UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
For the quarterly period ended April 4, 2015
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.)
3 Overlook Point, Lincolnshire, IL 60069
(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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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 May 1, 2015, there were 51,725,074 shares of Class A Common Stock, $.01 par value, outstanding.
ZEBRA TECHNOLOGIES CORPORATION AND SUBSIDIARIES
QUARTER ENDED APRIL 4, 2015
INDEX
PART I - FINANCIAL INFORMATION
Item 1.
Consolidated Balance Sheets as of April 4, 2015 (unaudited) and December 31, 2014
Consolidated Statements of Operations (unaudited) for the three months ended April 4, 2015 and March 29, 2014
Consolidated Statements of Comprehensive Income (Loss) (unaudited) for the three months ended April 4, 2015 and March 29, 2014
Consolidated Statements of Cash Flows (unaudited) for the three months ended April 4, 2015 and March 29, 2014
Notes to Consolidated Financial Statements
Item 2.
Item 3.
Item 4.
PART II - OTHER INFORMATION
Item 1A.
Item 6.
SIGNATURES
2
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except per share amounts)
Current assets:
Cash and cash equivalents
Investments and marketable securities
Accounts receivable, net
Inventories, net
Deferred income taxes
Income tax receivable
Prepaid expenses and other current assets
Total current assets
Property and equipment at cost, less accumulated depreciation and amortization
Goodwill
Other intangibles, net
Debt issuance cost
Other assets
Total assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
Accrued liabilities
Deferred revenue
Current portion of long-term debt
Income taxes payable
Total current liabilities
Long-term debt
Long-term deferred tax liability
Long-term deferred revenue
Other long-term liabilities
Total liabilities
Stockholders’ equity:
Preferred Stock, $.01 par value; authorized 10,000 shares; issued 0 shares
Class A Common Stock, $.01 par value; authorized 150,000 shares; issued 72,152 shares
Additional paid-in capital
Treasury stock at cost, 20,322 and 20,498 shares, respectively
Retained earnings
Accumulated other comprehensive loss
Total stockholders’ equity
Total liabilities and stockholders’ equity
See accompanying notes to consolidated financial statements.
3
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)
(Unaudited)
Net sales:
Net sales of tangible products
Revenue from services and software
Total net sales
Cost of sales:
Cost of sales of tangible products
Cost of services and software
Total cost of sales
Gross profit
Operating expenses:
Selling and marketing
Research and development
General and administrative
Amortization of intangible assets
Acquisition and integration costs
Exit and restructuring costs
Total operating expenses
Operating income
Other income (expense):
Investment income (loss) gain
Foreign exchange loss
Forward interest rate swaps gain
Interest expense
Other, net
Total other (expense) income
(Loss) income before income taxes
Income tax (benefit) expense
Net (loss) income
Basic (loss) earnings per share
Diluted (loss) earnings per share
Basic weighted average shares outstanding
Diluted weighted average and equivalent shares outstanding
See accompanying notes to consolidated financial statements
4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Amounts in thousands)
Other comprehensive income (loss):
Unrealized gain on anticipated sales hedging transactions, net of tax
Unrealized loss on forward interest rate swaps hedging transactions, net of tax
Unrealized holding (loss) gain on investments, net of taxes
Foreign currency translation adjustment
Comprehensive (loss) income
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization
Amortization of debt issuance cost and discount
Share-based compensation
Excess tax benefit from share-based compensation
Unrealized gain on forward interest rate swaps
All other, net
Changes in assets and liabilities, net of businesses acquired:
Income taxes
Other operating activities
Net cash provided by operating activities
Cash flows from investing activities:
Purchases of property and equipment
Acquisition of businesses, net of cash acquired
Proceeds from sale of long-term investments
Purchases of long-term investments
Purchases of investments and marketable securities
Maturities of investments and marketable securities
Proceeds from sales of investments and marketable securities
Net cash used in investing activities
Cash flows from financing activities:
Payment of debt
Proceeds from exercise of stock options and stock purchase plan purchases
Net cash (used in) provided by financing activities
Effect of exchange rate changes on cash
Net 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:
Income taxes paid, net
Interest 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. These financial statements 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, 2014.
These interim financial statements include all adjustments (of a normal, recurring nature) necessary to present fairly Zebra’s consolidated financial position as of April 4, 2015, consolidated statements of operations, consolidated statements of comprehensive income (loss) and consolidated statements of cash flows for the three months ended April 4, 2015 and March 29, 2014. These results, however, are not necessarily indicative of results for the full year.
Reclassifications: Prior-period amounts differ from amounts previously reported because certain immaterial amounts in the prior years’ financial statements have been reclassified to conform to the current year’s presentation.
Note 2 – Recently Issued Accounting Pronouncement
In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2015-03 “Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” This guidance requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by this ASU. This standard is effective for annual periods beginning after December 15, 2015 and interim periods within those annual periods. Management is assessing the impact of adoption on its consolidated financial statements.
In May 2014, the FASB issued update 2014-09, ASC 606, Revenue from Contracts with Customers. This guidance is a comprehensive new revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. This standard is effective for annual periods beginning after December 15, 2016 and interim periods within those annual periods. In April 2015, the FASB issued an exposure draft that would delay by one year the effective date of its new revenue recognition standard; comments are due by May 29, 2015. Management is assessing the impact of adoption on its consolidated financial statements.
