Zebra Technologies 10-K 2006
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 000-19406
Zebra Technologies Corporation
(Exact name of registrant as specified in its charter)
333 Corporate Woods Parkway, Vernon Hills, IL 60061
(Address of principal executive offices) (Zip Code)
Registrants telephone number, including area code: (847) 634-6700
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Class A Common Stock, par value $.01 per share
Indicate by check mark if the registrant is a
well-known seasoned issuer (as defined in Rule 405 of the Securities Act).
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Act. Yes o No ý
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 ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Act).
Yes ý No o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Act).
Yes o No ý
As of July 1, 2005, the aggregate market value of each of the registrants Class A Common held by non-affiliates was approximately $3,192,500,000. The closing price of the Class A Common Stock on July 1, 2005, as reported on the Nasdaq Stock Market, was $44.28 per share.
As of February 23, 2006, 70,562,061 shares of Class A Common Stock, par value $.01 per share, were outstanding.
Documents Incorporated by Reference
Certain sections of the registrants Notice of Annual Meeting of Stockholders and Proxy Statement for its Annual Meeting of Stockholders to be held on May 9, 2006 are incorporated by reference into Part III of this report.
ZEBRA TECHNOLOGIES CORPORATION AND SUBSIDIARIES
References in this document to Zebra, we, us, or our refer to Zebra Technologies Corporation and its subsidiaries, unless the context specifically states otherwise.
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 Zebras printer and software products and competitors product offerings. They also include the effect of market conditions in North America and other geographic regions on our financial results. Profits will be affected by our ability to control manufacturing and operating costs. Because of a large investment portfolio, interest rate and financial market conditions will also have an impact on results. Foreign exchange rates will have an effect on financial results due to the large percentage of our international sales. 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 the Risk Factors portion of Managements Discussion and Analysis of Financial Condition and Results of Operations, which discusses additional risks. 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 annual report.
Item 1. Business
Zebra Technologies designs, manufactures and distributes specialty printing devices that print variable information on demand at the point of issuance. These devices are used worldwide by manufacturers, service organizations and governments for automatic identification, data collection and personal identification in applications that improve productivity, deliver better customer service and provide more effective security. Our product range consists of direct thermal and thermal transfer label and receipt printers, radio frequency identification (RFID) printer/encoders, dye sublimation card printers, and digital photo printers. We also sell a comprehensive range of specialty supplies consisting of self-adhesive labels, thermal transfer ribbons, thermal printheads, batteries and other accessories, including software for label design and printer network management.
We design our products to operate at the point of issuance to produce and dispense high-quality labels, plastic cards, and photographs on demand. The exceptional diversity of applications using our printer products for barcoding and personal identification is comprised of routing and tracking, transactions processing, and identification and authentication. They include applications that require high levels of data accuracy and where speed and reliability are critical. They also include specialty printing for receipts and tickets where improved customer service and productivity gains may be the primary reason for printing, rather than a barcoding application. Plastic cards are used for secure, reliable personal identification or access control. Digital photo printers are sold on an OEM basis to professional photographers and for use in kiosks at retail and other locations.
Applications for our technology span most industries and geographies. They include inventory control, small package delivery, baggage handling, automated warehousing, JIT (Just-In-Time) manufacturing, employee time and attendance records, file management systems, hospital information systems, medical specimen labeling, shop floor control, in-store product labeling, employee ID cards, drivers licenses, and access control systems. As of December 31, 2005, management estimates that Zebra has sold almost 5,000,000 printers to users in approximately 100 countries.
We believe competitive forces on businesses worldwide to strengthen security, reduce costs, improve quality, deliver better customer service, and increase productivity, support the adoption of bar code, RFID and specialty printing applications because these technologies deliver significant and predictable economic benefits. Industry-mandated compliance requirements for bar code labeling and RFID tagging are also important catalysts in the deployment of these systems. We also believe that companies are adopting automatic identification systems that incorporate barcoding and RFID for business improvement applications. Many of these applications make increasing use of enterprise-wide resource planning (ERP) and other process improvement systems in manufacturing and service organizations. Greater emphasis on supply chain management, the drive to reduce errors in healthcare, and heightened concern over safety and security will lead to increased use of automatic
identification systems. Still other applications are taking advantage of recent advances in wireless and hand-held computing technologies.
