UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
For the quarterly period ended March 31, 2007
OR
For the transition period from to
Commission File Number: 000-19406
Zebra Technologies Corporation
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
333 Corporate Woods Parkway, Vernon Hills, IL 60061
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (847) 634-6700
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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. Check one:
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act. Yes ¨ No x
As of April 30, 2007, there were the following shares outstanding:
Class A Common Stock, $.01 par value 69,075,356
ZEBRA TECHNOLOGIES CORPORATION
QUARTER ENDED MARCH 31, 2007
INDEX
PAGE
PART I - FINANCIAL INFORMATION
Item 1.
Consolidated Financial Statements
Consolidated Balance Sheets as of March 31, 2007 (unaudited) and December 31, 2006
Consolidated Statements of Earnings (unaudited) for the three months ended March 31, 2007 and April 1, 2006
Consolidated Statements of Comprehensive Income (unaudited) for the three months ended March 31, 2007 and April 1, 2006
Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2007 and April 1, 2006
Notes to Consolidated Financial Statements
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
PART II - OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.
Exhibits and Reports on Form 8-K
SIGNATURES
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Item 1. Consolidated Financial Statements
ZEBRA TECHNOLOGIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
Current assets:
Cash and cash equivalents
Investments and marketable securities
Accounts receivable, net
Inventories, net
Deferred income taxes
Prepaid expenses
Total current assets
Property and equipment at cost, less accumulated depreciation and amortization
Long-term deferred income taxes
Goodwill
Other intangibles, net
Long-term investments and marketable securities
Other assets
Total assets
Current liabilities:
Accounts payable
Accrued liabilities
Income taxes payable
Total current liabilities
Deferred rent
Other long-term liabilities
Total liabilities
Stockholders’ equity:
Preferred Stock
Class A Common Stock
Additional paid-in capital
Treasury stock
Retained earnings
Accumulated other comprehensive income
Total stockholders’ equity
Total liabilities and stockholders’ equity
See accompanying notes to consolidated financial statements.
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CONSOLIDATED STATEMENTS OF EARNINGS
(Amounts in thousands, except per share data)
(Unaudited)
Net sales
Cost of sales
Gross profit
Operating expenses:
Selling and marketing
Research and development
General and administrative
Amortization of intangible assets
Acquired in-process research and development
Total operating expenses
Operating income
Other income (expense):
Investment income
Interest expense
Foreign exchange gains
Other, net
Total other income
Income before income taxes and cumulative effect of accounting change
Income taxes
Income before cumulative effect of accounting change
Cumulative effect of accounting change (net of tax effect of $694)
Net income
Basic earnings per share before cumulative effect of accounting change
Diluted earnings per share before cumulative effect of accounting change
Basic earnings per share
Diluted earnings per share
Basic weighted average shares outstanding
Diluted weighted average and equivalent shares outstanding
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Other comprehensive income (loss):
Foreign currency translation adjustment
Changes in unrealized losses on hedging transactions, net of tax benefit
Changes in unrealized gains and (losses) on investments, net of tax (benefit)
Comprehensive income
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
Stock-based compensation
Excess tax benefit from share-based compensation
Cumulative effect of accounting change (net of tax)
Changes in assets and liabilities, net of effects of acquisitions:
Inventories
Other operating activities
Net cash provided by operating activities
Cash flows from investing activities:
Purchases of property and equipment
Acquisition of businesses acquired, net of cash acquired
Purchases of investments and marketable securities
Maturities of investments and marketable securities
Sales of investments and marketable securities
Net cash used in investing activities
Cash flows from financing activities:
Purchase of treasury stock
Proceeds from exercise of stock options and stock purchase plan purchases
Net cash provided by (used in) financing activities
Effect of exchange rate changes on cash
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental disclosures of cash flow information:
Interest paid
Income taxes paid
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 – Basis of Presentation
Management prepared these unaudited interim consolidated financial statements for Zebra Technologies Corporation and subsidiaries (Zebra) according to the rules and regulations of the Securities and Exchange Commission (SEC) for interim financial information. Accordingly, they do not include all of the information and footnotes required by United States generally accepted accounting principles (GAAP) for complete financial statements. Therefore, these consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in Zebra’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006.
The consolidated balance sheet as of December 31, 2006, in this Form 10-Q is taken from the audited consolidated balance sheet in our Form 10-K. These interim financial statements include all adjustments necessary to present fairly Zebra’s consolidated financial position as of March 31, 2007, the consolidated results of operations for the three months ended March 31, 2007 and April 1, 2006, and cash flows for the three months ended March 31, 2007 and April 1, 2006. These results, however, are not necessarily indicative of results for the full year.
Note 2—Stock-Based Compensation
As of March 31, 2007, Zebra has two stock option and stock purchase plans available for future grants. Prior to January 1, 2006, we accounted for option grants using the intrinsic value method in accordance with the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, as permitted by SFAS No. 123, Accounting for Stock Based Compensation. Accordingly, we recognized no compensation cost as all options granted under these plans had grant prices equal to the market value of the underlying common stock on the date of grant and the number of shares was fixed.
