidoti & Company

Good afternoon, thanks for taking the call. Just on the, following up I guess on the strength and on the EAS, the consumables, is that more -- maybe if you can talk a little about the, is it newer accounts that's driving that or is it a mixture of the older account, can you swap through that maybe just a little bit.

Rob van der Merwe

Chris, it's a combination of both and even within the account there is a mixed issue and when I say mix issue, there is a mixed change and we were migrating from lower to higher margins, but I'd say for the business that's flowed through thus far, I would consider it 60 to 70% of this net new business I don't know Ray?

Ray Andrews

Yeah I'm not sure I can quote a number on that, I can just say anecdotally, we talked about Hard Tag @ Source. The other program that's generating a lot of interest particularly in the new business front and even with existing customers is our Enhanced Performance Labels that allows to put the labels on take up a smaller footprint on an article so there is some good that can be tagged, that maybe wouldn't be effectively tagged in the past but it would cover up the trade name or other key parts of the package and particularly as higher end goods to put into areas like U.S. drug chains, higher priced items. There's going to be a lot more interest in solutions to protect them both on the consumables area and in using Alpha type solutions.

Chris McGinnis - Sidoti & Company

And I guess on the Para Labeling side other than capacity is there anything else that needs to be addressed in that segment for you guys to get to your growth initiatives?

Rob van der Merwe

We need to make more acquisitions. So, as I said earlier there is an opportunity in the market around the consolidation that's occurred to move fairly quickly, I mean we could do it organically it would take a little longer so you want a pretty good mix of acquisition in there, Chris I'll would say that's probably the biggest one and then when you acquire them, you typically get some expertise and skill sets and management and so on that comes with it, other capabilities. Its -- the big step there for is still to make some more acquisitions to get up to that critical mess.

Chris McGinnis - Sidoti & Company

All right, but there is no like certain technology or anything that's lacking. You just need more capacity, need more acquisition I guess monthly.

Rob van der Merwe

I mean there is some additional product line capability that will come up with us acquisitions and some expertise that enables upfront end development where we need to improve, but again that will come with the acquisitions.

Chris McGinnis - Sidoti & Company

And then just on the ERP and the implementation for '011 I -- can we just walk through that a little bit. What's holding -- I guess what are the layers on the -- I guess there -- will us see reduction in the SG&A or else some cost -- leverage all for that and then also is that putting the question the operating margin for the target for next year?

Rob van der Merwe

This implementation is been dialed in our thinking. We are on track with the implementation. It's just the nature of we're rolling it in out in a stage way because we think that's an effective way to do it, and also effective way to manage the commercial risk of the implementation. This year is been upfront in work in terms of streamlining our business processes. That's been very deliberate because we wanted to do it the right way. You do it once, and then you don't want to redo it because that's when your implementation is real costly if you start changing things after the fact. So, that's near completion and now we're starting to configure the system with timing is critical so we are picking rollout really in first quarter for North America because that's our slowest point in the season, is the smallest point in retail, so that else mitigate the risk. Then we ramp up at the Europe and we're still incurring execution cost, so while we're getting savings from the North America rollout in 2011 and we're still incurring expense in capital to prepare for the European and then the Asia rollouts. We're going to -- will happen in to later in 2011 and into 2012 so that's what's part of the cost equation on that rollout. Does that answer your question?

Chris McGinnis - Sidoti & Company

Okay, yeah. I guess and then just on the operating targets for '011 with that with those and to risk it all and --

Rob van der Merwe

Well, as I said that's been part, that was filed in part of our thinking area.

Chris McGinnis - Sidoti & Company

It already is? All right, thank you very much. Appreciate it.

Operator

Thank you. Our next question comes from the line of Jerome Lande with Millbrook Capital. Please proceed with your question.

Jerome Lande - Millbrook Capital

Hi, Jerome here. On the CapEx so I understand the projects you're going on this year, what I want to understand, you have some detail to Ajit but roll it forward, right. In 2011, understanding that you're going to be implementing a lot of this stuff, should we expect to see CapEx come back to traditional norms? Should we expect elevated levels 2011 because of the ERP or should we expect see elevated levels in the future because of other projects you have in mind, can you give us understanding in your outlook, can you give us some guidance?

Rob van der Merwe

Yes. Okay, I can give you some general guidance. I would expect it to be in the same range over the -- at least the next two to three years perhaps, and it's a general number. The SAP ERP implementation, the big CapEx to this year that will ramp down gradually and you are still in three, does that ramps down our expansion plans particularly in ALS as part of that organic, that's also kind of continue to consume capital.

Jerome Lande - Millbrook Capital

Okay, so on a kind of contributory basis, not to painting the corner here, but let's just say traditional CapEx would be 15 to 20 rate and you're going to be close to double that is in 11, 12 half of that is the ERP work still, or can you give some sense of the -- what proportion the ERP is contributing to the variants over the next couple of years?

Rob van der Merwe

ERP is as I said it's -- I mentioned earlier it's in 9 to 10 range this year and just figured out to ramp down to zero over a three-year period with an approximation if you're trying to fill out the model.

Jerome Lande - Millbrook Capital

Three years including 2010 so in other words ending to zero at the end of 2012?

Rob van der Merwe

At the end of 2012 so that means there's some spend in 2012.