Concern for safety and security and personal identification contribute to demand for our card printer products. This concern has heightened interest in systems that provide personal identification and access control, including secure ID systems for drivers licenses, employee and visitor badges, national identification cards, event passes, club membership cards, and keyless entry systems.
Zebra completed its initial public offering in August 1991. We are
organized under the laws of the State of Delaware, and our principal offices
are located at 333 Corporate Woods Parkway, Vernon Hills, Illinois 60061. Our
main telephone number is
Our printers are used to produce bar code labels, RFID smart labels, receipts and tags, plastic cards, and photographs. We also sell related specialty labeling materials, thermal ink ribbons, and bar code label design and network management software. These products are used to provide bar code labeling, personal identification, and specialty printing solutions principally in the manufacturing, retail, service, and government sectors of the economy. We work closely with distributors, resellers and end users of our products to design and implement labeling solutions that meet their technical demands. To achieve this flexibility, we provide our customers with a broad selection of printer models, each of which can be configured for a specific application. Additionally, we will select and, if necessary, create appropriate labeling stock, ink ribbons and adhesives to suit a particular application. In-house engineering personnel in software, mechanical, electronic and chemical engineering participate in the creation and development of bar code labeling solutions for particular applications.
Sales of hardware (printers and replacement parts) and supplies were as follows (in thousands):
Label and Receipt Printers
We produce the industrys broadest range of on-demand thermal transfer and direct thermal label printers. Our printing systems include hundreds of optional configurations that can be selected to meet particular customer needs. We believe this breadth of product is a unique and significant competitive strength, because it allows Zebra to satisfy the widest variety of thermal printing applications.
Of the major printing technologies, which include ink jet, laser and impact dot matrix, management believes that direct thermal and thermal transfer technologies are best suited for most bar code labeling applications. Thermal transfer printing produces dark, solid blacks and sharply defined lines that are important for printing readily scannable bar codes. These images can be printed on a wide variety of labeling materials, which enable users to affix bar code labels to virtually any object. This capability is very important in the industrial and service sectors Zebra serves. Direct thermal printing is best suited where simplicity, lightweight and cost are important factors in the application. Accordingly, this technology is found principally in Zebras mobile and desktop units.
We offer 33 bar code printer models with numerous variations, including:
Performance Tabletop Printers. Zebra produces high-end printers targeted at applications requiring continuous operation in high output, mission-critical settings. These units provide a wide variety of optional configurations, features, print widths, speeds and dot densities. We offer four models under the XiIII Plus Series line. List prices range from $2,995 to $7,495.
RFID Printer/Encoders. Zebra also manufactures and markets a growing line of printer/encoders used for radio frequency identification (RFID) in the retail supply chain, for defense logistics, and other applications. These units are used to print and encode smart labels in a single pass. Smart labels are printable labels embedded with an ultra-thin radio frequency
transponder. Information encoded in these transponders can then be read and modified by a radio frequency reader. As of December 31, 2005, we offered four RFID and two RFID-ready printer/encoders, which have list prices from $1,695 to $6,995.
Mid-Range Tabletop Printers. We offer six printer models designed for less demanding applications. These units have fewer option configurations and features for a lower price. Products in this category consist of the Zebra Stripeâ, S and Z Series as well as the TLP 2746e printers. List prices range from $1,145 to $3,490.
Desktop Printers. Applications with low volume suit Zebras desktop printers. We currently offer six desktop models consisting of direct thermal and thermal printers in two-, three- and four-inch widths. List prices range from $395 to $895.
Mobile Printers. Zebra makes 8 mobile printer models, which provide durability, light weight and wireless connectivity interfaces. These printers print in two-, three- and four-inch widths and are marketed under the Cameo, QL, TR, PS, PA/PT and RW lines. List prices range from $550 to $4,795.
Print Engines. Zebras 170PAX3 and 110PAX3 print engines are sold to manufacturers of high-speed automatic label applicator systems. We also offer the R110PAX3 RFID print engine targeted at emerging packaged goods RFID labeling applications.
In addition to their use in on-demand automatic identification applications, our thermal printers can also be used for on-site batch production of custom bar code labels and other graphics. This capability results in shorter lead times, reduced inventory, and more flexibility than can be provided with traditional off-site printing.