Effective January 1, 2006, Zebra adopted SFAS No. 123(R), Share-Based Payments, utilizing the modified retrospective approach, which requires the prior period financial statements to be restated to recognize compensation costs in the amounts previously reported in the pro forma footnote disclosures. Zebra recognizes compensation costs using the straight-line method over the vesting period of 2 to 5 years. Compensation costs were as follows:
For the three months ended March 31, 2007
For the three months ended April 1, 2006
SFAS No. 123(R) requires the cash flows resulting from the tax benefits from tax deductions in excess of the compensation cost recognized (excess tax benefits) to be classified as financing cash flows in the statement of cash flows. As a result, $479,000 of excess tax benefits for the three months ended March 31, 2007, have been classified as financing cash flows. The excess tax benefits for the three months ended April 1, 2006 was $1,285,000.
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For purposes of calculating the compensation cost consistent with SFAS No. 123(R), the fair value is estimated on the date of grant using a binomial model. Volatility is based on an average of the implied volatility in the open market and the annualized volatility of Zebra’s stock prices over our entire stock history. The following table shows the weighted-average assumptions used for stock option grants as well as the fair value of the options granted based on those assumptions:
Expected dividend yield
Forfeiture rate
Volatility
Risk free interest rate
- Range of interest rates
Expected weighted-average life
Fair value of options granted
Weighted-average grant date fair value of options granted
In accordance with the WhereNet acquisition agreement, we assumed the existing unvested WhereNet stock options and made them exercisable for Zebra common stock. These new options have vesting dates that range from February 6, 2007 through October 23, 2010. The following table shows the weighted-average assumptions used for these grants as well as the fair value of these grants based on those assumptions:
The fair value of the employees’ purchase rights issued under the Stock Purchase Plan are estimated using the following weighted-average assumptions for purchase rights granted. Expected lives of three months to one year have been used along with these assumptions.
Fair market value
Option price
Expected volatility
Stock option activity for the period ended March 31, 2007, was as follows:
Fixed Options
Outstanding at beginning of year
Granted
Transferred in from WhereNet
Exercised
Forfeited
Outstanding at end of period
Options exercisable at end of period
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The following table summarizes information about fixed stock options outstanding at March 31, 2007:
Range of
Exercise Prices
Number
of Shares
$ 1.29-$18.17
$ 18.17-$25.23
$ 25.23-$42.50
$ 42.50-$46.18
$ 46.18-$53.92
Aggregate intrinsic value
Weighted-average remaining contractual term
As of March 31, 2007, there was $17,140,000 of unearned compensation cost related to stock options granted under the plans. That cost is expected to be recognized over a weighted-average period of 1.9 years.
Note 3 – Inventories
The components of inventories are as follows (in thousands):
Raw materials
Work in process
Finished goods
Total inventories
Note 4 – Business Combinations
WhereNet Corp. On January 25, 2007, Zebra acquired all of the outstanding stock of WhereNet Corp. for $127,200,000, which is net of cash acquired and transaction costs. Headquartered in Santa Clara, CA, WhereNet provides integrated wireless Real Time Locating Systems (RTLS) to companies primarily in the industrial manufacturing, transportation and logistics, and aerospace and defense sectors. The consolidated statements of earnings reflect the results of operations of WhereNet since the effective date of the purchase. The pro forma impact of this acquisition was not significant.
The following table (in thousands) summarizes the estimated fair values of the assets acquired and the liabilities assumed at the date of acquisition based on preliminary third party valuations. Therefore, the allocation of the purchase price is subject to refinement.
Current assets
Deferred tax assets
Property and equipment
Intangible assets
Total assets acquired
Current liabilities
Net assets acquired
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The purchase price was allocated to identifiable tangible and intangible assets acquired and liabilities assumed based on their estimated fair values resulting in goodwill of $80,530,000. A net operating loss of $30,513,000 is included in the deferred tax assets. The intangible assets of $30,616,000 consist mainly of the following:
Developed technology
Customer relationships
Backlog
The acquired in-process research and development of $1,853,000 was written-off at the date of the acquisition in accordance with FASB Interpretation No. 4, Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method. Acquired in-process technology is stated separately in the operating expense section of the consolidated statements of earnings.
The goodwill is not deductible for tax purposes.
Note 5 – Investments and Marketable Securities
We classify the majority of our investments in marketable debt securities as available-for-sale in accordance with the classifications defined in SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. As of March 31, 2007, all of our investments in marketable debt securities with maturities greater than one year are classified as long-term in the balance sheet due to our ability and intent to hold them until maturity.
SFAS No. 115 requires that changes in the market value of available-for-sale securities are reflected in the accumulated other comprehensive income caption of stockholders’ equity in the balance sheet, until we dispose of the securities. Once these securities are disposed of, either by sale or maturity, the accumulated changes in market value are transferred to investment income. On the cash flow statements, changes in the balances of available-for-sale securities are shown as purchases, sales and maturities of investments and marketable securities under investing activities.
