-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ISeIfnhmp0MNXRgy9YxUGIUWbSJa9hB3ueISDa9HkyrS4NN+fhnN19jfY+oqhSKl oclhiFCwXrI4iauX/iPN9w== 0000215419-04-000067.txt : 20040805 0000215419-04-000067.hdr.sgml : 20040805 20040805161455 ACCESSION NUMBER: 0000215419-04-000067 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20040627 FILED AS OF DATE: 20040805 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CHECKPOINT SYSTEMS INC CENTRAL INDEX KEY: 0000215419 STANDARD INDUSTRIAL CLASSIFICATION: COMMUNICATIONS EQUIPMENT, NEC [3669] IRS NUMBER: 221895850 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-11257 FILM NUMBER: 04954952 BUSINESS ADDRESS: STREET 1: 101 WOLF DR STREET 2: P O 188 CITY: THOROFARE STATE: NJ ZIP: 08086 BUSINESS PHONE: 856-384-2460 MAIL ADDRESS: STREET 1: 101 WOLF DRIVE CITY: THOROFARE, STATE: NJ ZIP: 08086 10-Q 1 form10q2q04.txt FORM 10-Q FOR SECOND QUARTER ENDED JUNE 27, 2004 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 27, 2004 ------------------------------------------------ OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ------- ------ Commission file number 1-11257 ----------------------------------------------------- Checkpoint Systems, Inc. - ---------------------------------------------------------------------------- (Exact name of Registrant as specified in its charter) Pennsylvania 22-1895850 -------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 101 Wolf Drive, P.O. Box 188, Thorofare, New Jersey 08086 - ---------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (856) 848-1800 --------------------------------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No -- -- Indicate by check mark whether the Registrant is an accelerated filer, (as defined in Rule 12b-2 of the Act). Yes X No -- -- APPLICABLE ONLY TO CORPORATE ISSUERS: As of July 30, 2004 there were 37,581,786 shares of the Registrant's Common Stock outstanding. CHECKPOINT SYSTEMS, INC. FORM 10-Q INDEX Page No. -------- Part I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Consolidated Balance Sheets 3 Consolidated Statements of Operations 4 Consolidated Statement of Shareholders' Equity 5 Consolidated Statements of Comprehensive (Loss)/Income 6 Consolidated Statements of Cash Flows 7 Notes to Consolidated Financial Statements 8-19 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 20-28 Item 3. Quantitative and Qualitative Disclosures about Market Risk 28 Item 4. Controls and Procedures 28 Part II. OTHER INFORMATION Item 1. Legal Proceedings 28-30 Item 4. Submission of Matters to a Vote of Security Holders 31 Item 6. Exhibits and Reports on Form 8-K 32 SIGNATURES 33 INDEX TO EXHIBITS 34 CHECKPOINT SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS June 27, Dec. 28, 2004 2003 -------- -------- (Unaudited) ASSETS (Thousands) CURRENT ASSETS Cash and cash equivalents $ 68,452 $110,376 Accounts receivable, net of allowances of $13,020 and $12,003 140,793 137,494 Inventories 91,636 80,986 Other current assets 31,960 32,170 Deferred income taxes 12,926 13,076 -------- -------- Total current assets 345,767 374,102 REVENUE EQUIPMENT ON OPERATING LEASE, net 4,073 4,002 PROPERTY, PLANT, AND EQUIPMENT, net 94,322 100,393 GOODWILL 209,296 212,206 OTHER INTANGIBLES, net 50,510 53,446 OTHER ASSETS 26,979 29,173 -------- -------- TOTAL ASSETS $730,947 $773,322 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Short-term borrowings and current portion of long-term debt $ 23,141 $ 79,437 Accounts payable 44,745 62,833 Accrued compensation and related taxes 29,580 36,911 Other accrued expenses 32,214 31,653 Income taxes 22,858 28,120 Unearned revenues 24,661 27,813 Restructuring reserve 8,598 10,173 Other current liabilities 35,851 20,272 -------- -------- Total current liabilities 221,648 297,212 LONG-TERM DEBT, LESS CURRENT MATURITIES 33,102 42,601 CONVERTIBLE SUBORDINATED DEBENTURES 23,257 23,753 ACCRUED PENSIONS 64,734 65,871 OTHER LONG-TERM LIABILITIES 17,941 19,588 MINORITY INTEREST 1,040 1,007 COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY Preferred stock, no par value, authorized 500,000 shares, none issued Common Stock, par value $.10 per share, 3,962 3,948 authorized 100,000,000 shares, issued 39,621,592 and 39,479,407 Additional capital 306,555 282,529 Retained earnings 92,409 93,422 Common stock in treasury, at cost, 2,043,856 shares and 4,640,631 shares (20,701) (47,003) Accumulated other comprehensive loss (13,000) (9,606) -------- -------- TOTAL SHAREHOLDERS' EQUITY 369,225 323,290 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $730,947 $773,322 ======== ======== See accompanying notes to consolidated financial statements. CHECKPOINT SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Quarter Six Months (13 weeks) Ended (26 weeks) Ended --------------------- --------------------- June 27, June 29, June 27, June 29, 2004 2003 2004 2003 -------- -------- -------- -------- (Restated (Restated see Note 14) see Note 14) (Thousands, except per share data) Net revenues $189,270 $175,720 $369,916 $332,137 Cost of revenues 112,220 100,109 221,659 193,377 -------- -------- -------- -------- Gross profit 77,050 75,611 148,257 138,760 Selling, general, and administrative expenses 63,558 56,623 125,435 111,520 Other operating expense 19,950 - 19,950 - -------- -------- -------- -------- Operating (loss)/income (6,458) 18,988 2,872 27,240 Interest income 332 385 785 724 Interest expense 1,473 2,928 3,653 5,971 Other (loss)/gain, net (169) (209) (113) 539 -------- -------- -------- -------- (Loss)/earnings before income taxes (7,768) 16,236 (109) 22,532 Income taxes (1,350) 5,542 871 7,691 Minority interest 24 17 33 34 -------- -------- -------- -------- Net (loss)/earnings $ (6,442) $ 10,677 $ (1,013) $ 14,807 ======== ======== ======== ======== Net (loss)/earnings per share: Basic $ (.17) $ .33 $ (.03) $ .45 ======== ======== ======== ======== Diluted $ (.17) $ .29 $ (.03) $ .42 ======== ======== ======== ======== See accompanying notes to consolidated financial statements. CHECKPOINT SYSTEMS, INC. CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (Unaudited) Six Months (26 weeks) Ended June 27, 2004 ----------------------------------------------------- Accumu- lated Other Addit- Compre- Common ional Retained hensive Treasury Stock Capital Earnings Loss Stock Total ------ ------- -------- ------- -------- ----- (Thousands) Balance, December 28, 2003 $3,948 $282,529 $ 93,422 $ (9,606) $(47,003) $323,290 (Common shares: issued 39,479,407 reacquired 4,640,631) Net (loss) (1,013) (1,013) Exercise of stock options 14 1,734 1,748 (142,185 shares) Net gain on interest rate swap 269 269 Subordinated debentures conversion 22,292 26,302 48,594 Foreign currency translation adjustment (3,663) (3,663) ------ -------- -------- -------- -------- -------- Balance, June 27, 2004 $3,962 $306,555 $ 92,409 $(13,000) $(20,701) $369,225 ====== ======== ======== ======== ======== ======== (Common shares: issued 39,621,592 reacquired 2,043,856) See accompanying notes to consolidated financial statements. CHECKPOINT SYSTEMS, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS)/INCOME (Unaudited) Quarter Six Months (13 weeks) Ended (26 weeks) Ended --------------------- -------------------- June 27, June 29, June 27, June 29, 2004 2003 2004 2003 ------- ------- ------- ------- (Restated (Restated see Note 14) see Note 14) (Thousands) Net (loss)/earnings $(6,442) $10,677 $(1,013) $14,807 Net gain/(loss) on interest rate swap, net of tax 265 (19) 269 (64) Foreign currency translation adjustment (188) 11,479 (3,663) 16,268 ------- ------- ------- ------- Comprehensive (loss)/income $(6,365) $22,137 $(4,407) $31,011 ======= ======= ======= ======= See accompanying notes to consolidated financial statements. CHECKPOINT SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Six Months (26 weeks) Ended --------------------------- June 27, June 29, 2004 2003 ------- ------- (Restated see Note 14) (Thousands) Cash flows from operating activities: Net (loss)/earnings $ (1,013) $ 14,807 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 13,406 14,630 (Gain)/loss on disposal of fixed assets 161 (900) (Increase)/decrease in current assets, net of the effects of acquired companies: Accounts receivable (2,818) 5,722 Inventories (12,700) (2,937) Other current assets (1,544) (438) Increase/(decrease) in current liabilities, net of the effects of acquired companies: Accounts payable (17,388) (4,193) Income taxes (4,971) 1,413 Unearned revenues (2,791) (80) Restructuring reserve (1,520) (1,319) Other current and accrued liabilities 10,452 (3,076) -------- -------- Net cash (used in)/provided by operating activities $(20,726) $ 23,629 -------- -------- Cash flows from investing activities: Acquisition of property, plant, and equipment (5,065) (7,801) Acquisitions, net of cash acquired (155) - Other investing activities 468 439 -------- -------- Net