Note 3 Business Combinations
On October 27, 2014, Zebra completed its acquisition of the Enterprise Business (“Enterprise”) from Motorola Solutions Inc. (“MSI”) for a purchase price of $3.45 billion (the “Acquisition”). This transaction positions Zebra as a leading technology innovator, with the accelerating convergence of mobility, data analytics and cloud computing. It will enable Zebra to further sharpen its strategic focus on providing mission-critical solutions for its customers. Certain assets and liabilities historically associated with the Enterprise business were retained by MSI, including MSI’s iDEN infrastructure business. The Acquisition was pursuant to the Master Acquisition Agreement dated April 14, 2014, as amended (the “Master Acquisition Agreement”) and was structured as a combination of stock and asset acquisitions and a merger of certain US entities, resulting in 100% ownership of Enterprise.
Zebra financed the Acquisition through a combination of cash on hand and borrowings of $3.25 billion (the “Indebtedness”), including the sale of 7 1⁄4% senior notes due 2022 with an aggregate principal amount of $1.05 billion (the “Notes”) and a new credit agreement with various lenders that provided a term loan of $2.2 billion (the “Term Loan”) due 2021. See Note 13 Long Term Debt footnote. Consideration was paid in the form of cash to MSI in the amount of $3.45 billion, including working capital adjustments.
The allocations of the purchase price for the Acquisition have been prepared on a preliminary basis based on third-party valuations and changes to these allocations may occur as additional information becomes available. We are in the process of evaluating third-party valuations related to the fair value of our tangible and intangible assets, in addition to determining and recording the tax effects of the transaction to include all assets and liabilities at fair value. Acquired goodwill represents the premium paid over the fair value of the net tangible and intangible assets acquired. Zebra paid this premium for a number of reasons, including acquiring an experienced workforce and enhancing technology capabilities as further described above.
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During the first quarter of 2015, Zebra adjusted certain preliminary values. The fair value adjustments are reflected in the table below and primarily result in an increase of $0.9 million in assets and a decrease of $6.1 million in liabilities and a corresponding decrease to goodwill of $7.0 million.
Also, additional consideration of $48.8 million was paid to MSI in relation to the opening the cash balance. The income statement impact relating to these fair value adjustments is not significant.
The following table summarizes the preliminary estimated fair values of the assets acquired and the liabilities assumed at the date of acquisition (in thousands):
Accounts receivable (1)
Inventories
Deferred income taxes, current
Other current assets
Property and equipment
Intangible assets
Other non-current assets
Tax liabilities
Other current liabilities (2)
Unrecognized tax benefits
Other non-current liabilities
Total identifiable net assets
On a preliminary basis pending the receipt of final valuations, 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 $2.329 billion.
Currently, the entire goodwill is assigned to the Enterprise segment. The final assignment of goodwill to reporting units has not been completed as of the date these financial statements are issued.
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Note 4 – Fair Value Measurements
Financial assets and liabilities are to be measured using inputs from three levels of the fair value hierarchy. Fair value is based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Zebra uses a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels:
Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.
Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.
Level 3: Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.
In determining fair value, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. In addition we consider counterparty credit risk in the assessment of fair value.
Financial assets and liabilities carried at fair value as of April 4, 2015, are classified below (in thousands):
Assets:
Forward contracts (1)
Money market investments related to the deferred compensation plan
Total assets at fair value
Liabilities:
Forward interest rate swap contracts (2)
Liabilities related to the deferred compensation plan
Total liabilities at fair value
Financial assets and liabilities carried at fair value as of December 31, 2014, are classified below (in thousands):
U.S. government and agency securities
Obligations of government-sponsored enterprises (3)
State and municipal bonds
Corporate securities
Investments subtotal
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The following is a summary of investments (in thousands):
Obligations of government-sponsored enterprises
Total investments
The carrying value for Zebra’s financial instruments classified as current assets (other than short-term investments) and current liabilities approximate fair value due to their short maturities.
Note 5 – Accounts Receivable
The components of accounts receivable are as follows (in thousands):
Gross Accounts receivable
Accounts receivable reserves
Note 6 – Inventories
The components of inventories are as follows (in thousands):
Raw material
Work in process
Finished goods
Inventories, gross
Inventory reserves
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Note 7 – Goodwill and Other Intangible Assets
In 2014, we acquired intangible assets in the amount of $1.014 billion for developed technology, customer relationships and trade names associated with the Acquisition. These intangible assets have an estimated useful life ranging from 1 to 15 years. See Note 3 Business Combinations for specific information regarding the Acquisition.
Intangible assets are as follows (in thousands):
Current technology
Trade names
Unpatented technology
Patents and patent rights
Customer relationships
Accumulated amortization
Amortization of intangibles assets was $67.6 million and $2.7 million for the three months ended April 4, 2015 and March 29, 2014 respectively.
In 2014, we acquired goodwill in the amount of $2.329 billion, see Note 3 Business Combinations for specific information regarding the Acquisition.
Note 8 Other Assets
Other assets consist of the following (in thousands):
Investments related to the deferred compensation plan
Long-term investments
Other long-term assets
Long-term trade receivable
Long-term notes receivable
Deposits
Total
The long-term investments are primarily in venture capital backed technology companies and our ownership interest is between 2.0% to 8.3%.
