Robert van der Merwe – President & Chief Executive Officer
George W. Off – Chairman
Raymond D. Andrews – Chief Financial Officer & Senior Vice President
Ajit Pai – Thomas Weisel Partners
Robert Labick – CJS Securities, Inc.
CheckPoint Systems, Inc. (CHKP) Investor Call January 3, 2008 10:00 AM ET
Good morning. My name is Elizabeth and I will be your conference operator today. At this time I would like to welcome everyone to the CheckPoint Systems Investor Conference Call. (Operator Instructions) I would now like to turn the conference call over to Mr. Bob Joyce. Sir, you may now begin your conference.
Thank you operator. Good morning and welcome to CheckPoint Systems’ investor call. Joining us from the company are Rob van der Merwe, President & Chief Executive Officer; George Off, Chairman; and Ray Andrews, Senior Vice President and Chief Financial Officer.
Statements in this conference call reflecting our future plans and strategies are forward-looking statements and are based on current expectations and assumptions. These expectations and assumptions are subject to risk and uncertainty which could affect our future plans. CheckPoint’s actual results and the timing and occurring of expected events could differ materially from our plan and expectations due to a number of factors such as changes in the overall economic conditions and changes in the legal environment as well as those factors disclosed in our filings with the Securities & Exchange Commission. You should also be aware that all information in this discussion is as of January 3, 2008. CheckPoint undertakes no duty to update any forward-looking statements to conform the statement to actual results or changes in the company’s expectations.
At this time I would now like to turn the call over to George Off. Please go ahead sir.
George W. Off
Good morning everyone. I’m pleased to be here to discuss important CheckPoint plans. Joining me today are Rob van der Merwe, our new President & CEO and Ray Andrews our new CFO. For today’s call I plan to talk in more detail about our management transition, about our strong performance in 2007 and about our outlook for 2008. Ray will discuss financial information for 2007 and 2008 and Rob will share his initial thoughts about CheckPoint and then we’ll be glad to take your questions.
I hope you will come away from the call today with the following three points. First, speaking for myself and for our board, we are delighted that Rob has taken on the position of president and CEO. He brings an outstanding background and we believe he’s the right guy to accelerate our growth. I’m also pleased to introduce Ray Andrews as our new CFO. He has strong credentials and has established respect and creditability with the board of directors and with the management team since joining us in August of 2005. The second point, we produced strong results in 2007 and overall I’m comfortable with our guidance for the full year 2007 and that implies outstanding growth in sales and profits versus 2006. Results have been strong across all geographies and all product lines. The integration of our two new acquisitions the Alpha Securities Products and the SIDEP Asialco are going well. The third point, going into 2008 we have a robust list of customer sales activity, a strong pipeline of new products and we expect our recent acquisitions to contribute significantly to growth in 2008.
We set a goal for double digit growth in sales in 2008 and non GAAP EPS from continuing operations in the range of $1.65 to $1.75. Our balance sheet remains strong. We expect to improve free cash flow in 2008 and we’re searching for additional opportunities for value creation uses of our cash.
Now, let me talk about Ray Andrews our new CFO. Ray is a CPA and his background experience comes from two well respected companies: DuPont and Koch Industries. His background includes in-depth experience in international business processes and controls, acquisitions and divestitures. Ray joined CheckPoint in August of 2005 as corporate controller and chief accounting officer. During the last two and a half years Ray has established creditability with the board and the audit committee and his fellow senior managers. Since joining Ray has strengthened the talent in our world wide controller organization, improved our processes and information systems and he’s established the controller organization that has business partners helping move the business forward.
Since many of you knew Craig Burns let me comment. We’re sorry to see Craig move on. He made countless contributions to the company in his 11 years here. He was recruited to a good opportunity and I think he just felt that the business was in good shape and it was a good time for him personally to make a change. We thank him for his contributions and we wish him well and we’re grateful that he had Ray ready to take over the CFO position.
Now, let’s talk about our new president and CEO Rob van der Merwe. Fortunately, many of you already know Rob from his position as Chairman & CEO at Paxar. Paxar has many similarities to CheckPoint such as a similar customer base of retailers and consumer goods manufacturers and a similar global footprint. Prior to Paxar Rob worked for many years at Kimberly-Clark where he had a distinguished career of increasing responsibility. He was group president of their multi-billion dollar global consumer tissue business and before that he ran their Europe Middle East Africa operations based in London. The result of all this experience is that Rob knows our customers needs and he hits the ground running. I’ve gotten to know Rob well over the last two years and have great respect for his leadership ability and his accomplishments. I’m confident in his ability to lead CheckPoint and that he and I will work well together. I plan to stay as active chairman, help Rob come up to speed on the business and help grow the business.