Changes in market value of trading securities would be recorded in investment income as they occur, and the related cash flow statement would include changes in the balances of trading securities as operating cash flows.
All investments are either marketable debt securities or partnership interests We account for marketable debt securities as available-for-sale securities. We account for the partnership interests using the cost method until our ownership percentage reaches 5% of the total partnership portfolio value, because at that point we begin using the equity method to account for them. During 2006, we reached the 5% threshold on one of our partnership interests. For the three months ended March 31, 2007, we recorded $372,000 in equity in earnings related to this partnership interest, which is included in investment income. No other gains or losses on trading securities were recorded in investment income.
Change in unrealized gains and losses on available-for-sale securities are included in these financial statements as follows (in thousands):
Changes in unrealized gains and losses on available- for-sale securities, net of tax, recorded in accumulated other comprehensive income
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Note 6—Stockholders’ Equity
Share count and par value data related to stockholders’ equity are as follows:
March 31,
2007
Par value per share
Shares authorized
Shares outstanding
Common Stock - Class A
Shares issued
Shares held
Note 7—Other Comprehensive Income (Loss)
Stockholders’ equity includes certain items classified as other comprehensive income, including:
Foreign currency translation adjustment relates to our non-U.S. subsidiary companies that have designated a functional currency other than the U.S. dollar. We are required to translate the subsidiary functional currency financial statements to dollars using a combination of historical, month-end, and average foreign exchange rates. This combination of rates creates the foreign currency translation adjustment component of other comprehensive income.
Unrealized gains (losses) on foreign currency hedging activities relate to derivative instruments used to hedge the currency exchange rates for forecasted euro sales. These hedges are designated as cash flow hedges, and we have deferred income statement recognition of gains and losses until the hedged transaction occurs. See Note 10 for more details.
Unrealized gains (losses) on investments classified as available-for-sale are deferred from income statement recognition until the gains or losses are realized. See Note 5 above for more details.
The components of other comprehensive income included in the Consolidated Statements of Comprehensive Income are as follows (in thousands):
Foreign currency translation adjustments
Changes in unrealized losses on foreign currency hedging activities:
Gross
Income tax benefit
Net
Changes in unrealized gains and (losses) on investments classified as available-for-sale:
Income tax (benefit)
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The components of accumulated other comprehensive income (loss) included in the Consolidated Balance Sheets are as follows (in thousands):
Unrealized losses on foreign currency hedging activities:
Unrealized gains and (losses) on investments classified as available-for-sale:
Note 8—Earnings Per Share
Earnings per share before cumulative effect of accounting change were computed as follows (in thousands, except per share amounts):
Basic earnings per share:
Net income before cumulative effect of accounting change
Weighted average common shares outstanding
Per share amount
Diluted earnings per share:
Add: Effect of dilutive securities – stock options
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Earnings per share after the cumulative effect of the accounting change were computed as follows (in thousands, except per share amounts):
Potentially dilutive securities that were excluded from the earnings per share calculation consist of stock options with an exercise price greater than the average market price of the Class A common stock. These options were as follows:
Potentially dilutive shares
Note 9—Goodwill and Other Intangible Asset Data
Intangible asset data are as follows (in thousands):
Amortized intangible assets
Current technology
Patent and patent rights
Total
Unamortized intangible assets
Aggregate amortization expense
For the year ended December 31, 2006
Estimated amortization expense
For the year ended December 31, 2007
For the year ended December 31, 2008
For the year ended December 31, 2009
For the year ended December 31, 2010
For the year ended December 31, 2011
Thereafter
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We test the impairment of goodwill each year or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. We completed our last assessment during June 2006. At that time, no adjustment to goodwill was necessary due to impairment.
We evaluate the impairment of identifiable intangibles and other long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable.
Factors considered that may trigger an impairment review consist of:
Significant underperformance relative to expected historical or projected future operating results,
Significant changes in the manner of use of the acquired assets or the strategy for the overall business,
Significant negative industry or economic trends,
Significant decline in Zebra’s stock price for a sustained period, and
Significant decline in market capitalization relative to net book value.
If we believe that one or more of the above indicators of impairment have occurred and the undiscounted cash flow test is failed, we measure impairment based on a projected discounted cash flow methodology using a discount rate that incorporates the risk inherent in the cash flows.
Note 10—Derivative Instruments
In the normal course of business, portions of Zebra’s operations are subject to fluctuations in currency values. We manage these risks using derivative financial instruments.