Note 9 Accrued Liabilities
The components of accrued liabilities are as follows (in thousands):
Accrued payroll
Accrued warranty
Accrued taxes
Interest payable
Amount owed to seller
Customer reserves
Accrued other expenses
Total accrued liabilities
Note 10 – Costs Associated with Exit and Restructuring Activities
During the first quarter 2015, Zebra incurred exit and restructuring costs resulting from organizational design changes primarily related to the Acquisition as follows (in thousands):
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Type of Cost
Severance, stay bonuses, and other employee-related expenses
Professional services
Exit and restructuring charges for the three months ended April 4, 2015 were $1.5 million and $9.7 million for the Legacy Zebra segment and Enterprise segment, respectively. Additional costs to be incurred in connection with this program are not expected to be significant.
As of December 31, 2014, we have incurred the following exit and restructuring costs related to the 2014 organization design changes, Location Solutions business management structure and manufacturing operations relocation and restructuring (in thousands):
Relocation and transition costs
A rollforward of the exit and restructuring accruals is as follows (in thousands):
Balance at the beginning of period
Charged to earnings
Cash paid
Balance at the end of period
Liabilities related to exit and restructuring activities are included in accrued liabilities.
Note 11 – Derivative Instruments
Portions of our operations are subject to fluctuations in currency values. We manage these risks using derivative financial instruments. We conduct business on a multinational basis in a wide variety of foreign currencies. Our exposure to market risk for changes in foreign currency exchange rates arises from international financing activities between subsidiaries, foreign currency denominated monetary assets and liabilities and transactions arising from international trade. Our objective is to preserve the economic value of non-functional currency denominated cash flows. We attempt to hedge transaction exposures with natural offsets to the fullest extent possible and, once these opportunities have been exhausted, through foreign exchange forward and option contracts with third parties.
In addition, we have exposure to market risk for changes in interest rates resulting from the variable interest payments on the term facility that was used to fund the Acquisition. We entered into forward interest rate swaps to hedge the interest rate risk associated with the Term Loan.
The fair value of the forward starting interest rate swap contracts is estimated using market quoted forward interest rates for the London Interbank Offered Rate “LIBOR” at the balance sheet date and the application of such rates subject to the interest rate swap terms. In accordance with ASC 815, Derivative and Hedging we recognize derivative instruments as either assets or liabilities on the balance sheet and measure them at fair value. Gains and losses resulting from changes in fair value are accounted for depending on the use of the derivative and whether it is designated as and qualifies for hedge accounting.
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Credit and market risk
Financial instruments, including derivatives, expose us to counter party credit risk for nonperformance and to market risk related to interest and currency exchange rates. We manage our exposure to counterparty credit risk through specific minimum credit standards, diversification of counterparties, and procedures to monitor concentrations of credit risk. Our counterparties in derivative transactions are commercial banks with significant experience using derivative instruments. We monitor the impact of market risk on the fair value and cash flows of our derivative and other financial instruments considering reasonably possible changes in interest rates and currency exchange rates and restrict the use of derivative financial instruments to hedging activities. We continually monitor the creditworthiness of our customers to which we grant credit terms in the normal course of business. The terms and conditions of our credit sales are designed to mitigate or eliminate concentrations of credit risk with any single customer.
Fair Value of Derivative Instruments
Zebra has determined that derivative instruments for hedges that have traded but have not settled are considered Level 1 in the fair value hierarchy, and hedges that have not traded are considered Level 2 in the fair value hierarchy. Derivative instruments are used to manage risk and are not used for trading or other speculative purposes, nor do we use leveraged derivative financial instruments. Our foreign currency exchange contracts are valued using broker quotations or market transactions, in either the listed or over-the-counter markets.
Hedging of Net Assets
We use forward contracts to manage exposure related to our pound and euro denominated net assets. Forward contracts typically mature within three months after execution of the contracts. 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 asset positions, which would ordinarily offset each other.
Summary financial information related to these activities included in our consolidated statements of operations as other income (expense) is as follows (in thousands):
Realized gains from foreign exchange derivatives
Loss on net foreign currency assets
Foreign exchange (loss)
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Notional balance of outstanding contracts:
Pound/US dollar
Euro/US dollar
Net fair value of outstanding contracts
Hedging of Anticipated Sales
We can manage the exchange rate risk of anticipated euro-denominated sales using purchased options, forward contracts, and participating forwards. We designate these contracts as cash flow hedges which mature within twelve months after the execution of the contracts. Gains and losses on these contracts are deferred in other comprehensive income until the contracts are settled and the hedged sales are realized. The deferred gains or losses will then be reported as an increase or decrease to sales.
Summary financial information related to the cash flow hedges is as follows (in thousands):
Change in unrealized gains on anticipated sales hedging:
Gross
Income tax expense
Net
Summary financial information related to the cash flow hedges of future revenues follows (in thousands, except percentages):
Notional balance of outstanding contracts versus the dollar
Hedge effectiveness
Net gains (losses) included in revenue
Forward Contracts
We record our forward contracts at fair value on our consolidated balance sheet as a current asset or current liability, depending upon the fair value calculation as detailed in Note 4 of Zebra’s consolidated financial statements. The amounts recorded on our consolidated balance sheet are as follows (in thousands):
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Forward Interest Rate Swaps
The forward interest rate swaps hedge the interest rate risk associated with the variable interest payments on our Term Loan that was used to fund the Acquisition.