Zebra makes 11 card printer models for printing national identity cards, drivers licenses, employee identification badges, smart cards, on-demand access control cards, gift cards and customer loyalty cards. These cards can typically be printed in seconds for less than one dollar each. Users can select from a number of printer options, including monochrome and color printing, single- and two-sided printing, lamination, and magnetic stripe and smart card encoding. Bar codes, smart chips and magnetic stripe encoding can be used to record such personal data as health records, financial transactions, security access codes and vital statistics. We offer two c-Series and nine i-Series card printers. Printers in the i-Series incorporate features that automatically optimize printer settings for a given ribbon. The list prices for all of Zebras card printers range from $1,795 to $7,995.
Digital photo printing is an extension of our core thermal printing technology. With the November 2003 acquisition of Atlantek we began producing digital photo printers; we currently manufacture two printers jointly developed with and marketed by Eastman Kodak. Our high-speed thermal photo printer is sold as the Kodak Professional ML-500 Digital Photo Print System. The ML-500 is designed for professional photographers for use in event and in-studio printing and can print an 8x10 photograph in about 13 seconds. During the fourth quarter of 2005, we introduced a second printer designed to work as part of a photo kiosk or a standalone in professional photography applications. We currently sell this printer on an OEM basis to Eastman Kodak, which incorporates the printer into Kodak photo kiosks and markets the standalone version as the Kodak Professional 9810 Digital Photo Printer.
Supplies products consist of stock and customized thermal labels, wristbands, smart labels and tags, plastic cards, card laminates, and thermal transfer ribbons. Zebra promotes the use of genuine Zebra brand supplies with its equipment.
Zebra fully supports its printers, resellers and end users with an extensive line of superior quality, high performance supplies optimized to a particular users needs. Supplies are chosen in consultation with the reseller and end user based on the specific application, printer and environment in which the labeling system must perform. In the case of bar code labeling solutions, supplies also include proprietary ribbon and label formulations that are designed to maximize printer performance and meet the most demanding end user performance criteria. Factors such as adhesion, resistance to scratches, smudges and abrasion and chemical and environmental exposures are all taken into account when selecting the type of ribbon and labeling materials. The use of supplies that are not carefully matched to specific printers can degrade print speed and print quality.
Zebra has specialized printer management, label design and driver solutions to help unlock the full potential of Zebra printers. The ZebraLink Solutions suite of networking, software, firmware, and printer management products is designed for ease of integration and use, from small business to enterprise supply chain applications. Our goal is to provide software that enables high levels of functionality to all major computer network and software systems. Network systems include Ethernet, 802.11 and Bluetooth wireless systems. Operating systems include Windows, UNIX, Linux and various IBM systems
The ZebraNet Bridge Enterprise printer management application enables organizations to efficiently deploy, manage and monitor Zebra printers from a single location. Leveraging the powerful printer management features built into many Zebra printers and Zebra print servers, ZebraNet Bridge Enterprise delivers real-time printer error and status notifications for maximum up-time performance. Easy to use and flexible tools within the program allow system administrators to create highly manageable printer groups for real-time control and monitoring of Zebra printers on their network.
Label design and integration software is specifically designed to optimize the performance of Zebra bar code label printers. In 2005, we introduced ZebraDesigner and ZebraDesigner Pro, label design and printer configuration tools that bring greater ease of use and improved functionality to the label design and printing process. Zebra also offers BAR-ONE for mySAPâ Business Suite for users of the SAPâ ERP system. To facilitate using Zebra printers with a broad range of software applications, Zebra offers Windows printer drivers designed to optimize the printer experience.
To expand the global applications for its software and printers, we are developing multi-lingual capabilities in our software and user interfaces.
For bar code label and receipt printers, we currently provide service at depot repair centers at our Vernon Hills, Illinois, Preston, U.K. and the Netherlands facilities. We also provide service at a depot repair center in Toronto, Canada through a partnership with Getronics. Zebra Authorized Service Providers (ZASP) also provide repair services for most Zebra products at their locations. In addition, IBM and National Service Center (NSC) provide on-site repair services in the United States. We share the revenue for on-site service contracts sold by IBM and NSC for Zebra printing systems installed in the United States, and with IBM in Europe. Outside of the United States, Zebras resellers in each country may provide maintenance service, either directly as ZASPs or through independent service agents. Zebra also provides service and technical support assistance from in-house support personnel located in the United States, the United Kingdom and Singapore, who are available by telephone hotline five days a week during regular local business hours. Also, for most Zebra products, Zebra provides interactive technical support via the Internet, which can be accessed through Zebras Web site, www.zebra.com, 24 hours a day, seven days a week.
