CheckPoint Systems, Inc. (NASDAQ:CHKP) Investor Call January 3, 2008 10:00 AM ET
Robert van der Merwe – President & Chief ExecutiveOfficer
George W. Off – Chairman
Raymond D. Andrews – Chief Financial Officer & SeniorVice President
Ajit Pai – Thomas Weisel Partners
Robert Labick – CJS Securities, Inc.
Good morning. My name is Elizabethand I will be your conference operator today. At this time I would like to welcome everyone to the CheckPoint SystemsInvestor Conference Call. (OperatorInstructions) I would now like to turnthe 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 derMerwe, President & Chief Executive Officer; George Off, Chairman; and Ray Andrews,Senior Vice President and Chief Financial Officer.
Statements in this conference call reflecting our futureplans and strategies are forward-looking statements and are based on currentexpectations and assumptions. Theseexpectations and assumptions are subject to risk and uncertainty which could affectour future plans. CheckPoint’s actual results and the timing and occurring ofexpected events could differ materially from our plan and expectations due to anumber of factors such as changes in the overall economic conditions andchanges in the legal environment as well as those factors disclosed in ourfilings with the Securities & Exchange Commission. You should also be aware that all informationin this discussion is as of January 3, 2008. CheckPoint undertakes no duty to update any forward-looking statementsto conform the statement to actual results or changes in the company’sexpectations.
At this time I would now like to turn the call over toGeorge 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, ournew President & CEO and Ray Andrews our new CFO. For today’s call I plan to talk in more detailabout our management transition, about our strong performance in 2007 and aboutour outlook for 2008. Ray will discussfinancial information for 2007 and 2008 and Rob will share his initial thoughtsabout CheckPoint and then we’ll be glad to take your questions.
I hope you will come away from the call today with thefollowing three points. First, speakingfor myself and for our board, we are delighted that Rob has taken on theposition of president and CEO. He bringsan outstanding background and we believe he’s the right guy to accelerate ourgrowth. I’m also pleased to introduceRay Andrews as our new CFO. He hasstrong credentials and has established respect and creditability with the boardof directors and with the management team since joining us in August of 2005. The second point, we produced strong resultsin 2007 and overall I’m comfortable with our guidance for the full year 2007and that implies outstanding growth in sales and profits versus 2006. Results have been strong across allgeographies and all product lines. Theintegration of our two new acquisitions the Alpha Securities Products and theSIDEP Asialco are going well. The thirdpoint, going into 2008 we have a robust list of customer sales activity, astrong pipeline of new products and we expect our recent acquisitions tocontribute significantly to growth in 2008.
We set a goal for double digit growth in sales in 2008 andnon 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 2008and we’re searching for additional opportunities for value creation uses of ourcash.
Now, let me talk about Ray Andrews our new CFO. Ray is a CPA and his background experiencecomes from two well respected companies: DuPont and Koch Industries. His background includes in-depth experiencein international business processes and controls, acquisitions anddivestitures. Ray joined CheckPoint inAugust of 2005 as corporate controller and chief accounting officer. During the last two and a half years Ray hasestablished creditability with the board and the audit committee and his fellowsenior managers. Since joining Ray hasstrengthened the talent in our world wide controller organization, improved ourprocesses and information systems and he’s established the controller organizationthat 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 thecompany in his 11 years here. He wasrecruited to a good opportunity and I think he just felt that the business wasin good shape and it was a good time for him personally to make a change. We thank him for his contributions and wewish him well and we’re grateful that he had Ray ready to take over the CFOposition.
Now, let’s talk about our new president and CEO Rob van derMerwe. Fortunately, many of you alreadyknow Rob from his position as Chairman & CEO at Paxar. Paxar has many similarities to CheckPointsuch as a similar customer base of retailers and consumer goods manufacturersand a similar global footprint. Prior toPaxar Rob worked for many years at Kimberly-Clark where he had a distinguishedcareer of increasing responsibility. Hewas group president of their multi-billion dollar global consumer tissuebusiness and before that he ran their Europe Middle East Africa operationsbased in London. The result of all this experience is that Robknows our customers needs and he hits the ground running. I’ve gotten to know Rob well over the lasttwo years and have great respect for his leadership ability and hisaccomplishments. I’m confident in hisability to lead CheckPoint and that he and I will work well together. I plan to stay as active chairman, help Robcome up to speed on the business and help grow the business.