cash used in investing activities $ (4,752) $ (7,362) -------- -------- Cash flows from financing activities: Proceeds from stock issuances 1,525 914 Net change in short-term debt 2,820 998 Payment of long-term debt (19,213) (27,154) -------- -------- Net cash used in financing activities $(14,868) $(25,242) -------- -------- Effect of foreign currency rate fluctuations on cash and cash equivalents (1,578) 2,484 -------- -------- Net decrease in cash and cash equivalents $(41,924) $ (6,491) Cash and cash equivalents: Beginning of period 110,376 54,670 -------- -------- End of period $ 68,452 $ 48,179 ======== ======== See accompanying notes to consolidated financial statements. CHECKPOINT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF ACCOUNTING The consolidated financial statements include the accounts of Checkpoint Systems, Inc. and its majority-owned subsidiaries ("Company"). All inter-company transactions are eliminated in consolidation. The consolidated financial statements and related notes are unaudited and do not contain all disclosures required by generally accepted accounting principles in annual financial statements. Refer to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 28, 2003 for the most recent disclosure of the Company's accounting policies. The consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the Company's financial position at June 27, 2004 and December 28, 2003 and its results of operations and changes in cash flows for the twenty-six week periods ended June 27, 2004 and December 28, 2003. Certain reclassifications have been made to the 2003 financial statements and related footnotes to conform to the 2004 presentation. Variable Interest Entity - ------------------------ On February 3, 2004, the Company made a $2.5 million minority investment in Goliath Solutions, a start-up developer of RFID-based technology for point-of- purchase advertising and display compliance monitoring in the grocery, chain-drug, mass merchandise, and convenience store channels of trade, which is considered a variable interest entity (VIE). Management has determined that the Company is the primary beneficiary and has therefore consolidated Goliath Solutions' assets, liabilities, and results of operations in the Company's consolidated financial statements. The creditors (or beneficial interest holders) of Goliath Solutions have no recourse to the general credit of the Company. As of June 27, 2004, the Company's investment in Goliath Solutions was approximately $2.5 million, representing the Company's maximum exposure to loss. Stock Options - ------------- At June 27, 2004, the Company had one stock-based employee compensation plan. Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation", encourages, but does not require companies to record compensation cost for stock-based employee compensation plans at fair value. The Company continues to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees". Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's common stock at the date of grant over the amount an employee must pay to acquire the stock. Since all options were granted at market value, there is no compensation cost to be recognized. CHECKPOINT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited) Had compensation cost for the Company's stock option plans been determined based upon the fair value at the grant date using the Black Scholes option pricing model prescribed under SFAS 123, the Company's net earnings and net earnings per share would approximate the pro-forma amounts as follows: Quarter Six Months (13 weeks) Ended (26 weeks) Ended ------------------- ------------------- June 27, June 29, June 27, June 29, 2004 2003 2004 2003 ------- ------- ------- ------- (Restated (Restated see Note 14) see Note 14) (Thousands) Net (loss)/earnings, as reported $(6,442) $10,677 $(1,013) $14,807 Total stock-based employee compensation expense determined under fair value based method, net of tax (255) (806) (723) (1,672) ------- ------- ------- ------- Pro-forma net (loss)/earnings $(6,697) $ 9,871 $(1,736) $13,135 ======= ======= ======= ======= Net (loss)/earnings per share: Basic, as reported $ (.17) $ .33 $ (.03) $ .45 ======= ======= ======= ======= Basic, pro-forma $ (.18) $ .30 $ (.05) $ .40 ======= ======= ======= ======= Diluted, as reported $ (.17) $ .29 $ (.03) $ .42 ======= ======= ======= ======= Diluted, pro-forma $ (.17) $ .27 $ (.05) $ .38 ======= ======= ======= ======= 2. INVENTORIES June 27, December 28, 2004 2003 ------- ----------- (Thousands) Raw materials $11,775 $ 8,285 Work in process 4,159 3,547 Finished goods 75,702 69,154 ------- ------- $91,636 $80,986 ======= ======= Inventories are stated at the lower of cost (first-in, first-out method) or market. CHECKPOINT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited) 3. GOODWILL AND OTHER INTANGIBLE ASSETS The Company had intangible assets with a net book value of $50.5 million and $53.4 million as of June 27, 2004 and December 28, 2003, respectively. The following table reflects the components of intangible assets as of June 27, 2004 and December 28, 2003: June 27, 2004 December 28, 2003 ---------------------- ---------------------- Amortizable Gross Gross Life Carrying Accumulated Carrying Accumulated (years) Amount Amortization Amount Amortization ----------- -------- ------------ -------- ------------ (Thousands) Customer lists 20 $30,299 $13,731 $31,020 $14,584 Trade name 30 27,699 4,540 28,226 3,763 Patents, license agreements 5 to 14 36,776 26,649 37,362 25,439 Other 3 to 6 936 280 952 328 ------- ------- ------- ------- $95,710 $45,200 $97,560 $44,114 ======= ======= ======= ======= Estimated amortization expense for 2004 and each of the five succeeding years is: (Thousands) 2004 $3,948 2005 $3,885 2006 $3,652 2007 $3,600 2008 $3,578 2009 $3,571 The changes in the carrying amount of goodwill for the six months ended June 27, 2004, are as follows: Labeling Retail Security Services Merchandising Total -------- -------- ------------- ------- (Thousands) Balance as of beginning of fiscal year 2004 (December 29, 2003) $106,095 $38,433 $67,678 $212,206 Goodwill acquired during year 593 - - 593 Exchange rate changes (1,882) (209) (1,412) (3,503) ------- ------- ------- -------- Balance as of June 27, 2004 $104,806 $38,224 $66,266 $209,296 ======== ======= ======= ======== CHECKPOINT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited) Pursuant to SFAS 142, the Company will perform its annual assessment of goodwill by comparing each individual reporting unit's carrying amount of net assets, including goodwill, to their fair value during the fourth quarter of each fiscal year. Future annual assessments could result in impairment charges, which would be accounted for as an operating expense. 4. LONG-TERM DEBT Long-term debt at June 27, 2004 and December 28, 2003 consisted of the following: June 27, December 28, 2004 2003 ------- ----------- (Thousands) EUR 244 million variable interest rate term loan maturing in 2006 $37,942 $45,863 $100 million multi-currency variable interest rate revolving credit facility maturing in 2006 2,784 2,791 EUR 9.5 million capital lease maturing in 2021 10,341 10,733 EUR 2.7 million capital lease maturing in 2007 1,462 1,693 Other capital lease maturing in 2004 - 27 ------- ------- Total 52,529 61,107 Less current portion 19,427 18,506 ------- ------- Total long-term portion (excluding convertible subordinated debentures) 33,102 42,601 Convertible subordinated debentures 23,257 83,753 Less called portion of convertible subordinated debentures - 60,000 ------- ------- Total long-term portion $56,359 $66,354 ======= ======= At June 27, 2004, EUR 31.2 million (approximately $37.9 million) was outstanding under the multi-currency term loan. The outstanding borrowings under the revolving credit facility were JPY 300 million (approximately $2.8 million). The availability under the $100 million multi-currency revolving credit facility has been reduced by letters of credit totaling $12.3 million, primarily related to the surety bond posted in connection with the ID Security Systems Canada Inc. litigation. On February 18, 2004, the Company called $60.0 million of the convertible subordinated debentures for redemption on April 13, 2004. The debentures were convertible into common stock at a conversion price of $18.375 per share. Of the called debentures, $47.2 million were converted into 2.570 million shares of the Company's common stock and $12.8 million were redeemed for cash. CHECKPOINT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited) 5. INCOME TAXES Income taxes are provided on an interim basis at an estimated effective annual tax rate. The Company's earnings generated by the operations of its Puerto Rico subsidiary are partially exempt from Federal income taxes under Section 936 of the Internal Revenue Code (as amended