We produced strong growth in sales and earnings in 2007. I would like to comment on the 2007 growth drivers and that will help us put 2008 into focus for you. In our securities segment our core EAS business was strong in all of our geographies. We benefited from expanding business with Carrefour and METRO in Europe and both of these retailers could yield more business in 2008 and 2009 as other divisions consider our RF technology. In the United States our CCTV systems integration business experienced exceptional growth in 2007 driven by a broad group of new accounts and additional business from existing accounts.
In the labeling services segment our Check-Net service business bureau has produced outstanding revenue growth in 2007. The acquisition of ADS in November, 2006 has helped as we saw ADS sales increase better than projected. Organic growth in the Check-Net business was also excellent. We see a number of opportunities to add new customers searching for a second source due to the Avery Paxar merger.
The rapid growth in our CCTV systems integration business and our Check-Net service bureau business has affected our overall gross margins. Both the CCTV and the Check-Net service bureau business operate at margins in the low 30% range and both of these businesses also experienced additional pressure on their margins in 2007 because of the challenges of servicing their rapid growth. Margins were lower than our expectations.
As you know, our cost focus has produced good productivity in 2007. We anticipate that our SG&A will come in at least 200 basis points lower as a percent of revenue in 2007 versus 2006. We have achieved broad cost improvements in all of our geographies and in our manufacturing and supply chain operations. As a result we have seen strong top and bottom line growth in 2007.
Now, let’s take a look at our prospects for 2008. As noted earlier we have a robust list of customer sales prospects for all of our product lines and a strong pipeline of new products. In addition, our recent acquisitions are going well and will contribute significantly in 2008. I think I could best summarize my thoughts as follows: we have set a target for double digit revenue growth in 2008 driven primarily by the recent acquisitions as well as modest organic growth. We’ve also set goals to improve our gross profit margins and we plan to continue our focus on cost reductions so the goal of EPS growth is significant. Given current market conditions and the outlook for our business we expect to deliver in the range of $1.65 to $1.75 of non GAAP EPS from continuing operations in 2008 excluding restructuring charges.
Let me provide more insight to our thought process. As you know, our business has a seasonality factor with sales and profits coming in stronger during the second half of the year. We think the market conditions for our retail customers will support modes organic growth for CheckPoint in 2008 and that the conditions will vary by geography. Two thirds of our sales are outside of the United States. We expect modest growth in the United States and in Europe and continuing growth in Asia similar to this year. We also have assumed that foreign exchange rates will stay about the same as 2007.
Regarding our goals to improve gross margins in 2008 I would comment as follows: as mentioned earlier our CCTV business and our Check-Net business margins were under pressure this year due to the challenges related to their rapid growth and both businesses have vigorous plans to strengthen their margins in 2008. Both of these businesses should see top line growth in 2008 but not at the same exceptional levels as we saw in 2007.
The ALPA S3 gross profit margins are higher than our company average and we have a goal to grow that business significantly in 2008 which should improve our overall margin. As always we’re focused on continuous cost reduction in our geographic regions and in our manufacturing and supply chain operations. As an example we have significantly upgraded our sourcing organization in China in the last 12 months and this opens up many cost reduction possibilities. We have also set a goal to improve our SG&A productivity in 2008. For example, with the acquisitions we have a goal to absorb most of their sales into our existing G&A costs which should help us reduce G&A as a percent of revenue. The target for double digit revenue growth coupled with goals to improve gross profits and SG&A as a percent of revenue leads to our EPS forecast in 2008. We also expect to improve our free cash flow in 2008. Our balance sheet remains strong so we’re continuing to search for additional value created opportunities.
Rob, Ray and I are looking forward to sharing more details with you on our call at the end of February when we release the final results for 2007. Now I’d like to turn the call over to Ray Andrews so that he can provide additional information.
Raymond D. Andrews
First I want to reinforce several points that George made about our results in 2007 then I’ll provide some additional insight on our expectations for 2008. For 2007 we expect revenues to exceed $820 million. Sales remain strong in the fourth quarter in our core EAS business, our Check-Net service business and our North America CCTV business. Our recent acquisitions are also performing well. We have not changed our 2007 guidance on non GAAP diluted EPS from continuing operations of $1.33 to $1.28 per share and this excludes restructuring and certain other one time charges as gross margins are expect to be lower than previously projected.