Hedging of Net Assets
We use forward contracts and options to manage exposure related to our pound and euro denominated net assets. We record gains and losses on these contracts and options in income each quarter along with the transaction gains and losses related to our net euro asset position, which would ordinarily offset each other. Summary financial information related to these activities follows (in thousands):
April 1,
2006
Change in gains and (losses) from foreign exchange derivatives
Gain (loss) on net foreign currency assets
Net foreign exchange gain
Notional balance of outstanding contracts:
Pound/US dollar
Euro/US dollar
Euro/Pound
Net fair value of outstanding contracts
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Hedging of Anticipated Sales
We manage the exchange rate risk of anticipated euro denominated sales using forward contracts and option collars. We designate these contracts as cash flow hedges. Gains and losses on these contracts are deferred in other comprehensive income until the contracts are settled and the hedged sales are realized, at which time the deferred gains or losses will be reported as an increase or decrease to sales. Summary financial information related to the cash flow hedges of future revenues follows (in thousands, except percentages):
Net unrealized losses deferred in other comprehensive income:
Notional balance of outstanding contracts
Hedge effectiveness
Net gains and (losses) included in revenue for the:
Three months ended March 31, 2007
Three months ended April 1, 2006
Note 11—Contingencies
On January 31, 2003, a Writ of Summons was filed in the Nantes Commercial Court, Nantes, France, by Printherm, a French corporation, and several of its shareholders (collectively, “Printherm”), against Zebra Technologies France (“ZTF”), a French corporation and wholly-owned subsidiary of Zebra. Printherm seeks damages in the amount of €15,304,000 and additional unspecified damages in connection with ZTF’s termination of negotiations in December 2000 respecting the proposed acquisition by Zebra of the capital stock of Printherm. The negotiation was terminated based on unsatisfactory results of the ongoing due diligence. We believe that Printherm’s claims are without merit and that a loss is not likely to occur. We will vigorously defend the action.
Printherm filed bankruptcy proceedings on August 30, 2004, and the Commercial Court ordered its liquidation on November 30, 2004. The case was put on hold until the Court appointed liquidator filed a submission in August 2005, which started the proceedings again. ZTF filed its answer on November 19, 2005, in anticipation of a Court-ordered December 19, 2005, hearing date. In response to a request by Printherm’s liquidator, the Court postponed the hearing date so as to provide time for Printherm to respond to ZTF’s answer. The hearing has not been scheduled and we are unsure when it will be scheduled
On July 3, 2006, a Zebra reseller filed for bankruptcy protection. At the time of the filing, the reseller owed various Zebra subsidiaries a total of $12,065,000. The entire balance due to Zebra is guaranteed by Condor Insurance, a Nevis insurance company, through a United Kingdom insurance broker. During June 2006, Zebra initiated a suit in the U.K. courts to enforce the guarantee. On January 18, 2007, a summary judgment hearing was held in the case. At the conclusion of that hearing, Zebra’s petition for summary judgment was granted, and we were awarded damages of €11,119,000 (approximately $14,650,000). However, we have become aware that Condor’s financial position has deteriorated such that Condor may not be able to pay the judgment awarded to us. Management has reviewed the situation and determined that a loss is probable as defined in SFAS No. 5, Loss Contingencies. Our range of estimated losses ranges from insignificant up to 100%. Our best estimate is that the loss will be at the high end of the range, and we have, therefore, reserved 100% of the balance due. However, we are continuing to take legal action to collect the judgment against the insurance company and reduce Zebra’s loss. If Zebra is able to recover some or all of the loss, we will reverse our reserve and record a gain at that time.
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Note 12—Warranty. Zebra provides warranty coverage of generally of up to one year on printers against defects in material and workmanship. Printheads are warranted for six months and batteries are warranted for three months. A provision for warranty expense is recorded at the time of shipment and adjusted quarterly based on historical warranty experience. The following is a summary of Zebra’s accrued warranty obligation.
Balance at the beginning of the year
Warranty expense year-to-date
Warranty payments made year-to-date
Balance at the end of the period
During 2005, Zebra began providing for environmental recycling reserves similar to warranty reserves. In the European Union, we have an obligation in the future to recycle printers. This reserve is based on all new printers sold after August 13, 2005, and printers sold prior to that date that are returned to us upon our sale of a new printer to a customer. The following is a summary of Zebra’s accrued recycling obligation.
Recycling expense year-to-date
Recycling payments made year-to-date
Exchange rate impact
Note 13—Income Taxes
On January 1, 2007, we adopted Financial Accounting Standards Board (FASB) Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109”. According to FIN No. 48, we identified, evaluated, and measured the amount of income tax benefits to be recognized for all of our income tax positions. The net income tax assets recognized under FIN No. 48 did not differ from the net assets recognized before adoption, and, therefore, we did not record an adjustment related to the adoption of FIN No. 48. Zebra did not have any unrecognized tax benefits as of March 31, 2007 and do not expect any significant changes in unrecognized tax benefits during the next 12 months.
Zebra has concluded all U.S. federal income tax audits for years through 2003. The tax years 2002 through 2006 remain open to examination by multiple state taxing jurisdictions. Foreign tax audits have been completed for year through 2003.
Zebra’s continuing practice is to recognize interest and/or penalties related to income tax matters as part of income tax expense. For the quarter ended March 31, 2007, we did not accrue any interest or penalties into income tax expense.