under the Small Business Job Protection Act of 1996) and substantially exempt from Puerto Rico income taxes. Under current law, this exemption from Federal income tax is subject to certain limits during the years 2002 through 2005 and will be eliminated thereafter. Under Statement of Financial Accounting Standards No. 109 (SFAS 109), "Accounting for Income Taxes," deferred tax liabilities and assets are determined based on the difference between financial statement and tax basis of assets and liabilities using enacted statutory tax rates in effect at the balance sheet date. 6. PER SHARE DATA The following data shows the amounts used in computing earnings per share and the effect on income and the weighted average number of shares of dilutive potential common stock: Quarter Six Months (13 weeks) Ended (26 weeks) Ended ------------------- -------------------- June 27, June 29, June 27, June 29, 2004 2003 2004 2003 ------- ------- ------- ------- (Restated (Restated see Note 14) see Note 14) (Thousands, except per share amounts) Basic (loss)/earnings per share: Net (loss)/earnings $(6,442) $10,677 $(1,013) $14,807 ======= ======= ======= ======= Weighted average common stock outstanding 37,576 32,762 36,271 32,743 ======= ======= ======= ======= Basic (loss)/earnings per share $ (.17) $ .33 $ (.03) $ .45 ======= ======= ======= ======= CHECKPOINT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited) Diluted (loss)/earnings per share: Net (loss)/earnings $(6,442) $10,677 $(1,013) $14,807 Interest on subordinated debentures, net of tax (1) - 961 - 1,921 ------- ------- ------- ------- Net (loss)/earnings available for dilutive securities $(6,442) $11,638 $(1,013) $16,728 ======= ======= ======= ======= Weighted average common stock outstanding 37,576 32,762 36,271 32,743 Additional common shares resulting from stock options (2) 837 501 951 296 Additional common shares resulting from subordinated debentures (1) - 6,528 - 6,528 ------- ------- ------- ------- Weighted average common stock and dilutive stock outstanding 38,413 39,791 37,222 39,567 ======= ======= ======= ======= Diluted (loss)/earnings per share $ (.17) $ .29 $ (.03) $ .42 ======= ======= ======= ======= (1) The conversion of 1,266 and 2,902 common shares for the second quarter and the first six months of 2004, respectively, from the subordinated debentures is not included as it is anti-dilutive. (2) Excludes approximately 1,258, 1,179, 1,023 and 1,816 anti-dilutive outstanding stock options for the second quarters of 2004 and 2003, and the first six months of 2004 and 2003, respectively. CHECKPOINT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited) 7. SUPPLEMENTAL CASH FLOW INFORMATION Cash payments for interest and income taxes for the thirteen and twenty-six week periods ended June 27, 2004 and June 29, 2003 were as follows: Quarter Six Months (13 weeks) Ended (26 weeks) Ended -------------------- -------------------- June 27, June 29, June 27, June 29, 2004 2003 2004 2003 ------- ------- ------- ------- (Thousands) Interest $1,940 $4,514 $3,010 $5,988 Income tax payments, net $2,078 $4,153 $2,328 $3,107 During the first six months of 2004, $47.7 million of convertible subordinated debentures were converted into 2.597 million shares of the Company's common stock. 8. PROVISION FOR RESTRUCTURING Accrual Cash Accrual at Payments at Beginning (and Exchange March 28, of 2004 Rate Changes) 2004 --------- ------------ -------- (Thousands) Severance and other employee- related charges $ 8,878 $ (679) $ 8,199 Lease termination costs 1,295 (74) 1,221 ------- ------- ------- $10,173 $ (753) $ 9,420 ======= ======= ======= Accrual Cash Accrual at Payments at March 28, (and Exchange June 27, 2004 Rate Changes) 2004 -------- ------------ ------- (Thousands) Severance and other employee- related charges $ 8,199 $ (764) $ 7,435 Lease termination costs 1,221 (58) 1,163 ------- ------- ------- $ 9,420 $ (822) $ 8,598 ======= ======= ======= At the end of the second quarter 2004, 395 of the 512 planned employee terminations, related to the 2003 restructuring, had occurred. The Company expects the terminations and restructuring actions to be completed by the end of 2005. Termination benefits are being paid out over a period of 1 to 24 months after termination. CHECKPOINT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited) 9. OTHER OPERATING EXPENSE On August 1, 2004, the Company and ID Security Systems Canada Inc. entered into a settlement agreement effective July 30, 2004, pursuant to which the Company agreed to pay $19.95 million, in full and final settlement of the claims covered by the litigation between the two companies (see Note 11). Payment in full was made on August 5, 2004. 10. PENSION BENEFITS The components of net periodic benefit cost for the thirteen and twenty-six week periods ended June 27, 2004 and June 29, 2003 were as follows: Quarter Six Months (13 weeks) Ended (26 weeks) Ended -------------------- -------------------- June 27, June 29, June 27, June 29, 2004 2003 2004 2003 ------- ------- ------- ------- Service cost $ 329 $ 336 $ 681 $ 638 Interest cost 927 824 1,860 1,617 Expected return on plan assets 1 1 2 2 Amortization of prior service cost 1 - 2 1 Amortization of net loss 28 26 57 51 ------- ------- ------- ------- Net benefit cost $ 1,284 $ 1,185 $ 2,598 $ 2,305 ======= ======= ======= ======= The Company expects the cash requirements for funding the pension benefits to be approximately $3.4 million during fiscal 2004, including $0.7 million which was funded during the quarter ended June 27, 2004. CHECKPOINT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited) 11. CONTINGENT LIABILITIES The Company is involved in certain legal and regulatory actions, all of which have arisen in the ordinary course of business, except for the matters described in the following paragraphs. Management believes it is remotely possible that the ultimate resolution of such matters will have a material adverse effect on the Company's consolidated results of operations and/or financial condition, except as described below. ID Security Systems Canada Inc. versus Checkpoint Systems, Inc. On May 24, 2002, the jury in the Civil Action No. 99-CV-577 in the United States District Court for the Eastern District of Pennsylvania, filed by plaintiff ID Security Systems Canada Inc. against Checkpoint Systems, Inc., held in favor of the Company on the plaintiff's claim for Monopolization of Commerce, but against the Company on claims of Attempted Monopolization and Conspiracy to Monopolize. In addition, the jury held against the Company on two tort claims related to tortious interference and unfair competition. Judgment was entered on the verdict in favor of the plaintiff, after trebling, in the amount of $79.2 million plus attorneys' fees and costs to be determined by the Court. On March 28, 2003, the Court issued an order which vacated the jury verdict on the antitrust claims and reduced the damages award related to tortious interference and unfair competition from $19 million to $13 million. On May 20, 2003, the Court further reduced the judgment from $13 million to $10.9 million. On the same date, the Court stayed execution of the judgment upon the posting of a bond in the amount of $11.3 million by the Company. Both ID Security Systems Canada Inc. and the Company filed appeals to the Third Circuit Court of Appeals related to the various decisions of the Court. Oral arguments for these appeals were heard on March 30, 2004. On August 1, 2004, the Company and ID Security Systems Canada Inc. entered into a settlement agreement effective July 30, 2004, pursuant to which the Company agreed to pay $19.95 million, in full and final settlement of the claims covered by the litigation. Payment in full was made on August 5, 2004. The Company does not admit or acknowledge any wrongdoing or liability regarding the litigation. In connection with the settlement, the parties have mutually released each other from all other claims, except for any claims relating to existing contracts between the parties. A release in favor of the Company was also provided by various affiliates and associates of ID Security Systems Canada Inc. Management believes that the settlement is in the best interest of the Company to avoid the risks, burden, and expenses of continued litigation. Matters related to ID Security Systems Canada Inc. versus Checkpoint Systems, Inc. A certain number of follow-on purported class action suits have arisen in connection with the jury decision in the ID Security Systems Canada Inc. litigation. The purported class action complaints generally allege a claim of monopolization and are substantially based upon the same allegations as contained in the ID Security Systems Canada Inc. case (Civil Action No. 99-CV-577) as discussed below. CHECKPOINT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited) On