In June 2014, we entered into a commitment letter for a new variable rate credit facility to fund the Acquisition and we also entered into two tranches of floating-to-fixed forward interest rate swaps (“Original Swaps”). These Original Swaps were used to economically hedge interest rate risk associated with the variable rate commitment until July 30, 2014, and as such, changes in their fair value were recognized in earnings in other income (expense). Effective July 30, 2014, the Original Swaps were designated as cash flow hedges of interest rate exposure associated with variability in future cash flows on the variable rate commitment. On October 27, 2014, the variable rate commitment was funded and we entered into a Term Loan that accrues interest at a variable rate of LIBOR (subject to a floor of 0.75% per annum) plus a margin of 4.0%. On October 30, 2014, we discontinued hedge accounting for the Original Swaps due to the syndication of the Original Swaps to a group of commercial banks (“Syndicated Swaps”), which resulted in their termination. The changes in fair value of the Original Swaps between July 30, 2014 and their termination were included in other comprehensive income (loss), and any ineffectiveness was insignificant. The amounts included in other comprehensive income (loss) will be amortized to earnings in other income (expense) as the interest payments under the Term Loan affect earnings. The Syndicated Swaps were not designated as hedges and the changes in fair value are recognized in earnings in other income (expense).
On November 20, 2014 we entered into additional floating-to-fixed forward starting interest rate swaps (“New Swaps”) and designated these as cash flow hedges of interest rate exposure associated with variability in future cash flows on our Term Loan. To offset the impact to earnings of the changes in fair value of the Syndicated Swaps, we also entered into fixed-to-floating forward starting interest rate swaps (“Offsetting Swaps”), which were not designated in a hedging relationship and the changes in the fair value are recognized in earnings in other income (expense). Changes in fair value of the New Swaps that are designated as cash flow hedges and are effective at offsetting variability in the future cash flows on our Term Loan are recognized in other comprehensive income (loss). Ineffectiveness is immediately recognized in earnings.
The location of the forward interest rate swaps designated in a hedge relationship is as follows (in thousands):
The interest rate swap designated in a hedging relationship is highly effective.
The forward interest rate swaps not designated in a hedging relationship are recorded in a net liability position of $12.9 million in the Consolidated Balance Sheets.
The gross and net amounts offset at April 4, 2015 were as follows (in thousands):
Counterparty A
Counterparty B
Counterparty C
Counterparty D
Counterparty E
Counterparty F
Counterparty G
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The volume of the forward interest rate swaps, New Swaps, designated in a hedge relationship is as follows (in thousands):
Notional balance of outstanding contracts
The New Swaps, each with a term of one year, are designated as cash flow hedges of interest rate exposure associated with variability in future cash flows on the Term Loan. The notional amount of the designated New Swaps effective in each year of the cash flow hedge relationships does not exceed the principal amount of the Term Loan which is hedged. The New Swaps have the following notional amounts per year (in thousands):
Year 2015
Year 2016
Year 2017
Year 2018
Year 2019
Year 2020
The gain (loss) recognized on the forward interest rate swaps not designated in a hedge relationship is as follows (in thousands):
Gain on forward interest-rate swaps
The gain (loss) recognized in other comprehensive income (loss) on the forward interest rate swaps designated in a hedging relationship is as follows (in thousands):
Change in unrealized loss on forward interest rate swap hedging:
Income tax (benefit)
No gain (loss) was reclassified from accumulated other comprehensive income (loss) into earnings on the forward interest rate swaps designated in a hedging relationship during the three month periods ended April 4, 2015 and March 29, 2014.
At April 4, 2015, we expect that approximately $6.0 million in losses on the forward interest rate swaps designated in a hedging relationship will be reclassified from accumulated other comprehensive loss into earnings during the next 4 quarters.
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Note 12 – Warranty
In general, Zebra provides warranty coverage of one year on mobile computing products and WLAN products. Advanced data capture products are warranted from 1-5 years, depending on the product. Printers are warranted for one year against defects in material and workmanship. Thermal printheads are warranted for six months and batteries are warranted for one year. Battery based products, such as location tags, are covered by a 90-day warranty. A provision for warranty expense is recorded at the time of sale and is adjusted quarterly based on historical warranty experience.
The following table is a summary of Zebra’s accrued warranty obligation (in thousands):
Warranty expense
Warranty payments
Note 13 – Long-Term Debt
The following table summarizes the carrying value of our debt (in thousands):
Senior Notes
Term loan
Less unamortized discounts
Total outstanding debt
Current maturities of long-term debt
Less: current portion of unamortized discounts
Total short-term debt
Long-term debt, less current maturities
The estimated fair value of our long-term debt approximated $3.3 billion at April 4, 2015 and December 31, 2014. These fair value amounts represent the estimated value at which our lenders could trade our debt within the financial markets and does not represent the settlement value of these long-term debt liabilities to us. The fair value of the long-term debt will continue to vary each period based on fluctuations in market interest rates, as well as changes to our credit ratings. This methodology resulted in a Level 2 classification in the fair value hierarchy.