Sales mix due to the higher rates of growth in our lower margin business, higher than expected field service and distribution costs needed to address challenges related to the rapid growth in our CCTV systems integration business and Check-Net service business and pricing pressures on certain product lines continue to affect margins.
The fourth quarter [inaudible] of two acquisitions we made in November the Alpha Security Products S3 business and SIDEP Asialco. The Alpha S3 product line is off to an excellent start with strong sales in November and December although fourth quarter results of the S3 business will be impacted by intangible amortization and opening balance sheet inventory markup that will result from purchase accounting in accordance with US GAAP. We expect the operating income from the S3 business to be slightly positive. The SIDEP Asialco acquisitions driven by our strategy to grow a manufacturing capacity in China, fourth quarter operating income from this acquisition is expected to be slightly negative.
In the fourth quarter certain one time items will impact operating expense. These items are not reflected in our guidance. We expect a pre-tax charge of $4.2 million resulting from the change in George’s role. The agreement associated with George’s transition along with Rob’s employment and option agreements are available through the company’s website. We also expect to record a one time gain of approximately $2.5 million resulting from the sale of our operations in Austria. The sale is part of our ongoing plan to improve operating margins by moving from a direct to an indirect approach in non strategic countries.
I also want to highlight expectations for 2008 financial performance to support our guidance of non GAAP EPS from continuing operations in the range of $1.65 to $1.75 per share excluding restructuring costs. Our guidance is based on expectations that our markets will support modest growth in 2008 that our acquisitions will perform as expected and that during 2008 foreign exchange will remain at rates similar to what we experienced in 2007. As the year progresses we will continue our practice of highlighting the impact that exchange rates have on our operating results.
For 2008 we are forecasting double digit growth in revenue compared to 2007 driven largely by the acquisitions we made late in the year coupled with modest organic growth. We expect full year 2008 operating margins of at least 10%. The acquisition of the Alpha S3 business in particular is expected to provide a boost to our ongoing efforts to improve operating margins. While we do not provide quarterly guidance I’d like to remind you that CheckPoint in a seasonal business and typically experiences stronger revenues and operating margins in the second half of the year and that the first quarter is typically relatively weak. Finally, we are anticipating in 2008 an annualized tax rate of approximately 26%.
We are encouraged by the strong performance we are seeing as we close 2007 and we expect good momentum moving into 2008. We will provide additional details on 2007 performance and our expectations for 2008 in late February when we announce 2007 results.
Now, I’d like to turn the call over to Rob.
Robert van der Merwe
Good morning. I want to compliment George and his team for doing a great job in positioning CheckPoint for improved results in 2008 and beyond. He and I go back a couple of years and have a great mutual respect for each other so I’m looking forward to working with him to affect a very smooth transition this year.
My first order of duty is to visit all of our operations and facilities around the world, to meet the teams, to understand the competitive landscape and to learn first hand all the issues which we are facing in the market. I will also meet with customers and some of our suppliers and will share some of my perspectives from my travels when I talk to you again on the regularly scheduled conference call.
I will be focused on execution this year, of course, to ensure that the 2008 numbers materialize while also focusing the longer term vision for CheckPoint. I expect to work with my team to have the latter worked out by no later than quarter three and then approved by the board after which we will share any changes with you no later than the fourth quarter.
In summary, there are three main points we wanted to reiterate on today’s call before we take you questions. One, I have no doubt that both Ray and I will have a very smooth transition. Ray knows the business and I know the industry and have some experience in how to transform businesses while delivering results. Two, as you heard today CheckPoint is very nicely positioned to deliver improved results in 2008 and beyond. This is important from a continuity of results standpoint particularly as we go through a management succession. Three, there is significant opportunity to take CheckPoint to the next level. Now, clearly I have more work to do to learn the business and get my hands firmly on the wheel but it is one of the key reasons why I accepted this position. For example, CheckPoint has very strong market leadership positions in its core businesses.
We’re also going to see as you heard from George a host of new products launched this year. That’s exciting. Even more exciting is the prospect of driving innovation even faster in the years to come and thereby further stimulating organic growth and enhancing margins.
Finally, we have a very strong balance sheet and that’s been reiterated on all our calls and you heard that from George today. Our cash flows are strong and improving so our ability to make choiceful but meaningful acquisitions is available to us. So, like George I’m very excited about our future and I’m honored to be part of the CheckPoint team. With that operator, we will now open the call and George, Ray and I will take your questions.