August 1, 2002, a civil action was filed in United States District Court for the Eastern District of Pennsylvania, designated as Civil Action No. 02-6379(ER) by plaintiff Diane Furs, Inc. t/a Diane Furs against Checkpoint Systems, Inc. and served on August 21, 2002. On August 21, 2002, a Notice of Substitution of Plaintiff and Filing of Amended Complaint was filed by the plaintiff, and the named plaintiff was changed to Medi-Care Pharmacy, Inc. On August 2, 2002, a civil action was filed in the United States District Court, District of New Jersey (Camden) designated as Docket No. 02-CV-3730(JEI) by plaintiff Club Sports International, Inc., d/b/a Soccer CSI against Checkpoint Systems, Inc. and served on August 26, 2002. On October 2, 2002, a civil action was filed in the United States District Court, District of New Jersey (Camden) designated as Docket No. 02-CV-4777(JBS) by plaintiff Baby Mika, Inc. against Checkpoint Systems, Inc. and served on October 7, 2002. On October 23, 2002, a civil action was filed in the United States District Court, District of New Jersey (Camden) designated as Docket No. 02-CV-5001(JEI) by plaintiff Washington Square Pharmacy, Inc. against Checkpoint Systems, Inc. and served on November 1, 2002. On October 18, 2002, The United States District, District of New Jersey (Camden) entered an Order staying the proceedings in the Club Sports International, Inc. and Baby Mika, Inc. cases referred to above. In accordance with the Order, the Stay will also apply to the Washington Square Pharmacy, Inc. case referred to above. In addition, the Medi-Care Pharmacy, Inc. case, referred to above, will be voluntarily dismissed, and it has been re-filed in New Jersey and is included in the Stay Order. As a result of the settlement of the litigation with ID Security Systems Canada Inc. described above, an application can be made to the Court to dissolve the Stay Order at this time. On November 13, 2002, a civil action was filed in the United States District Court, District of New Jersey (Camden) designated as Docket No. 02-CV-5319(JEI) by plaintiff 1700 Pharmacy, Inc. against Checkpoint Systems, Inc. and served on November 15, 2002. On December 30, 2002, a civil action was filed in the United States District Court, District of New Jersey (Camden) designated as Docket No. 02-CV-6131(JEI) by plaintiff Medi-Care Pharmacy, Inc. against Checkpoint Systems, Inc. and served on January 3, 2003. Both the 1700 Pharmacy, Inc. case and the Medi-Care Pharmacy, Inc. case were consolidated with the previously mentioned cases and are included in the October 18, 2002 Stay Order referred to above. No liability has been recorded for any of the purported class action suits. CHECKPOINT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited) The following table set forth the movement in the warranty reserve: Quarter Six Months (13 weeks) Ended (26 weeks) Ended -------------------- -------------------- June 27, June 29, June 27, June 29, 2004 2003 2004 2003 ------- ------- ------- ------- (Thousands) Balance at the beginning of the period $ 4,636 $ 4,111 $ 4,591 $ 4,002 Accruals for warranties issued $ 489 $ 280 $ 795 $ 496 Accruals related to pre-existing warranties, including changes in estimate 15 - 15 - ------- ------- ------- ------- Total accruals $ 504 $ 280 $ 810 $ 496 Settlement made (423) (204) (627) (385) Foreign currency translation adjustment 36 186 (21) 260 ------- ------- ------- ------- Balance at the end of period $ 4,753 $ 4,373 $ 4,753 $ 4,373 ======= ======= ======= ======= 12. BUSINESS SEGMENTS Quarter Six Months (13 weeks) Ended (26 weeks) Ended -------------------- -------------------- June 27, June 29, June 27, June 29, 2004 2003 2004 2003 -------- -------- -------- -------- (Thousands) Business segment net revenues: Security $120,666 $111,962 $233,195 $204,726 Labeling Services 41,446 39,392 82,486 78,015 Retail Merchandising 27,158 24,366 54,235 49,396 -------- -------- -------- -------- Total $189,270 $175,720 $369,916 $332,137 ======== ======== ======== ======== Business segment gross profit: Security $ 55,847 $ 51,921 $103,864 $ 91,563 Labeling Services 11,985 11,724 22,642 23,047 Retail Merchandising 9,218 11,966 21,751 24,150 -------- -------- -------- -------- Total gross profit $ 77,050 $ 75,611 $148,257 $138,760 Operating expenses 83,508 56,623 145,385 111,520 Interest expense, net 1,141 2,543 2,868 5,247 Other (loss)/gain, net (169) (209) (113) 539 -------- -------- -------- -------- (Loss)/earnings before income taxes $ (7,768) $ 16,236 $ (109) $ 22,532 ======== ======== ======== ======== CHECKPOINT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited) 13. NEW ACCOUNTING PRONOUNCEMENTS AND OTHER STANDARDS No new accounting pronouncements and other standards material to the Company were issued in the first six months of 2004. 14. RESTATEMENT On May 21, 2004 the Company filed Amendment No. 1 to the Annual Report on Form 10-K for the fiscal year ended December 28, 2003 (Form 10-K/A) to restate the Company's financial results for the fiscal years 2002 and 2003 following the Company's discovery of errors in the computation of its income tax expense relating to tax credits on the income from the Company's Puerto Rico operations as well as certain foreign income inclusions for U.S. tax purposes for fiscal years 2002 and 2003. The effect of the adjustments was to increase income tax expense and decrease net earnings by $3.6 million in fiscal year 2002 and $0.7 million in fiscal year 2003. The Company has also restated its consolidated balance sheet at December 28, 2003 and its consolidated statements of operations for the quarter and six months ended June 29, 2003 that are included in this quarterly report on Form 10-Q. In 1996, Congress revised the Section 936 credit for U.S. manufacturers doing business in Puerto Rico. The tax credits expire for fiscal years beginning after December 31, 2005. The U.S. Internal Revenue Code provides limitations on the use of the tax credits during a phase-out period for years 2002-2005. The Company made an error in computing the limitation during the phase-out period. The effects of the adjustments are summarized as follows: Previously As reported restated ---------- -------- Consolidated Statement of Operations for the Quarter ended June 29, 2003 Income taxes $ 5,357 $ 5,542 Net earnings $ 10,862 $ 10,677 Consolidated Statement of Operations for the six months ended June 29, 2003 Income taxes $ 7,435 $ 7,691 Net earnings $ 15,063 $ 14,807 The restatement reduced the diluted earnings per share for the quarter ended June 29, 2003 from $.30 to $.29 and for the six months ended June 29, 2003 from $.43 to $.42, but had no effect on cash flows. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Information relating to Forward-Looking Statements This report includes forward-looking statements made pursuant to the safe harbor provision of the Private Securities Litigation Reform Act of 1995. Except for historical matters, the matters discussed are forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, that reflect the Company's current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties which could cause actual results to differ materially from historical results or those anticipated. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The following risk factors, among other possible factors, could cause actual results to differ materially from historical or anticipated results: (1) changes in international business conditions; (2) foreign currency exchange rate and interest rate fluctuations; (3) lower than anticipated demand by retailers and other customers for the Companys products, particularly in the current economic environment; (4) slower commitments of retail customers to chain-wide installations and/or source tagging adoption or expansion; (5) possible increases in per unit product manufacturing costs due to less than full utilization of manufacturing capacity as a result of slowing economic conditions or other factors; (6) the Company's ability to provide and market innovative and cost-effective products; (7) the development of new competitive technologies; (8) the Company's ability to maintain its intellectual property; (9) competitive pricing pressures causing profit erosion; (10) the availability and pricing of component parts and raw materials; (11) possible increases in the payment time for receivables, as a result of economic conditions or other market factors; (12) changes in regulations or standards applicable to the Company's products; (13) unanticipated liabilities or expenses; (14) adverse determinations in pending litigation affecting the Company; and (15) the impact of adverse determinations in pending litigation on liquidity and debt covenant compliance. More information about potential factors that could affect the Company's business and financial results is included in the Company's Annual Report on Form 10-K/A for the year ended December 2003, and the Company's other Securities and Exchange Commission filings. Critical Accounting Policies and Estimates - ------------------------------------------ For a discussion of the Company's critical accounting policies and estimates, see Item 7 "Management's Discussion And Analysis Of Financial Condition And Results Of Operations" in the Company's Annual Report on Form 10-K/A filed for the year ended December 28, 2003. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Management's discussion and analysis of financial condition and results of operations reflects the restatement of the Company's financial statements for the fiscal years 2002 and 2003 following the Company's discovery of errors in the computation of its income tax expense relating to tax credits on the income from the Company's Puerto Rico operations as well as certain foreign income inclusions for U.S. tax purposes for fiscal years 2002 and 2003. See Note 14 to the Consolidated Financial Statements. Second Quarter 2004 Compared to Second Quarter 2003 - --------------------------------------------------- Net Revenues Revenues for the second quarter 2004 compared to the second quarter 2003 increased by $13.6 million or 7.7% from $175.7 million to $189.3 million. Foreign currency translation had a positive impact on revenues of approximately $7.6 million or 4.3% in the second quarter of 2004 as compared to the second quarter of 2003. Security revenues increased by $8.7 million or 7.8% in the second quarter of 2004 as compared to the second quarter of 2003. Foreign currency translation had positive impact of approximately $4.5 million. The remaining increase was primarily due to growth in the closed-circuit television (CCTV) market in the USA, Japan, and Canada, partially offset by a decline in European electronic article surveillance (EAS) sales of $2.4 million. The growth in the US CCTV revenues of $4.8 million can be primarily attributed to enhanced products and applications, as well as a focus on customer service. Labeling services revenues increased by $2.1 million or 5.2% of which approximately $1.7 million was due to the positive impact of foreign currency translation. Increases in barcode labeling systems (BCS) revenues in the USA ($0.8 million), Check-Net revenues in Europe ($0.7 million) and Asia Pacific ($0.7 million), and radio frequency identification (RFID) library system revenues outside the USA ($0.6 million) were largely offset by lower BCS revenues in Europe ($2.4 million) caused by weak retail trading and price competition. Retail merchandising revenues increased by $2.8 million or 11.4%. The positive impact of foreign currency translation was approximately $1.4 million. The remaining increase was primarily due to an increase of $1.5 million in retail display system revenues in Europe partially offset by continued decreases in hand-held labeling systems (HLS) in Europe and the USA. The continuing transition from hand-held price labeling to automated barcoding and scanning by retailers caused the decline in HLS. Gross Profit Gross profit for the second quarter 2004 was $77.1 million, or 40.7% of revenues, compared to $75.6 million, or 43.0% of revenues, for the second quarter 2003. The benefit of foreign currency translation on gross profit was approximately $3.0 million in the second quarter of 2004 as compared to the second quarter of 2003. Included in gross profit are research and development costs, which increased from $3.0 million, or 1.7% of revenues, in the second quarter of 2003 to $6.9 million, or 3.6% of revenues, in the second quarter of 2004. Security gross profit, as a percentage of sales, decreased from 46.4% in the second quarter of 2003 to 46.3% in the second quarter of 2004. Improvements in manufacturing efficiencies and the benefits of a weaker U.S. dollar on MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) products sourced in U.S. dollars but sold in a different currency were offset by increases in field service costs due to large roll-outs. The increase in CCTV revenues as a percentage of security revenues also impacted the security gross profit percentage negatively. Gross profit, as a percentage of net revenues, for labeling services declined from 29.8% in the second quarter of 2003 to 28.9% in the second quarter of 2004. Increased technology spending on RFID library products primarily caused the decline. The retail merchandising gross profit, as a percentage of net revenues, declined from 49.1% in the second quarter of 2003 to 33.9% in the second quarter 2004. The decrease in gross profit as a percentage of net revenues resulted from an increase of $3.7 million in RFID technology spending to support the development of supply chain and in-store merchandising solutions for US and European retailers. Field service and installation costs for the second quarter of 2004 and 2003 were 9.2% and 8.7% of net revenues, respectively. The increase, as a percentage of net revenues, resulted from an increase in CCTV installations relative to total net revenues. Selling, General, and Administrative Expenses SG&A expenses increased $6.9 million over the second quarter of 2003. Foreign currency translation increased SG&A expenses by approximately $2.5 million. As a percentage of net revenues, SG&A expenses increased from 32.2% to 33.5% due primarily to the Company's ongoing commitment to invest in selling and marketing. Other Operating Expense On August 1, 2004, the Company and ID Security Systems Canada Inc. (ID Systems) entered into a settlement agreement effective July 30, 2004, pursuant to which the Company agreed to pay $19.95 million, in full and final settlement of the claims covered by the litigation between the two companies (see Note 11 of the Consolidated Financial Statements). Payment in full was made on August 5, 2004. Interest Expense and Interest Income Interest expense for the second quarter of 2004 decreased $1.5 million from the comparable quarter in 2003 due to debt repayment and the conversion of subordinated debentures into shares of the Company's common stock. Interest income for the second quarter of 2004 decreased by $0.1 million from the comparable quarter in 2003 (from $0.4 million to $0.3 million) as a result of lower interest rates in the second quarter of 2004. Other (Loss)/Gain, net Other (loss)/gain, net resulted from net foreign currency transaction losses of $(0.2) million for the second quarters of 2004 and 2003. Income Taxes Excluding the tax impact of the ID Systems settlement, the effective tax rate for the second quarter 2004 was 30.6%. For the second quarter 2003, the effective tax rate was 34.1%. The 2003 effective tax rate included an increase in tax related to a change in valuation allowance and an increase in deferred foreign withholding taxes. These items are not reflected in the 2004 effective tax rate. The Company recorded a tax benefit on the ID Systems settlement at the US statutory rate. However, as the ID Systems settlement created a taxable loss in the US, the Company recorded a valuation allowance of $1.9 million on US deferred tax assets related to foreign tax credit carryforwards. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Net (Loss)/Earnings Net (loss)/earnings were $(6.4) million, or $(0.17) per diluted share, in the second quarter 2004 compared to $10.7 million, or $0.29 per diluted share, in the second quarter 2003. The ID Systems settlement resulted in a reduction of net earnings of $14.9 million, or approximately $0.39 per diluted share. The weighted average number of shares used in the diluted earnings per share computation were 38.4 million and 39.8 million for the second quarters of 2004 and 2003, respectively. First Half 2004 Compared to First Half 2003 - ------------------------------------------- Net Revenues Revenues for the first six months of 2004 compared to the same period in 2003 increased by $37.8 million or 11.4% from $332.1 million to $369.9 million. Foreign currency translation had a positive impact on revenues of approximately $23.1 million or 7.0% in the first half of 2004 as compared to the second half of 2003. Security revenues increased by $28.5 million or 13.9% in the first six months of 2004 as compared to the first six months of 2003. Foreign currency translation had a positive impact of approximately $13.3 million. The remaining increase was primarily due to growth in the closed-circuit television (CCTV) market in the USA, Japan, and the UK and in the electronic article surveillance (EAS) market in Asia Pacific, partially offset by a $3.6 million decline in European EAS sales. The growth in the US CCTV revenues can be primarily attributed to enhanced products and applications, as well as a focus on customer service. Labeling services revenues increased by $4.5 million or 5.7% due to the