Private Offering
On October 15, 2014, Zebra completed a private offering of $1.05 billion aggregate principal of 7.25% Senior Notes due October 15, 2022 (the “Senior Notes”). The Senior Notes yielded an effective interest rate of 7.61% at issuance. The Senior Notes are governed by the terms of an indenture, dated as of October 15, 2014, by and among Zebra and U.S. Bank National Association, as Trustee. Interest on the Senior Notes is payable in cash on April 15 and October 15 of each year, commencing on April 15, 2015.
The Indenture covering the Senior Notes contains certain various restrictive and affirmative covenants. In addition, the Senior Notes are guaranteed jointly and severally, on a senior and unsecured basis by Zebra’s direct and indirect wholly-owned existing and future domestic restricted subsidiaries, subject to certain exceptions.
Credit Facilities
On October 27, 2014, Zebra entered into a new credit agreement which provides for a term loan of $2.2 billion (“Term Loan”) and a revolving credit facility of $250.0 million (“Revolving Credit Facility”). Borrowings under the Term Loan bear interest at a variable rate plus an applicable margin, subject to an all-in floor of 4.75%. As of April 4, 2015, the Term Loan interest rate was 4.75%. Interest payments are payable quarterly, starting January 27, 2015. Zebra has entered into interest rate swaps to manage interest rate risk on its long-term debt. See Note 11 Derivative Instruments.
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The credit agreement requires Zebra to prepay the Term Loan and Revolving Credit Facility, under certain circumstances or transactions defined in the credit agreement. Also, Zebra may make optional prepayments of the Term Loans, in whole or in part, without premium or penalty. Zebra made such optional principal prepayments of $50.0 million and $30.0 million on March 15, 2015 and May 13, 2015 respectively. Unless satisfied by further optional prepayments Zebra is required to make scheduled quarterly principal payments of $5.5 million beginning March 31, 2019, with the balance of $2.1 billion due on October 27, 2021.
The Revolving Credit Facility is available for working capital and other general corporate purposes including letters of credit. The amount (including letters of credit) shall not exceed $250.0 million. As of April 4, 2015, Zebra had established letters of credit amounting to $3.1 million, which reduced funds available for other borrowings under the agreement to $246.9 million. The Revolving Credit Facility will mature and the commitments thereunder will terminate on October 27, 2019.
Borrowings under the Revolving Credit Facility bear interest at a variable rate plus an applicable margin. As of April 4, 2015, the Revolving Credit Facility interest rate was 3.25%. Interest payments are payable quarterly. As of April 4, 2015 and December 31 2014, Zebra did not have any borrowings against the Revolving Credit Facility.
The Credit Facilities contains various restrictive and affirmative covenants and are collateralized by a security interest in substantially all of Zebra’s assets as defined in the security agreement and guaranteed by its direct and indirect wholly-owned existing and future domestic restricted subsidiaries, subject to certain exceptions.
Note 14 – Contingencies
We are subject to a variety of investigations, claims, suits and other legal proceedings that arise from time to time in the ordinary course of business, including but not limited to, intellectual property, employment, tort and breach of contract matters. We currently believe that the outcomes of such proceedings, individually and in the aggregate, will not have a material adverse impact on our business, cash flows, financial position, or results of operations. Any legal proceedings are subject to inherent uncertainties, and management’s view of these matters and their potential effects may change in the future.
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Note 15 – Earnings (Loss) Per Share
Earnings (loss) per share were computed as follows (in thousands, except per share amounts):
Weighted average shares:
Weighted average common shares outstanding
Effect of dilutive securities outstanding
Diluted weighted average shares outstanding
Basic per share amounts:
Per share amount
Diluted per share amounts:
Potentially dilutive securities that were excluded from the earnings per share calculation consist of stock options and stock appreciation rights (SARs) with an exercise price greater than the average market closing price of the Class A common stock. These excluded options and SARs were as follows:
Potentially dilutive shares
Note 16 – Equity-Based Compensation
Zebra has an equity-based compensation plan and an employee stock purchase plan under which shares of our common stock were available for future grants and sales. Zebra recognizes compensation costs using the straight-line method over the vesting period upon grant of up to 5 years.
Pre-tax equity-based compensation expense recognized in income was $8.8 million and $3.0 million for the three month periods ending April 4, 2015 and March 29, 2014, respectively. Tax related benefits of $3.1 million and $1.0 million were also recognized for the three month periods ending April 4, 2015 and March 29, 2014, respectively.
The company issued 175,261 and 123,019 shares in connection with stock based compensation and employee stock purchase programs during the three months ended April 4, 2015 and March 29, 2014 respectively.
The fair value of equity-based compensation 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 stock prices over our entire stock history. Stock option grants in the table below include both stock options, all of which were non-qualified, and stock appreciation rights (SARs) that will be settled in Zebra stock. Restricted stock grants are valued at the market closing price on the grant date. The following table shows the weighted-average assumptions used for grants of SARs as well as the fair value of the grants 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 SARs granted
Weighted-average grant date fair value of SARs granted (per underlying share)
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Stock option activity was as follows:
Options
Outstanding at beginning of year
Exercised
Expired
Outstanding at end of period
Exercisable at end of period
Intrinsic value of exercised options
SARs activity was as follows:
SARs
Granted
Forfeited
Intrinsic value of exercised SARs
Restricted stock award activity was as follows:
Restricted Stock Awards
Released
Performance share award activity was as follows:
Performance Share Awards
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Restricted stock unit activity was as follows:
Restricted Stock Units
Performance stock unit activity was as follows:
Performance Stock Units
As of April 4, 2015 total unearned compensation costs related to Zebra’s equity based compensation plans was $45.7 million which will be amortized over the weighted average remaining service period of 1.7 years.