The card printer depot repair facilities are located in Camarillo, California and Preston, U.K. Card printer resellers can receive technical support assistance from in-house support personnel located in the United States, the United Kingdom and Singapore, who are available by telephone during regular business hours. In addition, on-line support for card printers can be accessed through the Web site, www.zebracard.com, 24 hours a day, seven days a week.
All Zebra printing equipment is warranted against defects in material and workmanship for up to one year. Printheads are warranted for six months. Zebra supplies are warranted against defects in material and workmanship for their stated shelf life or twelve months, whichever ends first. Defective equipment and supplies may be returned for repair, replacement or refund during the applicable warranty periods.
Our products use thermal transfer, direct thermal and thermal dye sublimation technologies. Each technology has characteristics that provide specific benefits to the end user.
Thermal transfer printing is used in all performance and some mid-range, desktop and mobile bar code label printers, as well as high-speed print engines. This technology creates an image by applying an electrically heated printhead to a ribbon that releases ink onto labeling/ticketing media. The benefits of thermal transfer printing include superior image quality, the ability to print on a wide variety of smooth-surfaced materials, no requirement for specially coated or formulated labeling/ticketing media and the ability to use inks that are not viable with alternative printing technologies.
Direct thermal printing is used in some mid-range, desktop and mobile printer products. Direct thermal printing creates an image by applying the heated printhead directly to specially treated paper, which changes color when heated. Direct thermal technology is preferable where image durability is less critical and where the application does not require specialty-labeling materials such as plastics or metal foils.
Our card printers and digital photo printers incorporate thermal dye sublimation for color printing. This capability allows for the creation of personalized full color, photographic quality plastic cards and high-quality photographs. Traditional photographic processes are both more expensive and time consuming. We believe that personalized card applications such as drivers licenses, loyalty cards, school and work identification cards, security access cards and financial transaction cards are well suited to this technology. The growing acceptance of digital photography, over traditional halide-based technology, offers growth opportunities for Zebra in certain areas of photo printing.
Zebras printing systems incorporate Company-designed computer hardware, electrical mechanisms and software, which operate the printing functions of the system and communicate with the host computer. Zebras bar code label printers operate using Zebra Programming Language (ZPLâ), Zebra Programming Language II (ZPL IIâ), Eltron Programming Language (EPL) or Comtec Printer Control Language (CPCL), each of which is a proprietary printer driver language. These languages are compatible with virtually all computer operating systems, including UNIX, MS/DOSâ and Windows.
Zebra guarantees backward compatibility in ZPL and ZPL II to allow users to replace older Zebra printers with newer equipment without costly reprogramming of label design programs. This compatibility also allows users to operate multiple Zebra printers in different applications using standardized programs and to integrate these printers into a local area network. We believe that ZPL and ZPL II give us a competitive advantage by ensuring compatibility across a broad range of present and future printer products and by facilitating system upgrades and customer loyalty to Zebra products. Some independent software vendors have written label preparation programs with ZPL and ZPL II drivers specifically for Zebra printers. ZPL and ZPL II label format programs can be run on a personal computer with ordinary word processing programs, making ZPL and ZPL II particularly adaptable to PC-based systems.
Zebra also sells radio frequency identification (RFID) printer/encoders that can encode data into RFID transponders embedded in direct thermal or thermal transfer printable labels. These smart labels are finding growing acceptance in commercial and military supply chain management, as well as many closed-loop proprietary tracking applications. Zebra-manufactured printer/encoders and smart labels support both HF (13.56 MHz) and UHF (860-960 MHz) applications for RFID.
Sales and Marketing
Sales. We sell our products primarily through distributors, value-added resellers (VARs), and original equipment manufacturers (OEMs). We also sell our products directly to a select number of named accounts. For media and consumables, we also sell directly to end users through the Internet and telesales operations. Distributors and VARs purchase, stock and sell a variety of automatic identification components from different manufacturers and customize systems for end-user applications using their systems and application integration expertise. Because these sales channels provide specific software, configuration, installation, integration and support services required by end users within various market segments, these relationships allow Zebra to reach end users throughout the world in a wide variety of industries. Zebra experiences a minor amount of seasonality in sales, depending on the geographic region and/or vertical market.