positive impact of foreign currency translation of approximately $5.0 million. The remaining decrease was primarily due to lower barcode labeling systems (BCS) revenues in Europe ($4.1 million) caused by weak retail trading and price competition and a decrease in radio frequency identification (RFID) library system revenues in the USA ($2.0 million) resulting from the timing of several large orders that were recognized in the first quarter of 2003. This was largely offset by increases in BCS revenues in the USA ($2.3 million) and Check-Net revenues in Europe ($1.6 million) and Asia Pacific ($1.1 million). Retail merchandising revenues increased by $4.8 million or 9.8%. The positive impact of foreign currency translation was approximately $4.8 million. Increased retail display system revenues in Europe of $1.7 million were offset by decreased hand-held labeling system (HLS) revenues in Europe and the USA. The continuing transition from hand-held price labeling to automated barcoding and scanning by retailers caused the decline in HLS. Gross Profit Gross profit for the first half of 2004 was $148.3 million, or 40.1% of revenues, compared to $138.8 million, or 41.8% of revenues, for the first half of 2003. The benefit of foreign currency translation on gross profit was approximately $9.4 million in the first six months of 2004 as compared to the MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) same period in 2003. Included in gross profit are research and development costs, which increased from $5.4 million, or 1.6% of revenues, in the first half of 2003 to $12.4 million, or 3.4% of revenues, in the first half of 2004. Security gross profit, as a percentage of sales, decreased from 44.7% in the first six months of 2003 to 44.5% in the first six months of 2004. Improvements in manufacturing efficiencies and the benefits of a weaker U.S. dollar on products sourced in U.S. dollars but sold in a different currency were more than offset by increases in field service costs due to large roll-outs and a $1.6 million increase in technology spending. The increase in CCTV revenues as a percentage of security revenues also impacted the security gross profit percentage negatively. Gross profit, as a percentage of net revenues, for labeling services declined from 29.5% in the first half of 2003 to 27.4% in the first half of 2004. Increased technology spending of $1.1 million on RFID library products and competitive pricing pressures primarily caused the decline. The retail merchandising gross profit, as a percentage of net revenues, declined from 49.1% in the first six months of 2003 to 40.1% in the comparable period of 2004. The decrease resulted primarily from a $4.3 million increase in RFID technology spending to support the development of supply chain and in-store merchandising solutions for US and European retailers. Field service and installation costs for the first half of 2004 and 2003 were 9.4% and 8.8% of net revenues, respectively. The increase, as a percentage of net revenues, resulted from an increase in CCTV installations relative to total net revenues. Selling, General, and Administrative Expenses SG&A expenses increased $13.9 million over the first six months of 2003. Foreign currency translation increased SG&A expenses by approximately $7.8 million. As a percentage of net revenues, SG&A expenses increased from 33.6% to 33.9% due to the Company's increased investment in selling and marketing. Other Operating Expense On August 1, 2004, the Company and ID Security Systems Canada Inc. entered into a settlement agreement effective July 30, 2004, pursuant to which the Company agreed to pay $19.95 million, in full and final settlement of the claims covered by the litigation between the two companies (see Note 11 of the Consolidated Financial Statements). Payment in full was made on August 5, 2004. Interest Expense and Interest Income Interest expense for the first six months of 2004 decreased $2.3 million from the comparable quarter in 2003 due to debt repayment and the conversion of subordinated debentures into shares of the Company's common stock. Interest income for the first half of fiscal 2004 increased by $0.1 million from the comparable quarter in 2003 (from $0.7 million to $0.8 million). Higher cash balances in the first six months of 2004 were largely offset by lower interest rates during the same period. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Other (Loss)/Gain, net Other (loss)/gain, net resulted from net foreign currency transaction losses of $(0.1) million in the first half of fiscal 2004 and gains of $0.5 million in the first half of fiscal 2003. Income Taxes Excluding the tax impact of the ID Systems settlement, the effective tax rate for the first six months of 2004 was 30.0%. For the same period in 2003, the effective tax rate was 34.1%. The 2003 effective tax rate included an increase in tax related to a change in valuation allowance and an increase in deferred foreign withholding taxes. These items are not reflected in the 2004 effective tax rate. The Company recorded a tax benefit on the ID Systems settlement at the US statutory tax rate. However, as the ID Systems settlement created a taxable loss in the US, the Company recorded a valuation allowance of $1.9 million on US deferred tax assets related to foreign tax credit carryforwards. Net (Loss)/Earnings The Company's net (loss)/earnings were $(1.0) million, or $(0.03) per diluted share, for the first six months of 2004 compared to $14.8 million, or $0.42 per diluted share, in the same period of 2003. The ID Systems settlement resulted in a reduction of net earnings of $14.9 million, or approximately $0.39 per diluted share. The weighted average number of shares used in the diluted earnings per share computation were 37.2 million and 39.6 million for the first six months of 2004 and 2003, respectively. Exposure to International Operations Approximately 65.4% of the Company's sales are made in currencies other than U.S. dollars. Sales denominated in currencies other than U.S. dollars increase the Company's potential exposure to currency fluctuations, which can affect results. Management cannot predict, with any degree of certainty, changes in currency exchange rates and, therefore, the future impact that such changes may have on its operations. Restructuring The changes in the provision for restructuring are covered in Note 8 of the Consolidated Financial Statements. FINANCIAL CONDITION - ------------------- Liquidity and Capital Resources The Company's liquidity needs have related to, and are expected to continue to relate to, capital investments, acquisitions, and working capital requirements. The Company has met its liquidity needs over the last three years primarily through funds provided by long-term borrowings and more recently through cash generated from operations. Management believes that its anticipated cash needs for the foreseeable future can be funded from cash and cash equivalents on hand, the availability under the $100 million revolving credit facility, and cash generated from future operations. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) The Company's operating activities utilized approximately $20.7 million during the first six months of 2004 compared to $23.6 million generated in the same period of 2003. This change from the prior year was primarily attributable to a reduction in accounts payable and accrued compensation of $24.2 million and increases of $12.7 million in inventories and $2.8 million in accounts receivable due to increased revenues. The ID Systems settlement was not paid until the third quarter 2004 and is included in other current liabilities. At June 27, 2004, EUR 31.2 million (approximately $37.9 million) was outstanding under the multi-currency term loan. The outstanding borrowings under the revolving credit facility were JPY 300 million (approximately $2.8 million). The availability under the $100 million multi-currency revolving credit facility has been reduced by letters of credit totaling $12.3 million, primarily related to the surety bond posted in connection with the ID Security Systems Canada Inc. litigation. At June 27, 2004, the Company was in compliance with its debt covenants. On February 18, 2004, the Company called $60.0 million of its convertible subordinated debentures for redemption on April 13, 2004. The debentures were convertible into common stock at a conversion price of $18.375 per share. Of the called debentures, $47.2 million were converted into 2.570 million shares of the Company's common stock and $12.8 million were redeemed for cash. The Company does not anticipate paying any cash dividend in the near future and is limited by existing covenants in the Company's debt instruments with regard to paying dividends. On May 24, 2002, the jury in the Civil Action No. 99-CV-577 in the United States District