The fair value of the purchase rights issued to Zebra employees under the stock purchase plan is 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
Note 17 – Income Taxes
In the first quarter of 2015 we recognized a tax benefit of $32.9 million compared to a tax provision of $11.9 million for the corresponding period in the prior year. Zebra’s effective tax rates were 56.5% and 22.3% as of April 4, 2015 and March 29, 2014, respectively. Zebra’s effective tax rate was higher than the statutory rate of 35% in 2015 primarily due to pre-tax losses in the Unites States and pre-tax income in various non-US jurisdictions. Zebra’s effective tax rate in 2014 benefited from lower taxes on income in various non-US jurisdictions.
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Note 18 – Other Comprehensive Income
Stockholders’ equity includes certain items classified as accumulated other comprehensive income (AOCI), including:
The components of other comprehensive income are as follows (in thousands):
Unrealized gains (losses) on anticipated sales hedging transactions:
Unrealized gains (losses) on forward interest rate swaps hedging transactions:
Unrealized gains (losses) on investments:
Total accumulated other comprehensive gains (losses)
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Note 19 – Segment Information
Subsequent to the Acquisition, on October 27, 2014, Zebra has two reportable segments: Legacy Zebra (“Z”) and Enterprise (“E”). Segment assets are not reviewed by Zebra’s chief operating decision maker and therefore are not disclosed below:
Net Sales:
Z – Net sales
E – Net sales
Total segment net sales
Corporate, eliminations (1)
Operating income (loss):
Z – Operating income
E – Operating income
Total segment operating income
Corporate, eliminations (2)
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Note 20 – Subsequent Events
Since the date of the Enterprise acquisition Zebra has been working on and executing against its integration plan for the Enterprise business (the “Integration Plan”). Zebra anticipates completing the Integration Plan as soon as practicable and expects that the Integration Plan will allow the combined businesses to achieve further synergies and cost savings associated with the acquisition. As part of the Integration Plan, Zebra began realigning certain acquired assets of the Enterprise business with and into the Zebra corporate structure and business model in April 2015. The April 2015 transactions are expected to result in a charge of approximately $32 million to income tax expense in the second quarter of 2015.
On May 13, 2015 Zebra made principal prepayments of $30.0 million under its Term Loan. See Note 13 Long-Term Debt.
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Description of the Company
Zebra is a global leader respected for innovation and reliability. We offer products and services that give organizations greater visibility and insights into their operations, which we call Enterprise Asset Intelligence. Our products and services allow our customers to manage their assets, transactions and people more effectively, and thereby improve their operational efficiency, deliver a better customer experience, provide more effective security and achieve other objectives of their organization. We provide products and services in approximately 100 countries, with 122 facilities and approximately 6,800 employees worldwide.
In October 2014, Zebra acquired the Enterprise business (“Enterprise”) from Motorola Solutions Inc., excluding iDEN, for $3.45 billion in cash. Enterprise is an industry leader in mobile computing and data capture products. It also provides wireless LAN products, in addition to repair, maintenance, integration and device management services. Zebra’s financial results reflect the addition of Enterprise from the date of acquisition.
Executive Summary
This Executive Summary provides significant highlights from the discussion and analysis that follows.
Results of Operations: First Quarter of 2015 versus First Quarter of 2014
Consolidated Results of Operations
(Amounts in thousands, except percentages):
Net sales
Net sales increased across all regions and all Legacy Zebra product categories in the first quarter of 2015 which resulted in an increase of 209.8% compared to the first quarter in 2014. Sales related to the October 2014 acquisition of Motorola’s Enterprise Business increased sales for the first quarter of 2015 by $567.2 million.
Sales by product category were as follows (amounts in thousands, except percentages):
Product
Category
Hardware
Supplies
Service and software
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Sales to customers by geographic region were as follows (in thousands, except percentages):
Geographic Region
Europe, Middle East and Africa
Latin America
Asia-Pacific
Total International
North America
Gross Profit
Gross profit in the first quarter of 2015 increased 176.8% to $ 409.5 million. $ 244.6 million of the increase was due to the October 2014 acquisition of Enterprise. Gross profit in the Legacy Zebra segment increased to $171.4 million from $147.9 million from the first quarter of 2014.
Operating Income
Operating income decreased 63.0% from prior year. This was mainly due to acquisition costs, amortization of intangibles and exit and restructuring costs related to the acquisition of Enterprise. In addition, expenses across all functional areas increased due to the October 2014 acquisition of Enterprise.
Segment Information
Commencing with the acquisition of Enterprise in October 2014, our continuing operations consist of two reporting segments (1) Legacy Zebra, comprised of barcode and card printing, location and motion sensing and related services, and supplies products, and (2) Enterprise, comprised of our mobile computing, data capture, WLAN products and related services. The following commentary should be read in conjunction with the financial results of each operating business segment as detailed in Note 19, Segment Information in the Notes to the Consolidated Financial Statements. The segment results exclude acquisition and integration costs, amortization of intangible assets and exit and restructuring costs.