We functionally classify our direct VARs as Premier Partners, Advanced Partners, or Associate Partners, depending on their business competencies, depth and breadth of their sales teams, customer support capabilities, contribution to Zebras strategic goals, and sales commitment to Zebra. In addition, we offer VARs the opportunity to earn certifications for mobile/wireless printers, supplies, service and radio frequency identification (RFID) expertise. Beginning in 2005, we have also added certifications for demonstrated expertise in vertical markets that we have targeted for future growth. We also sell through distributors, which in turn sell to an extended VAR community. All VARs, as well as OEMs and systems integrators, provide customers with a variety of automatic identification components including scanners, accessories, applications software and systems integration expertise, and, in the case of some OEMs, resell the Zebra-manufactured products under their own brands as part of their own product offering. We believe that the breadth of this indirect channel network, both in terms of variety and geographic scope, enhances our ability to compete.
In some instances, we have designated a customer as a Strategic Account when purchases of Zebra products reach specified levels and support requirements for the account become highly customized. Zebra sales personnel, either alone or together
with our partners, manage these Strategic Accounts to ensure their needs, including consistent support for projects and applications, are being met.
The sales function also encompasses a group that manages a small number of Global Alliances. They direct the business development strategies for a limited number of third-party relationships that are strategic to new demand creation for specific vertical markets and/or specific applications.
Sales to international customers as a percent of net sales were as follows:
We believe that international sales have the long-term potential to grow faster than domestic sales because of the lower penetration of automatic identification applications outside North America. As a result, Zebra has invested resources to support our international growth and currently operates facilities and sales offices, or has representation, in 26 different countries.
Marketing. Marketing operations encompass marketing communications, product marketing, vertical marketing, solutions marketing, market research and channel marketing functions. The product marketing group identifies, evaluates and recommends new product opportunities and manages product introductions, positioning and demand creation. Product marketing also focuses on strategic planning and market definition and analyzes Zebras competitive strengths and weaknesses.
Zebra has sold almost 5,000,000 bar code label and card printers to customers in about 100 countries as of December 31, 2005.
Sales to ScanSource, Inc., a distributor of automatic identification products, as a percent of net sales were as follows:
No other customer accounted for 10% or more of total net sales during these years.
Production and Manufacturing
We design our products to optimize product performance, quality, reliability, durability and versatility. These designs combine cost-efficient materials, sourcing and assembly methods with high standards of workmanship. We assemble our products in-house largely on a configure-to-order basis using components that have been sourced from around the world. We have the in-house capability to produce mechanical and selected electronic assemblies and design many of our own tools, fixtures and test equipment. Often, our manufacturing and test engineers coordinate the development of new products with our new product engineers and vendors. This collaboration increases manufacturing efficiency by specifying and designing manufacturing processes and facilities simultaneously with product design.
We buy prefabricated component parts and subassemblies for use in the manufacture of our products. Critical subassemblies include printheads, power supplies, integrated circuits, and stepper motors, which are obtained from domestic and foreign suppliers at competitive prices. Purchase contracts provide for price increases in the event of certain increases in the costs of raw materials. Zebra typically experiences significant variance in demand thus carries inventory and partners with key suppliers to deal with the variation.
Research and Development
Zebra had research and development expenditures as follows (in thousands):
We devote significant resources to developing new printing solutions for our target markets and ensuring that our efficiently manufactured products maintain high levels of reliability.
Many companies are engaged in the design, manufacture and marketing of bar code label printers, card personalization solutions and dye sublimation photo printers. We consider our direct competition in bar code label and receipt printing to be producers of on-demand thermal transfer and direct thermal label printing systems and supplies. We also compete, however, with companies engaged in the design, manufacture and marketing of printing systems that use alternative technologies, such as impact dot matrix, ink-jet and laser printing. Similarly, we consider manufacturers of card personalization systems that are based on a broad range of alternative technologies as competition.
Dye sublimation, the technology incorporated in our card printer, is only one of several commercially available types of equipment used to personalize cards. We also compete with companies that produce identification cards using alternative technologies, which include ink-jet, thermal transfer, embossing, film-based systems, encoders, laser engraving and large-scale dye sublimation printers. These card personalization technologies offer viable alternatives to Zebras card printers and provide effective competition from a variety of companies, many of which are substantially larger than Zebra. In addition, service bureaus compete for end user business and provide an alternative to the purchase of our card printing equipment and supplies. Manufacturers also use dye sublimation technology in their digital photo printers.