Note 14—New Accounting Pronouncements
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which allows entities to voluntarily choose, at specified election dates, to measure many financial assets and financial liabilities (as well as certain non-financial instruments) at fair value (the “fair value option”). The election is made on an instrument-by-instrument basis and is irrevocable. If the fair value option is elected for an instrument, the Statement specifies that all subsequent changes in fair value for that instrument shall be reported in earnings. This Statement is effective for Zebra for the fiscal year ending December 31, 2008. We have not yet determined the effect this Statement will have on our operations or financial position.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Net sales for the first quarter of 2007, compared with the first quarter of 2006, advanced 18.6% on the strength of sales in North America and our Europe, Middle East and Africa region, our two largest geographic territories. Continued robust sales growth of our established printer and supplies lines were supplemented by sales from WhereNet, which we acquired in January 2007, and Swecoin, which we acquired in October 2006. Gross profit margin increased, as we benefited from favorable exchange rate movements, favorable changes in product mix and lower manufacturing variances. Higher operating expenses resulted from the addition of personnel related to the WhereNet and Swecoin acquisitions, in addition to increased expenditures on advertising, market development funding and information technology. We also incurred a one-time write-off for acquired in-process technology associated with the WhereNet acquisition, as well as higher expenses related to stock options expensing.
Results of Operations: First Quarter of 2007 versus first Quarter of 2006
Sales
Sales by product category, percent change, and percent of total sales for the three months ended March 31, 2007, and April 1, 2006, were (in thousands, except percentages):
Product Category
Hardware
Supplies
Service and software
Shipping and handling
Cash flow hedging activities
Total sales
Sales to customers by geographic region, percent changes and percent of total sales for the three months ended March 31, 2007, and April 1, 2006, were (in thousands, except percentages):
PercentChange
Percent ofTotal Sales - 2007
Percent of
Total Sales - 2006
Geographic Region
Europe, Middle East and Africa
Latin America
Asia-Pacific
Total International
North America
Favorable business trends in North America and international regions overall contributed to the quarterly sales growth. Strength within our historical printer and supplies product lines was supplemented by product and service revenue from WhereNet and Swecoin, which were acquired in January 2007 and October 2006. North American sales in particular benefited from the acquisition of WhereNet, which currently generates its sales predominantly in the United States. These business trends are also reflected in hardware sales, which increased 19.6% for the quarter on record printer unit volume shipments.
New printer products (defined as printers released within 18 months prior to the end of the applicable fiscal period) accounted for 11.5% of printer sales in the first quarter of 2007, compared with 14.4% of printer sales in the first quarter of 2006 and 12.2% for the fourth quarter of 2006.
Our international sales are denominated in multiple currencies, primarily the dollar, pound and euro. This directly causes our reported sales to be subject to fluctuations based on changes in currency rates. We estimate that favorable foreign exchange movements of the euro and the pound versus the dollar had a positive impact of $5,684,000 on sales during the first quarter.
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We currently hedge a portion of anticipated euro-denominated sales to partially protect Zebra against exchange rate movements. For the first quarter, this program resulted in a loss of $135,000. See Note 10 to the Consolidated Financial Statements included in this Report for a more detailed discussion of this hedging program.
Printer unit volumes and average selling price information is summarized below:
Total printers shipped
Average selling price of printers shipped
For the first quarter of 2007, unit volumes increased in nearly all product lines compared to the first quarter of 2006 with notable volume increases in the desktop and mobile printers. The average selling price decline is primarily related to higher sales growth of these lower-priced printers compared with the product mix for the first quarter of 2006.
Gross Profit
Gross profit information is summarized below (in thousands, except percentages):
Gross Margin
Gross profit margin was affected by favorable foreign currency movements, which increased first quarter gross profit by $4,606,000. Gross profit margin improvements were also a result of manufacturing variances and product mix.
Selling and Marketing Expenses
Selling and marketing expenses are summarized below (in thousands, except percentages):
Selling and marketing expenses
Percent of sales
We continue to invest heavily in demand-generating activities to build brand equity in our core product lines as well as in the emerging area of radio frequency identification (RFID). During the first quarter of 2007, selling and marketing expenses increased due to higher payroll costs of $2,912,000, which was predominantly related to our acquisitions of Swecoin and WhereNet. In addition, advertising expenses and market development funding increased $1,843,000 and travel costs increased $323,000.
Research and Development Costs
The development of new products and enhancement of existing products are important to Zebra’s business and growth prospects. To maintain and build our product pipeline, we made investments in research and development, summarized below (in thousands, except percentages):
Research and development costs
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Quarterly product development expenses fluctuate widely depending on the status of on-going projects. We are committed to a long-term strategy of significant investment in product development. For the first quarter of 2007, payroll and benefits increased by $1,417,000 and professional services costs increased by $669,000 in relation to the first quarter of 2006.