We produced strong growth in sales and earnings in2007. I would like to comment on the2007 growth drivers and that will help us put 2008 into focus for you. In our securities segment our core EASbusiness was strong in all of our geographies. We benefited from expanding business with Carrefour and METRO in Europeand both of these retailers could yield more business in 2008 and 2009 as otherdivisions consider our RF technology. Inthe United Statesour CCTV systems integration business experienced exceptional growth in 2007driven by a broad group of new accounts and additional business from existingaccounts.
In the labeling services segment our Check-Net servicebusiness bureau has produced outstanding revenue growth in 2007. The acquisition of ADS in November, 2006 hashelped as we saw ADS sales increase better than projected. Organic growth in the Check-Net business wasalso excellent. We see a number ofopportunities to add new customers searching for a second source due to theAvery Paxar merger.
The rapid growth in our CCTV systems integration businessand our Check-Net service bureau business has affected our overall grossmargins. Both the CCTV and the Check-Netservice bureau business operate at margins in the low 30% range and both ofthese businesses also experienced additional pressure on their margins in 2007because of the challenges of servicing their rapid growth. Margins were lower than our expectations.
As you know, our cost focus has produced good productivityin 2007. We anticipate that our SG&Awill come in at least 200 basis points lower as a percent of revenue in 2007versus 2006. We have achieved broad costimprovements in all of our geographies and in our manufacturing and supplychain operations. As a result we haveseen 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 ofcustomer sales prospects for all of our product lines and a strong pipeline ofnew products. In addition, our recentacquisitions are going well and will contribute significantly in 2008. I think I could best summarize my thoughts asfollows: we have set a target for doubledigit revenue growth in 2008 driven primarily by the recent acquisitions aswell as modest organic growth. We’vealso set goals to improve our gross profit margins and we plan to continue ourfocus on cost reductions so the goal of EPS growth is significant. Given current market conditions and theoutlook for our business we expect to deliver in the range of $1.65 to $1.75 ofnon GAAP EPS from continuing operations in 2008 excluding restructuringcharges.
Let me provide more insight to our thought process. As you know, our business has a seasonalityfactor with sales and profits coming in stronger during the second half of theyear. We think the market conditions forour retail customers will support modes organic growth for CheckPoint in 2008and 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 Statesand in Europe and continuing growth in Asia similar tothis year. We also have assumed thatforeign exchange rates will stay about the same as 2007.
Regarding our goals to improve gross margins in 2008 I wouldcomment as follows: as mentioned earlier our CCTV business and our Check-Netbusiness margins were under pressure this year due to the challenges related totheir rapid growth and both businesses have vigorous plans to strengthen theirmargins in 2008. Both of thesebusinesses should see top line growth in 2008 but not at the same exceptionallevels as we saw in 2007.
The ALPA S3 gross profit margins are higher than our companyaverage and we have a goal to grow that business significantly in 2008 whichshould improve our overall margin. Asalways we’re focused on continuous cost reduction in our geographic regions andin our manufacturing and supply chain operations. As an example we have significantly upgradedour sourcing organization in Chinain the last 12 months and this opens up many cost reduction possibilities. We have also set a goal to improve ourSG&A productivity in 2008. Forexample, with the acquisitions we have a goal to absorb most of their sales intoour existing G&A costs which should help us reduce G&A as a percent ofrevenue. The target for double digitrevenue growth coupled with goals to improve gross profits and SG&A as apercent of revenue leads to our EPS forecast in 2008. We also expect to improve our free cash flowin 2008. Our balance sheet remainsstrong so we’re continuing to search for additional value createdopportunities.
Rob, Ray and I are looking forward to sharing more detailswith you on our call at the end of February when we release the final resultsfor 2007. Now I’d like to turn the callover to Ray Andrews so that he can provide additional information.
Raymond D. Andrews
First I want to reinforce several points that George madeabout our results in 2007 then I’ll provide some additional insight on ourexpectations for 2008. For 2007 weexpect revenues to exceed $820 million. Sales remain strong in the fourth quarter in our core EAS business, our Check-Netservice business and our North America CCTV business. Our recent acquisitions are also performingwell. We have not changed our 2007guidance on non GAAP diluted EPS from continuing operations of $1.33 to $1.28per share and this excludes restructuring and certain other one time charges asgross margins are expect to be lower than previously projected.