Legacy Zebra Segment
(Amounts in thousands, except percentages)
Legacy Zebra Net Sales
Net sales for the first quarter of 2015 increased 15.0%, compared to the first quarter of 2014. Growth was primarily attributable to solid demand in the North America and EMEA regions. Increased sales were widespread across both distribution and end-user customers. From a product perspective, key areas of growth were in tabletop, desktop and mobile printers, aftermarket parts, supplies and location solution products. Movement in foreign currency, net of hedges, decreased sales growth by $2.5 million.
Legacy Zebra Gross Profit
Gross profit margin was 51.7% in the first quarter of 2015, compared to 51.3% in the first quarter of 2014. The increase in gross profit margin was principally due to increased volume leverage on fixed costs, lower freight costs, and favorable product mix.
Legacy Zebra Operating Income
Operating income for the first quarter increased 26.4% as a result of higher sales and gross profit partially offset by increases in operating expenses.
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Enterprise Segment
Enterprise Net Sales
On October 27, 2014, Zebra acquired Enterprise, a provider of industry-leading data capture, mobile computing and wireless LAN solutions.
For the three months ended April 4, 2015, net sales for Enterprise were $567.2 million. For the period, overall Enterprise sales reflected solid customer demand, particularly in the North America and Asia Pacific regions. Unfavorable changes in foreign currency adversely affected sales in Europe. Sales of mobile computing and data capture products continue to represent the majority of total enterprise sales while North America and EMEA continue to represent the largest geographic regions. Services sales were consistent with recent levels.
Enterprise Gross Profit
Gross profit for Enterprise in the first quarter of 2015 was $244.6 million. Gross margin for Enterprise for the first quarter of 2015, was 43.1% of sales.
The gross profit margin was adversely affected by the strengthening of the U.S. dollar and higher service costs. Excluding currency effects, hardware gross profit margin was relatively consistent with recent trends while service margin was lower. The mix of hardware and services sales was essentially consistent with recent trends.
Enterprise Operating Income
Enterprise operating income for the first quarter of 2015 was $53.9 million.
Consolidated Operating expenses
Operating expenses are summarized below (in thousands, except percentages):
Operating Expenses
Operating expenses for the first quarter of 2015 increased 312.3% mainly due to acquisition costs, amortization of intangibles, exit and restructuring costs and increased costs across all functional areas as a result of the October 2014 acquisition of Enterprise.
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Consolidated other income (expense)
Zebra’s non-operating income and expense items are summarized in the following table (in thousands):
Investment income (loss)
Foreign Exchange Loss
The company recognized a foreign exchange loss of $27.2 million, which reflects the change in value of non-USD assets and liabilities that were not hedged during the period.
Interest Expense
Interest expense increased $51.0 million reflecting the indebtedness incurred for the Acquisition.
Income Taxes
Liquidity and Capital Resources
In connection with the Acquisition in October 2014, we incurred indebtedness totaling $3.25 billion. As of April 4, 2015, we had cash of $329.5 million and long-term debt totaling $3.1 billion. We did not have any borrowings against our revolving credit facility with $246.9 million available ($250 million less $3.1 million of letters of credit). See Note 13 Long term debt in the Notes to the Consolidated Financial Statements for further details. The primary factors that influence our liquidity include, but are not limited to, the amount and timing of our revenues, cash collections from our customers, capital expenditures and acquisitions of third-parties. Management believes that existing capital resources and funds generated from operations are sufficient to meet anticipated capital requirements and service our indebtedness. The following table summarizes our cash flow activities for the periods indicated (in thousands):
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Cash Flow provided by (used in):
Operating activities
Investing activities
Financing activities
Effect of exchange rates on cash balances
The change in our cash and cash equivalents balance is reflective of the following:
During the first quarter 2015, Zebra had cash provided by operating cash flows of $35.6 million compared to $50.0 million in the prior year. The year over year decrease in operating cash flow is primarily a result of increased working capital requirements.
Cash used in investing activities during the first quarter of 2015 include additional consideration of $48.8 million paid to MSI in relation to the opening the cash balance and capital expenditures of $25.5 million which consists primarily of investments in our corporate office. Reflecting Zebra’s changing capital structure, cash used for investing activities reflect $25.1 of proceeds from the sale of investments in marketable securities during the first quarter of 2015 and purchases of marketable securities of $151.8 million during the first quarter of 2014.
On March 15, 2015, Zebra made principal prepayments of $50.0 million under its term loan. Proceeds received from the exercise of stock options and stock purchase plan purchases were $8.2 million this year compared to $4.9 million last year reflecting increased option exercises and ESPP purchases.
The following table shows our level of indebtedness and other information as of April 4, 2015 (in thousands):
Senior notes
Term loans
Total indebtedness
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The Revolving Credit Facility is available for working capital and other general corporate purposes including letters of credit. The amount (including letters of credit) shall not exceed $250.0 million. As of April 4, 2015, Zebra had established letters of credit amounting to $3.1 million, which reduced funds available for further borrowings under the agreement to $246.9 million. The Revolving Credit Facility will mature and the commitments thereunder will terminate on October 27, 2019.