Court for the Eastern District of Pennsylvania, filed by plaintiff ID Security Systems Canada Inc. against Checkpoint Systems, Inc., held in favor of the Company on the plaintiff's claim for Monopolization of Commerce, but against the Company on claims of Attempted Monopolization and Conspiracy to Monopolize. In addition, the jury held against the Company on two tort claims related to tortious interference and unfair competition. Judgment was entered on the verdict in favor of the plaintiff, after trebling, in the amount of $79.2 million plus attorneys' fees and costs to be determined by the Court. On March 28, 2003, the Court issued an order which vacated the jury verdict on the antitrust claims and reduced the damages award related to tortious interference and unfair competition from $19 million to $13 million. On May 20, 2003, the Court further reduced the judgment from $13 million to $10.9 million. On the same date, the Court stayed execution of the judgment upon the posting of a bond in the amount of $11.3 million by the Company. Both ID Security Systems Canada Inc. and the Company filed appeals to the Third Circuit Court of Appeals related to the various decisions of the Court. Oral arguments for these appeals were heard on March 30, 2004. On August 1, 2004, the Company and ID Security Systems Canada Inc. entered into a settlement agreement effective July 30, 2004, pursuant to which the Company agreed to pay $19.95 million, in full and final settlement of the claims MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) covered by the litigation. Payment in full was made on August 5, 2004 from cash on hand and borrowing capacity. Subsequent to the payment, management continues to believe that its anticipated cash needs for the foreseeable future can be funded from cash and cash equivalents on hand, the availability under the $100 million revolving credit facility, and cash generated from future operations. Capital Expenditures The Company's capital expenditures during the first half of fiscal 2004 totaled $5.1 million compared to $7.8 million during the first half of fiscal 2003. The decrease in 2004 principally resulted from lower manufacturing-related investments. The Company anticipates capital expenditures to primarily upgrade technology and improve its production capabilities to total approximately $14 million in 2004. Exposure to International Operations The Company manufactures products in the USA, the Caribbean, Europe, and the Asia Pacific region for both the local marketplace as well as for export to its foreign subsidiaries. The subsidiaries, in turn, sell these products to customers in their respective geographic areas of operation, generally in local currencies. This method of sale and resale gives rise to the risk of gains or losses as a result of currency exchange rate fluctuations on the inter-company receivables and payables. Additionally, the sourcing of product in one currency and the sales of product in a different currency can cause gross margin fluctuations due to changes in currency exchange rates. The Company selectively purchases currency forward exchange contracts to reduce the risks of currency fluctuations on short-term inter-company receivables and payables. These contracts lock in a predetermined exchange rate at the time the contract is purchased. This allows the Company to shift the risk, whether positive or negative, of currency fluctuations from the date of the contract to a third party. As of June 27, 2004, the Company had currency forward exchange contracts totaling approximately $33.8 million. The contracts are in the various local currencies covering primarily the Company's Western European, Canadian, and Australian operations. Historically, the Company has not purchased currency forward exchange contracts where it is not economically efficient, specifically for its operations in South America and Asia. The Company has historically not used financial instruments to minimize its exposure to currency fluctuations on its net investments in and cash flows derived from its foreign subsidiaries. The Company has used third party borrowings in foreign currencies to hedge a portion of its net investments in and cash flows derived from its foreign subsidiaries. As the Company reduces its third party foreign currency borrowings, the effect of foreign currency fluctuations on its net investments in and cash flows derived from its foreign subsidiaries increases. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) OTHER MATTERS - ------------- New Accounting Pronouncements and Other Standards No new accounting pronouncements and other standards material to the Company were issued in the second quarter of 2004. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There have been no significant changes to the market risks as disclosed in Item 7a. "Quantitative And Qualitative Disclosures About Market Risk" of the Company's Annual Report on Form 10-K/A filed for the year ended December 28, 2003. Item 4. DISCLOSURE CONTROLS AND PROCEDURES The Company carried out an evaluation, under the supervision and with the participation of the Company's principal executive officer and principal financial officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, the Company's principal executive officer and principal financial officer concluded that the Company's disclosure controls and procedures are effective in alerting them, on a timely basis, to material information required to be included in the Company's periodic SEC reports. PART II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS The Company is involved in certain legal and regulatory actions, all of which have arisen in the ordinary course of business, except for the matters described in the following paragraphs. Management believes it is remotely possible that the ultimate resolution of such matters will have a material adverse effect on the Company's consolidated results of operations and/or financial condition, except as described below. ID Security Systems Canada Inc. versus Checkpoint Systems, Inc. On May 24, 2002, the jury in the Civil Action No. 99-CV-577 in the United States District Court for the Eastern District of Pennsylvania, filed by plaintiff ID Security Systems Canada Inc. against Checkpoint Systems, Inc., held in favor of the Company on the plaintiff's claim for Monopolization of Commerce, but against the Company on claims of Attempted Monopolization and Conspiracy to Monopolize. In addition, the jury held against the Company on two tort claims related to tortious interference and unfair competition. Judgment was entered on the verdict in favor of the plaintiff, after trebling, in the amount of $79.2 million plus attorneys' fees and costs to be determined by the Court. On March 28, 2003, the Court issued an order, which vacated the jury verdict on the antitrust claims and reduced the damages award related to tortuous interference and unfair competition from $19 million to $13 million. On May 20, 2003, the Court further reduced the judgment from $13 million to $10.9 million. On the same date, the Court stayed execution of the judgment upon the posting of a bond in the amount of $11.3 million by the Company. Both ID Security Systems Canada Inc. and the Company filed appeals to the Third Circuit Court of Appeals related to the various decisions of the Court. Oral arguments for these appeals were heard on March 30, 2004. On August 1, 2004, the Company and ID Security Systems Canada Inc. entered into a settlement agreement effective July 30, 2004, pursuant to which the Company agreed to pay $19.95 million, in full and final settlement of the claims covered by the litigation. Payment in full was made on August 5, 2004. The Company does not admit or acknowledge any wrongdoing or liability regarding the litigation. In connection with the settlement, the parties have mutually released each other from all other claims, except for any claims relating to existing contracts between the parties. A release in favor of the Company was also provided by various affiliates and associates of ID Security Systems Canada Inc. Management believes that the settlement is in the best interest of the Company to avoid the risks, burden, and expenses of continued litigation. Matters related to ID Security Systems Canada Inc. versus Checkpoint Systems, Inc. A certain number of follow-on purported class action suits have arisen in connection with the jury decision in the ID Security Systems Canada Inc. litigation. The purported class action complaints generally allege a claim of monopolization and are substantially based upon the same allegations as contained in the ID Security Systems Canada Inc. case (Civil Action No. 99-CV-577) as discussed below. On August 1, 2002, a civil action was filed in United States District Court for the Eastern District of Pennsylvania, designated as Civil