Sales mix due to the higher rates of growth in our lowermargin business, higher than expected field service and distribution costsneeded to address challenges related to the rapid growth in our CCTV systems integrationbusiness and Check-Net service business and pricing pressures on certainproduct lines continue to affect margins.
The fourth quarter [inaudible] of two acquisitions we madein November the Alpha Security Products S3 business and SIDEP Asialco. The Alpha S3 product line is off to anexcellent start with strong sales in November and December although fourthquarter results of the S3 business will be impacted by intangible amortizationand opening balance sheet inventory markup that will result from purchaseaccounting in accordance with US GAAP. We expect the operating income from the S3 business to be slightlypositive. The SIDEP Asialco acquisitionsdriven by our strategy to grow a manufacturing capacity in China,fourth quarter operating income from this acquisition is expected to beslightly negative.
In the fourth quarter certain one time items will impactoperating expense. These items are notreflected in our guidance. We expect apre-tax charge of $4.2 million resulting from the change in George’s role. The agreement associated with George’stransition along with Rob’s employment and option agreements are availablethrough the company’s website. We alsoexpect to record a one time gain of approximately $2.5 million resulting fromthe sale of our operations in Austria. The sale is part of our ongoing plan toimprove operating margins by moving from a direct to an indirect approach innon strategic countries.
I also want to highlight expectations for 2008 financialperformance to support our guidance of non GAAP EPS from continuing operationsin the range of $1.65 to $1.75 per share excluding restructuring costs. Our guidance is based on expectations thatour markets will support modest growth in 2008 that our acquisitions will performas expected and that during 2008 foreign exchange will remain at rates similarto what we experienced in 2007. As theyear progresses we will continue our practice of highlighting the impact thatexchange rates have on our operating results.
For 2008 we are forecasting double digit growth in revenuecompared to 2007 driven largely by the acquisitions we made late in the yearcoupled with modest organic growth. Weexpect full year 2008 operating margins of at least 10%. The acquisition of the Alpha S3 business inparticular is expected to provide a boost to our ongoing efforts to improveoperating margins. While we do notprovide quarterly guidance I’d like to remind you that CheckPoint in a seasonalbusiness and typically experiences stronger revenues and operating margins inthe second half of the year and that the first quarter is typically relativelyweak. Finally, we are anticipating in2008 an annualized tax rate of approximately 26%.
We are encouraged by the strong performance we are seeing aswe close 2007 and we expect good momentum moving into 2008. We will provide additional details on 2007performance and our expectations for 2008 in late February when we announce2007 results.
Now, I’d like to turn the call over to Rob.
Robert van der Merwe
Good morning. I wantto compliment George and his team for doing a great job in positioningCheckPoint for improved results in 2008 and beyond. He and I go back a couple of years and have agreat mutual respect for each other so I’m looking forward to working with himto affect a very smooth transition this year.
My first order of duty is to visit all of our operations andfacilities around the world, to meet the teams, to understand the competitivelandscape and to learn first hand all the issues which we are facing in themarket. I will also meet with customers and some of our suppliers and willshare some of my perspectives from my travels when I talk to you again on theregularly scheduled conference call.
I will be focused on execution this year, of course, toensure that the 2008 numbers materialize while also focusing the longer termvision for CheckPoint. I expect to workwith my team to have the latter worked out by no later than quarter three andthen approved by the board after which we will share any changes with you nolater than the fourth quarter.
In summary, there are three main points we wanted toreiterate on today’s call before we take you questions. One, I have no doubt that both Ray and I willhave a very smooth transition. Ray knowsthe business and I know the industry and have some experience in how totransform businesses while delivering results. Two, as you heard today CheckPoint is very nicely positioned to deliverimproved results in 2008 and beyond. This is important from a continuity ofresults standpoint particularly as we go through a management succession. Three, there is significant opportunity totake CheckPoint to the next level. Now,clearly I have more work to do to learn the business and get my hands firmly onthe wheel but it is one of the key reasons why I accepted this position. For example, CheckPoint has very strongmarket leadership positions in its core businesses.
We’re also going to see as you heard from George a host ofnew products launched this year. That’sexciting. Even more exciting is theprospect of driving innovation even faster in the years to come and therebyfurther stimulating organic growth and enhancing margins.