The Revolving Credit Facility contains various restrictive and affirmative covenants and are collateralized by a security interest in substantially all of Zebra’s assets as defined in the security agreement and guaranteed by its direct and indirect wholly-owned existing and future domestic restricted subsidiaries, subject to certain exceptions. Zebra is in compliance with the covenants.
Certain domestic subsidiaries of Zebra (the “Guarantor Subsidiaries”) guarantee the Notes, the Term Loan and the Revolving Credit Facility on a senior basis: For the three months ended April 4, 2015, the non-Guarantor Subsidiaries would have (a) accounted for approximately 41.6% of our total revenue and (b) held approximately 14.5% of our total assets and approximately 13.0%, or $576.6 million, of our total liabilities including trade payables but excluding intercompany liabilities.
Historically, significant portions of our cash inflows were generated by our operations. We currently expect this trend to continue throughout 2015. We believe that our existing cash and investments, borrowings available under our Revolving Credit Facility, together with cash flows expected from operations will be sufficient to meet expected operating, capital expenditure and debt obligation requirements for the next 12 months.
Zebra had $219.9 million as of April 4, 2015, and $273.7 million as of March 29, 2014 of foreign cash and investments, which are primarily invested in U.S. dollar-denominated holdings.
Management believes that existing capital resources and funds generated from operations are sufficient to finance anticipated capital requirements.
Significant Customer
Our net sales to significant customers as a percentage of total net sales were as follows:
Customer A
Customer B
Customer C
No other customer accounted for 10% or more of total net sales during these periods. The customers disclosed above are distributors (i.e. not end users) of Zebra’s products.
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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 expressed or implied in such forward looking statements. These forward-looking statements are based on current expectations, forecasts and assumptions and are subject to the risks and uncertainties inherent in Zebra’s industry, market conditions, general domestic and international economic conditions, and other factors. These factors include:
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, 2014, for a further discussion of issues that could affect Zebra’s future results. Zebra undertakes no obligation, other than as may be required by law, 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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There were no material changes in Zebra’s market risk during the quarter ended April 4, 2015. 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, 2014.
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. See Note 11 to the Consolidated Financial Statements included in this report for further discussion of derivative instruments.
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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 (the “Exchange Act”)) as of the end of the period covered by this Form 10-Q. The 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, we have concluded that our disclosure controls and procedures were not effective as of April 4, 2015, as a result of a material weakness related to the process to review and prepare our quarterly income tax provision.
Remediation Plan
Management and the Board of Directors are committed to the continued improvement of our overall system of internal controls over financial reporting and have already begun to implement additional controls and procedures to remediate the review and preparation process relating to our quarterly income tax provision prior to the end of the year.
Changes in Internal Control over Financial Reporting
As noted in our 2014 Form 10K, in connection with our initial reviews of internal controls for Enterprise, we have identified certain internal control deficiencies related to Enterprise. We continue to identify and review the internal controls of the Enterprise business and are establishing a plan of remediation that is consistent with our obligation to assess the effectiveness of Enterprise’s internal controls over financial reporting as of December 31, 2015.
The identification, review, assessment and remediation of internal control deficiencies is overseen by senior management and our audit committee, and is undertaken primarily through the integration of processes and procedures with existing Zebra processes and procedures, development and implementation of formal policies, improved processes and documented procedures, as well as the hiring of additional finance personnel.
During the quarter covered by this report, there have been no other changes in our internal controls 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 Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting 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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See Note 14 to the Consolidated Financial Statements included in this report.
In addition to the other information included 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, 2014. The risks described in our Annual Report on Form 10-K could materially adversely affect our business, financial condition or future results. The risks described in our Annual Report are not the only risks facing our company. Additional risks and uncertainties not currently known to us or that we currently consider immaterial also may materially adversely affect our business, financial condition, and/or operating results. There have been no material changes to the risk factors included in our Annual Report for the year ended December 31, 2014, other than the risk entitled “We have identified a material weakness in our internal control over financial reporting which could, if not remediated, result in additional material misstatements in our financial statements” which risk is described below.
We have identified a material weakness in our internal control over financial reporting which could, if not remediated, result in additional material misstatements in our financial statements.
Our management is responsible for establishing and maintaining adequate internal controls over our financial reporting, as defined in Rule 13a-15(f) under the Securities Exchange Act. As disclosed in Item 4 of Part I of this report, management identified a material weakness in our internal control over financial reporting related to the process to review and prepare our quarterly income tax provision. A material weakness is defined as a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. As a result of this material weakness, our management concluded that our internal control over financial reporting was not effective as of the last day of the period covered by this report. We are actively engaged in developing a remediation plan designed to address this material weakness. If our remedial measures are insufficient to address the material weakness or if additional material weaknesses or significant deficiencies in our internal control are discovered or occur in the future, our consolidated financial statements may contain material misstatements and we could be required to restate our financial results.
Treasury Shares
Zebra did not purchase shares of Zebra Class A Common Stock during the first quarter of 2015.
On November 2011, Zebra’s Board authorized the purchase of up to an additional 3,000,000 shares under the purchase plan program and the maximum number of shares that may yet be purchased under the program is 665,475. The November 2011 authorization does not have an expiration date.
During the first quarter, Zebra acquired 1,240 shares of Zebra Class A Common Stock through the withholding of shares necessary to satisfy tax withholding obligations upon the vesting of restricted stock awards. These shares were acquired at an average price of $90.26 per share.
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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.
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