General and Administrative Expenses
General and administrative expenses are summarized in the table below (in thousands, except percentages):
General and administrative expenses
For the first quarter of 2007, the increase in general and administrative expenses compared to the first quarter of 2006 is related to higher payroll and benefits of $2,718,000, which includes increased SFAS No. 123(R) compensation expense of $965,000. Information system costs also increased $1,017,000 and legal expenses decreased $907,000.
Operating Income
Operating income is summarized in the following table (in thousands, except percentages):
Non-operating Income and Expenses
Zebra’s non-operating income and expense items are summarized in the following table (in thousands):
Foreign exchange gain
Rate of Return Analysis:
Average cash and marketable securities balances
Annualized rate of return
Income Taxes
The effective income tax rate for the first quarter of 2007 increased to 34.7% compared to 34.5% for the same period last year.
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Net Income before Cumulative Effect of Accounting Change
Zebra’s net income before cumulative effect of accounting change is summarized below (in thousands, except per share amounts):
Cumulative Effect of Accounting Change
During the first quarter of 2006, Zebra adopted SFAS No. 123(R), Share-Based Payments, utilizing the modified retrospective approach. SFAS No. 123(R) requires entities to estimate the number of forfeitures expected to occur and record expense based upon the number of awards expected to vest. Prior to the adoption of SFAS No. 123(R), Zebra accounted for forfeitures as they occurred as permitted under previous accounting standards. The requirement to estimate forfeitures is classified as an accounting change under APB Opinion No. 20, Accounting Changes, which requires a one-time adjustment in the period of adoption. The one-time adjustment (cumulative effect of accounting change) related to the change in estimating forfeitures increased income by $1,319,000, net of applicable taxes.
Net Income
Zebra’s net income is summarized below (in thousands, except per share amounts):
Liquidity and Capital Resources
During the first quarter of 2007, Zebra purchased WhereNet Corp. for $127,200,000. As a result, Zebra’s cash and investment balances have decreased during the quarter. As of March 31, 2007, Zebra had $452,485,000 in cash, cash equivalents, investments and marketable securities, compared with $559,189,000 at December 31, 2006. Factors affecting cash and investment balances during the first three months of 2007 include (note that changes discussed below include the impact of foreign currency):
Operations provided cash in the amount of $26,855,000, primarily from net income.
Accounts receivable increased $7,065,000 year-to-date because of higher sales. Days sales outstanding increased to 60 days in the first quarter of 2007 compared to 53 days at the end of 2006.
Inventories decreased $2,779,000. Inventory turns decreased during the first quarter of 2007 to 5.3 from 5.5 at the end of 2006.
Accounts payable decreased $12,275,000, due to timing of vendor payments.
Taxes payable increased $10,815,000 because of the timing of tax payments.
Purchases of property and equipment totaled $5,333,000.
Purchase of WhereNet Corp., totaled $127,200,000.
Net sales of investments totaled $107,208,000.
Purchases of treasury shares totaled $6,048,000. Zebra made open market repurchases of our shares under an authorization of the Board of Directors dated October 4, 2005.
Stock option exercises and purchases under the stock purchase plan contributed $4,337,000.
Management believes that existing capital resources and funds generated from operations are sufficient to finance anticipated capital requirements. It is our intention to actively pursue opportunities to acquire other businesses.
Critical Accounting Policies and Estimates
Management prepared the consolidated financial statements of Zebra Technologies Corporation under accounting principles generally accepted in the United States of America. These principles require the use of estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions we used are reasonable, based upon the information available.
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Our estimates and assumptions affect the reported amounts in our financial statements. The following accounting policies comprise those that we believe are the most critical in understanding and evaluating Zebra’s reported financial results.
Revenue Recognition
Product revenue is recognized once four criteria are met: (1) we have persuasive evidence that an arrangement exists; (2) delivery has occurred and title has passed to the customer, which happens at the point of shipment provided that no significant obligations remain; (3) the price is fixed and determinable; and (4) collectibility is reasonably assured. Other items that affect our revenue recognition include:
Customer returns
Customers have the right to return products that do not function properly within a limited time after delivery. We monitor and track product returns and record a provision for the estimated future returns based on historical experience and any notification received of pending returns. Returns have historically been within expectations and the provisions established, but Zebra cannot guarantee that it will continue to experience return rates consistent with historical patterns. Historically, our product returns have not been significant. However, if a significant issue should arise, it could have a material impact on our financial statements.
Growth Rebates
Some of our channel program partners are offered incentive rebates based on the attainment of specific growth targets related to products they purchase from us over a quarter or year. These rebates are recorded as a reduction to revenue. Each quarter, we estimate the amount of outstanding growth rebates and establish a reserve for them based on shipment history. Historically, actual growth rebates have been in line with our estimates.
Price Protection
Some of our customers are offered price protection by Zebra as an incentive to carry inventory of our product. These price protection plans provide that if we lower prices, we will credit them for the price decrease on inventory they hold. We estimate future payments under price protection programs quarterly and establish a reserve, which is charged against revenue. Our customers typically carry limited amounts of inventory, and Zebra infrequently lowers prices on current products. As a result, the amounts paid under these plans have been minimal.