Finally, we have a very strong balance sheet and that’s beenreiterated on all our calls and you heard that from George today. Our cash flows are strong and improving soour ability to make choiceful but meaningful acquisitions is available to us. So, like George I’m very excited about ourfuture and I’m honored to be part of the CheckPoint team. With that operator, we will now open the calland 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 avery strong 2007. You guys mentionedthat you expect 2007 revenues to be about $820 million. That seems to be higher than your initialguidance 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 bitmore in terms of extending margins. Iknow 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 theinitiative that you think will expand your margin next year.
George W. Off
Let me take a crack at your question first here and then ifRay wants to add to it fine. Two of ourbusinesses the Check-Net service bureau business and the CCTV business all thisyear have had customers who’ve come to us with various special requests withvery short timeframes and we just didn’t anticipate that would continue intothe fourth quarter. We thought thatwould be very unusual but, it has continued and so business has come in factstronger than we forecast in Q3. And,we’re happy with the business, pleased to service our customers but it doesalso require expedited deliveries, overtime runs, those kinds of things and ourguys are doing a great job of taking care of the customer but it does put alittle pressure on our margins. So,that’s why we’re still being a little bit cautious about the EPS for the fourthquarter. Ray did you want to comment?
Raymond D. Andrews
I think that’s part of the issue. In addition, we did just make twoacquisitions. That involves performingpurchase accounting and this is a complicated process and we’re in the processof doing that and we were just reluctant to narrow the range of our guidancewith that underway.
Regarding that are you anticipating any charges related tothe acquisitions?
Raymond D. Andrews
Well, abnormal intangible asset formation and amortizationexpense the first two months. Typically,there’s an inventory markup. All theseare items that are amortization type based, particularly amortization won’taffect EBITDA.
(Operator Instructions) Your next question comes from the line of Bob Labick with CJSSecurities.
A few questions. First, I wanted to ask if you could just give us an update from yourperspective on the US and European retail environment and then also just remindus, I believe its probably early in the first quarter but, when you’ll get alittle more visibility to the cap ex cycle expected for 2008.
Raymond D. Andrews
A couple comments on the retail environment, I thinkretailers are still working their way through Christmas and what has becomefairly significant for them – the after Christmas volume associated with giftcards and such. Some of the mediacoverage and such have indicated that maybe Christmas was a bit slower thanhoped for. But, all of that will take alittle bit of time to sort out. We havebuilt in modest growth assumptions for the coming year because we thinkretailers may be a bit cautious. But,we’re very excited about entering the market with some new products and we’vegot these new acquisitions that give us access to customers that we haven’tcalled on before. So, I think we stilllook to be comfortable with double digit growth assumptions.
George W. Off
Bob, I think we expect incremental capital expenditures fromthe acquisitions but nothing significant and we’ll provide more guidance onthat in February.
As it relates to the new products are you referring to theAlpha S3 or are there new organic products from CheckPoint coming out aswell? And, could you give us a sense ofwhat areas those might be in?
George W. Off
Let me give you some highlights Bob and you’re correct inthe Alpha S3 business the nature of that business is a constant introduction ofnew products about twice a year. We haveour January kickoff schedules and they’ve got a nice slate of new products tobe introduced there so that was what we were looking for and pleased with theirresults on their new product development. In our core businesses we have announced our new evolved family ofantennas systems. These systems improvedetection provide a bunch of functionality upgrades, improved networking, anice clear path toward RFID. We’re veryexcited about this new evolved family of systems but I would point out that newproducts require startup marketing and startup manufacturing expenses so,probably we’ll see more results in our numbers in the second half of the yearand beyond.
Then, we announced earlier last year that we enhanced ourEAS labels, our disposable labels. Whatwe call enhanced performance, these labels are smaller in size and improveddetection and customers like both of those characteristics. We’ve had good success with a limitedselection of SKUs in the last few months of 2007 and we’re working hard toexpand that list of SKUs that’s available and looking forward to good resultsfrom those products as well.
It’s a good strong pipeline of new products and we’reexcited about what they’ll do for us in the market.
Thanks so much. Welook forward to seeing you at our conference next week.
(Operator Instructions) At this time I do show that there are no further audio questions inqueue. I will now turn the call backover the management.
George W. Off
Thank you operator. Let me just summarize. I’m veryexcited about working with Rob and Ray on moving our business forward in 2008and we look forward to talking to you about CheckPoint on the call at the endof February when we produce our results and we’ll give you more informationthen. We just want to impart ourenthusiasm for the business and the management transition. Rob, welcome. Ray, congratulations. Thankseverybody for joining us.
This concludes today’s CheckPoint System’s investorconference call. You may nowdisconnect.
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