(Operator Instructions) Your first question comes from the line of Ajit Pai with TWP.
Congratulations for both the new appointment and also for a very strong 2007. You guys mentioned that you expect 2007 revenues to be about $820 million. That seems to be higher than your initial guidance but you didn’t change your EPS. Can you elaborate a little bit on why such a case? And, going forward for 2008 how do – do a bit more in terms of extending margins. I know you mentioned some of the initiatives that you’re going to take [inaudible] and all that stuff but, can you expand a little bit more about the initiative that you think will expand your margin next year.
George W. Off
Let me take a crack at your question first here and then if Ray wants to add to it fine. Two of our businesses the Check-Net service bureau business and the CCTV business all this year have had customers who’ve come to us with various special requests with very short timeframes and we just didn’t anticipate that would continue into the fourth quarter. We thought that would be very unusual but, it has continued and so business has come in fact stronger than we forecast in Q3. And, we’re happy with the business, pleased to service our customers but it does also require expedited deliveries, overtime runs, those kinds of things and our guys are doing a great job of taking care of the customer but it does put a little pressure on our margins. So, that’s why we’re still being a little bit cautious about the EPS for the fourth quarter. Ray did you want to comment?
Raymond D. Andrews
I think that’s part of the issue. In addition, we did just make two acquisitions. That involves performing purchase accounting and this is a complicated process and we’re in the process of doing that and we were just reluctant to narrow the range of our guidance with that underway.
Regarding that are you anticipating any charges related to the acquisitions?
Raymond D. Andrews
Well, abnormal intangible asset formation and amortization expense the first two months. Typically, there’s an inventory markup. All these are items that are amortization type based, particularly amortization won’t affect EBITDA.
(Operator Instructions) Your next question comes from the line of Bob Labick with CJS Securities.
A few questions. First, I wanted to ask if you could just give us an update from your perspective on the US and European retail environment and then also just remind us, I believe its probably early in the first quarter but, when you’ll get a little more visibility to the cap ex cycle expected for 2008.
Raymond D. Andrews
A couple comments on the retail environment, I think retailers are still working their way through Christmas and what has become fairly significant for them – the after Christmas volume associated with gift cards and such. Some of the media coverage and such have indicated that maybe Christmas was a bit slower than hoped for. But, all of that will take a little bit of time to sort out. We have built in modest growth assumptions for the coming year because we think retailers may be a bit cautious. But, we’re very excited about entering the market with some new products and we’ve got these new acquisitions that give us access to customers that we haven’t called on before. So, I think we still look to be comfortable with double digit growth assumptions.
George W. Off
Bob, I think we expect incremental capital expenditures from the acquisitions but nothing significant and we’ll provide more guidance on that in February.
As it relates to the new products are you referring to the Alpha S3 or are there new organic products from CheckPoint coming out as well? And, could you give us a sense of what areas those might be in?
George W. Off
Let me give you some highlights Bob and you’re correct in the Alpha S3 business the nature of that business is a constant introduction of new products about twice a year. We have our January kickoff schedules and they’ve got a nice slate of new products to be introduced there so that was what we were looking for and pleased with their results on their new product development. In our core businesses we have announced our new evolved family of antennas systems. These systems improve detection provide a bunch of functionality upgrades, improved networking, a nice clear path toward RFID. We’re very excited about this new evolved family of systems but I would point out that new products require startup marketing and startup manufacturing expenses so, probably we’ll see more results in our numbers in the second half of the year and beyond.
Then, we announced earlier last year that we enhanced our EAS labels, our disposable labels. What we call enhanced performance, these labels are smaller in size and improved detection and customers like both of those characteristics. We’ve had good success with a limited selection of SKUs in the last few months of 2007 and we’re working hard to expand that list of SKUs that’s available and looking forward to good results from those products as well.
It’s a good strong pipeline of new products and we’re excited about what they’ll do for us in the market.
Thanks so much. We look forward to seeing you at our conference next week.
(Operator Instructions) At this time I do show that there are no further audio questions in queue. I will now turn the call back over the management.
George W. Off
Thank you operator. Let me just summarize. I’m very excited about working with Rob and Ray on moving our business forward in 2008 and we look forward to talking to you about CheckPoint on the call at the end of February when we produce our results and we’ll give you more information then. We just want to impart our enthusiasm for the business and the management transition. Rob, welcome. Ray, congratulations. Thanks everybody for joining us.
This concludes today’s CheckPoint System’s investor conference call. You may now disconnect.
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