Software Revenue
We sell three types of software and record revenue as follows:
Our printers contain embedded firmware, which is part of the hardware purchase. We consider the sale of this firmware to be incidental to the sale of the printer and do not attribute any revenue to it.
We sell a limited amount of prepackaged, or off-the-shelf, software for the creation of bar code labels using our printers. There is no customization required to use this software, and we have no post-shipment obligations on the software. Revenue is recognized at the time this prepackaged software is shipped.
We sometimes provide custom software as part of a printer installation project. We bill custom software development services separate from the related hardware. Revenue related to custom software is recognized once the custom software development services have been completed and accepted by the customer.
Shipping and Handling
We charge our customers for shipping and handling services based upon our internal price list for these items. The amounts billed to customers are recorded as revenue when the product ships. Any costs incurred related to these services are included in cost of sales.
From time to time, Zebra will enter into sales transactions that include more than one product type. This bundle of products might include printers, current or future supplies, and services. When this type of transaction occurs, we allocate the purchase price to each product type based on the fair value of the individual products. The revenue for each individual product is then recognized when the recognition criteria for that product is fully met.
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Investments and Marketable Securities
Investments and marketable securities at March 31, 2007, consisted of U.S. government securities (8.9%), state and municipal bonds (79.4%), corporate bonds (2.0%) and partnership interests (9.7%). We classify our debt and marketable equity securities in one of three categories: trading, available-for-sale or held-to-maturity. Trading securities are bought and held principally for the purpose of selling them in the near term. Held-to-maturity securities are those debt securities that Zebra has the ability and intent to hold until maturity. All securities not included in trading or held-to-maturity are classified as available-for-sale except for partnership interests described below.
Trading and available-for-sale securities are recorded at fair value. Held-to-maturity securities are recorded at amortized cost, adjusted for the amortization or accretion of discounts or premiums. Unrealized holding gains and losses on trading securities are included in earnings. Unrealized holding gains and losses, net of the related tax effect, on available-for-sale securities are excluded from earnings and are reported as a separate component of stockholders’ equity until realized. As of March 31, 2007, Zebra’s investments in marketable debt securities are classified as available-for-sale. In addition, as of March 31, 2007, all of our investments in marketable debt securities with maturities greater than one year are classified as long-term in the balance sheet due to our ability and intent to hold them until maturity.
All investments in marketable securities except the partnership interests are classified as available-for-sale securities. We account for the partnership interests using the costs method until our ownership percentage reaches 5% of the total partnership portfolio value. At that time, we begin using the equity method until to account for the partnership. During 2006, we reached the 5% threshold on one of our partnership interests.
Accounts Receivable
We have standardized credit granting and review policies and procedures for all customer accounts, including:
Credit reviews of all new customer accounts,
Ongoing credit evaluations of current customers,
Credit limits and payment terms based on available credit information,
Adjustments to credit limits based upon payment history and the customer’s current credit worthiness, and
An active collection effort by regional credit functions, reporting directly to the corporate financial officers.
We reserve for estimated credit losses based upon historical experience and specific customer collection issues. Over the last three years, accounts receivable reserves varied from 1.0% to 2.9% of total accounts receivable. Accounts receivable reserves as of March 31, 2007, were $4,085,000, or 2.9% of the balance due. Included in the accounts receivable reserve is $2,302,000 related to the reseller noted in the following paragraph. In addition, other assets include an additional reserve of $10,236,000 related to this reseller. We feel this reserve level is appropriate considering the quality of the portfolio as of March 31, 2007. While credit losses have historically been within expectations and the provisions established, we cannot guarantee that our credit loss experience will continue to be consistent with historical experience.
During 2006, a Zebra reseller filed for bankruptcy protection in Austria. At the time of the filing, the reseller owed various Zebra subsidiaries a total of $12,065,000. The entire balance due to Zebra is guaranteed by Condor Insurance, a Nevis insurance company through a United Kingdom insurance broker. During June 2006, Zebra initiated a suit in the U.K. courts to enforce the guarantee. However, during the fourth quarter of 2006, we discovered that the insurance company’s financial position was such that it may not be able to pay the judgment awarded to us. We reviewed the situation and determined that a loss is probable, and, therefore, reserved 100% of the balance due, which is now $12,538,000. However, we are continuing to take legal action to collect the judgment against the insurance company and reduce Zebra’s loss. If Zebra is able to recover some or all of the loss, we will reverse the reserve and record a gain at that time.
We value our inventories at the lower of the actual cost to purchase or manufacture using the first-in, first-out (FIFO) method, or the current estimated market value. We review inventory quantities on hand and record a provision for excess and obsolete inventory based on forecasts of product demand and production requirements for the subsequent twelve months.