Action No. 02-6379(ER) by plaintiff Diane Furs, Inc. t/a Diane Furs against Checkpoint Systems, Inc. and served on August 21, 2002. On August 21, 2002, a Notice of Substitution of Plaintiff and Filing of Amended Complaint was filed by the plaintiff, and the named plaintiff was changed to Medi-Care Pharmacy, Inc. On August 2, 2002, a civil action was filed in the United States District Court, District of New Jersey (Camden) designated as Docket No. 02-CV-3730(JEI) by plaintiff Club Sports International, Inc., d/b/a Soccer CSI against Checkpoint Systems, Inc. and served on August 26, 2002. On October 2, 2002, a civil action was filed in the United States District Court, District of New Jersey (Camden) designated as Docket No. 02-CV-4777(JBS) by plaintiff Baby Mika, Inc. against Checkpoint Systems, Inc. and served on October 7, 2002. On October 23, 2002, a civil action was filed in the United States District Court, District of New Jersey (Camden) designated as Docket No. 02-CV-5001(JEI) by plaintiff Washington Square Pharmacy, Inc. against Checkpoint Systems, Inc. and served on November 1, 2002. On October 18, 2002, The United States District, District of New Jersey (Camden) entered an Order staying the proceedings in the Club Sports International, Inc. and Baby Mika, Inc. cases referred to above. In accordance with the Order, the Stay will also apply to the Washington Square Pharmacy, Inc. case referred to above. In addition, the Medi-Care Pharmacy, Inc. case, referred to above, will be voluntarily dismissed, and it has been re-filed in New Jersey and is included in the Stay Order. As a result of the settlement of the litigation with ID Security Systems Canada Inc. described above, an application can be made to the Court to dissolve the Stay Order at this time. On November 13, 2002, a civil action was filed in the United States District Court, District of New Jersey (Camden) designated as Docket No. 02-CV-5319 (JEI) by plaintiff 1700 Pharmacy, Inc. against Checkpoint Systems, Inc. and served on November 15, 2002. On December 30, 2002, a civil action was filed in the United States District Court, District of New Jersey (Camden) designated as Docket No. 02-CV-6131 (JEI) by plaintiff Medi-Care Pharmacy, Inc. against Checkpoint Systems, Inc. and served on January 3, 2003. Both the 1700 Pharmacy, Inc. case and the Medi-Care Pharmacy, Inc. case were consolidated with the previously mentioned cases and are included in the October 18, 2002 Stay Order referred to above. No liability has been recorded for any of the purported class action suits. All-Tag Security S.A., et al. On April 22, 2004 the United States District Court For The Eastern District Of Pennsylvania issued an opinion granting All-Tag Security S.A. and All-Tag Security Americas, Inc.'s (jointly "All-Tag") and Sensormatic Electronics Corporation's motion for summary judgment, which was filed on February 15, 2002, and ordered the case closed. The Company originally filed suit on May 1, 2001, alleging that the disposable, deactivatable radio frequency security tag manufactured by All-Tag S.A. and sold by Sensormatic infringed on a patent owned by the Company. The Court determined that the US patent is invalid because the original application failed to identify a co-inventor. The original US application was filed in March 1988 and was scheduled to expire on March 15, 2008. The Company acquired the patent in 1995 when it acquired Actron AG. On May 24, 2004, the Company filed a Notice of Appeal to the District Court's decision. The Company's appeal is currently pending before the United States Court of Appeals for the Federal Circuit. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) An annual meeting of shareholders was held on April 29, 2004. (b) Directors elected at the meeting were: William S. Antle, III, W. Craig Burns, John E. Davies, Jr., and R. Keith Elliott. Directors whose term of office as a director continued after the meeting are: Robert O. Aders, David W. Clark, Jr., Alan R. Hirsig, George W. Off, Jack W. Partridge and Sally Pearson (c) Shareholders voted upon the election and approved the following three matters: (1) The election of William S. Antle, III, W. Craig Burns, John E. Davies, Jr., and R. Keith Elliott as the Company's Class I directors to hold office until the 2007 Annual Shareholders Meeting. Shareholders voted as follows: William S. Antle, III W. Craig Burns John E. Davies Jr. R. Keith Elliott --------------------- -------------- ------------------ ---------------- For 30,805,001 31,006,693 31,021,220 30,365,773 Against 836,861 635,169 620,642 1,276,089 ---------- ---------- ---------- ---------- 31,641,862 31,641,862 31,641,862 31,641,862 ========== ========== ========== ========== (2) To approve the Checkpoint Systems, Inc. 2004 Omnibus Incentive Compensation Plan. For Against Abstained Unvoted ---------- --------- ----------- --------- 18,924,082 5,169,525 75,759 7,472,496 (3) To approve the Checkpoint Systems, Inc. 423 Employee Stock Purchase Plan: For Against Abstained Unvoted ---------- --------- ----------- --------- 23,084,763 1,026,357 58,247 7,472,495 Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 31.1 Rule 13a-14(a)/15d-14(a) Certification of George W. Off, Chairman of the Board, President and Chief Executive Officer. 31.2 Rule 13a-a4(a)/15d-14(a) Certification of W. Craig Burns, Executive Vice President, Chief Financial Officer and Treasurer. 32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K On April 14, 2004, the Company filed a Current Report on Form 8-K attaching a press release dated April 14, 2004 announcing that the holders of $47.2 million of the $60.0 million of aggregate principal amount of its existing 5-1/4% Convertible Subordinated Debentures due 2005 ("the Notes") called for redemption on April 13, 2004, elected to convert their Notes into 2,569,797 shares of the Company's common stock at a conversion price of $18.375 per share. The shares of Company common stock issuable as a result of the conversion are freely-tradable, unrestricted shares. On May 13, 2004 the Company filed a Current Report on Form 8-K attaching a press release dated May 12, 2004 announcing that it intended to restate its financial results for 2002 and 2003. SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CHECKPOINT SYSTEMS, INC. /s/W. Craig Burns August 5, 2004 - ---------------------------- W. Craig Burns Executive Vice President, Chief Financial Officer and Treasurer /s/Arthur W. Todd August 5, 2004 - ---------------------------- Arthur W. Todd Vice President, Corporate Controller and Chief Accounting Officer INDEX TO EXHIBITS ----------------- Exhibit Description - ---------- ----------- 31.1 Rule 13a-14(a)/15d-14(a) Certification of George W. Off, Chairman of the Board, President and Chief Executive Officer 31.2 Rule 13a-4(a)/15d=14(a) Certification of W. Craig Burns, Executive Vice President, Chief Financial Officer and Treasurer 32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 936 of the Sarbanes-Oxley Act of 2002. EX-31 2 exh3112q04.txt EXHIBIT 31.1 SECOND Q 2004 FORM 10-Q CERTIFICATION I, George W. Off, Chairman of the Board, President and Chief Executive Officer of Checkpoint Systems, Inc. certify that: 1. I have reviewed this quarterly report on Form 10-Q of Checkpoint Systems, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. By: /s/George W. Off ---------------------------- Name: George W. Off Title: Chairman of the Board, President and Chief Executive Officer Date: August 5, 2004 EX-31 3 exh3122q04.txt EXHIBIT 31.2 SECOND QUARTER 2004 FORM 10-Q CERTIFICATION I, W. Craig Burns, Executive Vice President, Chief Financial Officer and Treasurer of Checkpoint Systems, Inc. certify that: 1. I have reviewed this quarterly report on Form 10-Q of Checkpoint Systems, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. By: /s/W. Craig Burns ------------------------------- Name: W. Craig Burns Title: Executive Vice President, Chief Financial Officer and Treasurer Date: August 5, 2004 EX-32 4 exh322q04.txt EXHIBIT 32 SECOND QUARTER 2004 FORM 10-Q CERTIFICATION FURNISHED PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The undersigned executive officers of the Registrant hereby certify that this Quarterly Report on Form 10-Q for the quarter ended June 27, 2004 (the Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant. By: /s/George W. Off ------------------------------- Name: George W. Off Title: Chairman of the Board, President and Chief Executive Officer By: /s/W. Craig Burns ------------------------------- Name: W. Craig Burns Title: Executive Vice President, Chief Financial Officer and Treasurer A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission upon request. This certification accompanies the Report and shall not be treated as having been filed as part of the Report. Date: August 5, 2004 -----END PRIVACY-ENHANCED MESSAGE-----