Jerome Lande - Millbrook Capital

Okay and question on Alpha. You talked about opportunity in Europe so on, and I don't know if you could talk about it, there's obviously been a lot of chatter about it being in Wal-Mart, I guess what I'm wondering is can you describe the competitive framework for Alpha a little bit it continues to perform really, really well and I'm wondering what it is the drive that I mean to some degree they were doing? Was it seems new ways to present security in retailing. But are they still ahead of the curve, are you still ahead of the curve, what competitors have out there or are they're competing products, that kind of things?

Rob van der Merwe

Yes, Jerome, Alpha continues to stay ahead of the pack through innovation. I mean it's a continuous innovation cycle if they go through to stay ahead of the competition. Competitions being relatively less visible in the U.S., more visible in Europe because Alpha got there later and there were some copycats in some regional and local players that got into the market distributors and so on.

Primarily, with products that were knocked off the back of what Alpha created in the first place, but that nonetheless respond quite at a movement if you will to try and get into this business. Again, it depends on your ability to innovate but very important to your ability to get in, and so a pilot study with an associated payback, and then to service that part of the -- of the retail as they ramp-up which we've now installed in Europe in the various organizations in various countries. We've had that training and learning process underway for two full years now, and we're starting to see traction.

So on the one hand, even if you can have the technology, but you need to have the people on the ground that are trained to go in, and so ROI kinds of programs and stay within until ROI is realized, it's not a one-hit wonder in a sell it and get out. I'd expect that the noise level of competition to continue and it's a lucrative business. We continue to grow and hold our margins which supports that the model is working, so the growth path there on and the margins that they're enjoying I would expect to continue for sometime.

Unless of course, something comes in from that field which, you know, always happen in any business but I think that will be difficult to replicate in a very rapidly.

Jerome Lande - Millbrook Capital

So because of the competitive differences in Europe, is the financial profile still comparable to what it's been -- dominant in U.S. business or you experienced margin pressure?

Rob van der Merwe

No, no, I think I mean the margin; there is a mix issue between the two. You got to ship and all the rest of it, but it's fundamentally the same model, it's just as robust that some customers are having the same kinds of problems.

Ray Andrews

It's such a fit fast payback in that product line, and that there's a significant value after the customer, and that helps monitor prices.

Jerome Lande - Millbrook Capital

And one last thing in Alpha, the innovation that you're talking about and obviously, you're not going to give away the secret sauce here, but when you think about what is coming down the pike is it continued feature robustness in the existing kind of form factors, the spiders and plastic cases and things like that or is it entirely new areas?

Ray Andrews

It's a combination. So, have to pioneer -- we're pioneering new stuff going forward. We re-crafted our innovation process inside Checkpoint a couple of years ago and we have robust pipeline now, products to come to market, one, two, three, four years out. The more we plan forward, the more we have to deal with building patent estates and so on and so forth. So we're getting a little more sophisticated around that. And the answer is some of our -- what you see today, some will look quite different.

Jerome Lande - Millbrook Capital

Great. Thanks a lot and congratulations on a strong quarter.

Ray Andrews

Thanks Jerome.

Operator

Thank you. Our next question is a follow-up from Ajit Pai. Please proceed with your question.

Ajit Pai - Stifel Nicolaus

Yeah. I think you talked a couple of times about, for the Apparel Labeling side, growing by acquisitions and that being a priority. So can you just describe to us, from a strategic perspective, are you being opportunistic? What does the pipeline looks like? And also are your waiting to digest Brilliant completely, start watching some synergies come before you make your next acquisition or if you get the right opportunity go ahead and do it even before a prior acquisition, you're already seeing the full benefits of it.

Rob van der Merwe

No. We've digested Brilliant. We're done. And on the other question, there is this synergistic relationship between two core businesses. So in other words ALS and the Shrink Management side, they are connected. They are also connected throughout. The end-to-end solutions that customers are looking for are connected between the two core businesses.

In other words RFID carriers move between both core businesses. So, as we drive ALS or Apparel Labeling, we're actually starting to support what it is we're trying to do merchandise visibility, give us critical mass in the Apparel segment, which is one where traction for RFID, at SKU level is likely to emerge in 2011.

Ajit Pai - Stifel Nicolaus

Right. But the acquisition pipeline is it looking rich? Are the acquisitions more about scaling the business or about developing the portfolio further? I think you did answer similar questions from someone by saying that most of the acquisitions you're looking at will give you complimentary and additional capabilities. But what is the focus right now? Is it just the scale, is it the capability?

Rob van der Merwe

Scale.

Ajit Pai - Stifel Nicolaus

Scale. And are they closed? Is the environment one where the folks that are willing right now and are speaking with you to get acquired or are expectations for valuations unrealistic and potential targets are not really speaking with you right now?

Rob van der Merwe

Ajit, I'd love to be able to answer those questions. All I can say is what I said before and that is if there are candidates out there -- the industry is still shaking out, they're all a sufficient size that would be of interest to us and I think the numbers around their expectations versus what we are prepared to pay are in the range of what I would call feasible and that's probably what I could say at this point.

Ajit Pai - Stifel Nicolaus

Okay. Thank you so much.

Rob van der Merwe

Sure.

Operator

Thank you. Ladies and gentlemen, at this time I would like to turn the conference back Bob Powers for closing comments.

Bob Powers

Thank you, Jane and thank you very much for your interest and we look forward to speaking with you on next quarter's call. So long.

Operator

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

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Source: Checkpoint Systems, Inc. Q2 2010 Earnings Call Transcript
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