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Over the last three years, our reserves for excess and obsolete inventories have ranged from 10.0% to 12.8% of gross inventory. As of March 31, 2007, reserves for excess and obsolete inventories were $10,852,000, or 11.8% of gross inventory. We feel this reserve level is appropriate considering the quantities and quality of the inventories as of March 31, 2007.
Valuation of Long-Lived and Intangible Assets and Goodwill.
If we believe that one or more of the above indicators of impairment have occurred and the undiscounted cash flow test is failed in the case of amortizable assets, we measure impairment based on projected discounted cash flows using a discount rate that incorporates the risk inherent in the cash flows. Net intangible assets, long-lived assets and goodwill amounted to $271,584,000 as of March 31, 2007.
Contingencies
We record estimated liabilities related to contingencies based on our estimates of the probable outcomes. Quarterly, we assess the potential liability related to pending litigation, tax audits and other contingencies and confirm or revise estimates and reserves as appropriate.
For a discussion of the Printherm litigation matters, see Note 11 to the Consolidated Financial Statements.
Stock-based Compensation
As of March 31, 2007, Zebra has two stock option and stock purchase plans available for future grants. As of January 1, 2006, Zebra adopted SFAS No. 123(R), Share-Based Payments, utilizing the modified retrospective approach, which requires the prior period financial statements to be restated to recognize compensation costs in the amounts previously reported in the pro forma footnote disclosures. See Note 2 to the Consolidated Financial Statements for further information on the adoption and impact of SFAS No. 123(R).
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Significant Customer
ScanSource, Inc. is our most significant customer. Our net sales to ScanSource, Inc., an international distributor of Zebra products, as a percentage of total net sales, were as follows:
For the three months ended
No other customer accounted for 10% or more of total net sales during these time periods.
Expectations
As stated on our quarterly conference call on April 30, 2007, we estimate net sales, gross profit margins, operating expenses, and earnings for the second quarter of 2007 as follows (in thousands, except per share amounts and percentages):
Gross profit margins
Operating expenses
The effective tax rate is expected to be 34.5% of income before income taxes for the second quarter of 2007.
Safe Harbor
Forward-looking statements contained in this filing are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995 and are highly dependent upon a variety of important factors which could cause actual results to differ materially from those reflected in such forward looking statements. These factors include:
Market acceptance of Zebra’s printer and software products and competitors’ product offerings and the potential effects of technological changes,
The effect of market conditions in North America and other geographic regions,
Our ability to control manufacturing and operating costs,
Success of integrating acquisitions,
Interest rate and financial market conditions because of our large investment portfolio,
Foreign exchange rates due to the large percentage of our international sales,
The outcome of litigation in which Zebra is involved, particularly litigation or claims related to infringement of third-party intellectual property rights, and
New regulations in the European Union that restrict the use of certain hazardous substances in electrical and electronic equipment.
When used in this document and documents referenced, the words “anticipate,” “believe,” “estimate,” “will” and “expect” and similar expressions as they relate to Zebra or its management are intended to identify such forward-looking statements. We encourage readers of this report to review Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2006, for a further discussion of issues that could affect Zebra’s future results. Zebra undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances or any other reason after the date of this report.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
There were no material changes in Zebra’s market risk during the quarter ended March 31, 2007. For additional information on market risk, refer to the “Quantitative and Qualitative Disclosures About Market Risk” section of our Form 10-K for the year ended December 31, 2006.
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Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this Form 10-Q. The controls evaluation was conducted under the supervision of our Disclosure Committee, and with the participation of management, including our Chief Executive Officer and Chief Financial Officer. Based on that evaluation, our Chief Executive Office and Chief Financial Officer, have concluded that our disclosure controls and procedures were effective to provide reasonable assurance that (i) the information required to be disclosed by us in this report on Form 10-Q was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) information required to be disclosed by us in our reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There were no changes in our internal controls over financial reporting during the quarter ended March 31, 2007, that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
Inherent Limitations on the Effectiveness of Controls
Our management, including our Chief Executive Office and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Zebra have been detected.
These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
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Item 1. Legal Proceedings
See Note 11 to the Consolidated Financial Statements included in this Form 10-Q.
Item 1A. Risk Factors
In addition to the other information include in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2006, and the factors identified under “Safe Harbor” at the end of Item 2 of Part I of this Quarterly Report on Form 10-Q, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing Zebra. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, and/or operating results.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Treasury Shares
During the first quarter of 2007, Zebra purchased 38,389 shares of Zebra common stock. The repurchase was under a purchase authorization approved by the Board of Directors. In September 2005, the Board authorized the purchase of up to 2,500,000 shares of Zebra common stock. The purchase price is at management’s discretion, and there is no expiration on the authorization. During the first quarter of 2007, Zebra purchased shares as follows:
ISSUER PURCHASES OF EQUITY SECURITIES
Period
January 2007 (January 1 – January 27)
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Item 6. Exhibits and Reports on Form 8-K
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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.
/s/ Edward L. Kaplan
/s/ Charles R. Whitchurch
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