Our ability to compete effectively depends on a number of factors. These factors include the reliability, quality and reputation of the manufacturer and its products; hardware and software innovations and specifications; breadth of product offerings; information systems connectivity; price; level of technical support; supplies and applications support offered by the manufacturer; available distribution channels; and financial resources to support new product design and innovation. We believe that Zebra presently competes favorably with respect to these factors.
We face competition in one or more of our product lines from the many competitors, including the following (listed in alphabetical order): Altech; Argox; Canon; CIM; Cognitive Solutions, a subsidiary of Axiohm Transaction Solutions; ColorX; Copal; Datacard; Datamax, a unit of Dover Corporation; Evolis; Fargo Electronics; Fuji; Godex; Hewlett-Packard; Hitachi; Intermec Technologies; Lexmark International; LogickaComp; MagiCard; Matica; Microcom; Mitsubishi; NBS; Nisca; Olmec; ONeil Product Development; Olympus; Paxar; Poloroid; Printronix; Sato; Shinko; Song Woo Electronics; Sony; Taiwan Semiconductor; Tokyo Electric Company; Victor Data Systems; Woosim; and Xerox
The supplies business is highly fragmented and competition is comprised of numerous competitors of various sizes depending on the geographic area.
We believe that direct thermal and thermal transfer printing will be the label and receipt printer technology of choice in Zebras target applications for the foreseeable future. Among the many advantages of direct thermal and thermal transfer printing is the ability to print high-resolution, durable images on a wide variety of label materials at relatively low costs and very high speeds compared with alternative printing technologies. We view radio frequency identification (RFID) smart label printing and encoding as a complementary technology to bar coded label and receipt printing, offering significant growth opportunities to Zebra as the technology becomes more widely adopted.
If other technologies were to evolve or become available to Zebra, it is possible that those technologies would be incorporated into our products. Alternatively, if such technologies were to evolve or become available to our competitors, Zebras products may become obsolete. This obsolescence would have a significant negative effect on Zebras business, financial position, results of operations and cash flows.
Therefore, we continually assess competitive and complementary methods of bar code printer and other means of automatic identification. Alternative print technologies assessed include ink jet, laser, impact dot matrix and laser etching. While we cannot be sure that new technology will not supplant direct thermal and thermal transfer printing for bar code labels and receipts, we are not aware of any developing technology that offers the advantages of direct thermal and thermal transfer printing for our targeted label and receipt printer applications. We are continually monitoring and evaluating new HF and UHF RFID technologies, supporting their standards development, and rapidly adopting RFID into new Zebra products as new markets and applications emerge.
Intellectual Property Rights
Zebra relies on a combination of trade secrets, patents, employee and third party nondisclosure agreements, copyright laws and contractual rights to establish and protect its proprietary rights in its products. We have and actively protect several domestic and international trademarks. We hold 212 United States and foreign patents and have 290 United States and foreign patent applications pending pertaining to products. The duration of these patents ranges from 14 to 20 years. The expiration of any individual patent would not have a significant negative impact on our business.
Despite our efforts to protect our intellectual property rights, it may be possible for unauthorized third parties to copy portions of our products or to reverse engineer or otherwise obtain and use some technology and information that we regard as proprietary. Moreover, the laws of some countries do not afford Zebra the same protection to proprietary rights, as do United States laws. There can be no assurance that legal protections relied upon by Zebra to protect its proprietary position will be adequate. While Zebras intellectual property is valuable and provides certain competitive advantages, we do not believe that the legal protections afforded to our intellectual property are fundamental to our success.
Patents have become increasingly used by businesses generally as a strategic business tool and in recent years the number of patent applications and grants has risen dramatically. As a result, it is increasingly important that Zebra takes appropriate steps to maintain and develop its own patent portfolio and reduce the risk of disputes involving third party intellectual property rights.
Other trademarks mentioned in this report are the property of their respective holders and include IBM, a registered trademark of International Business Machines; Kodak, a registered trademark of the Eastman Kodak; UNIX, a registered trademark of UNIX Systems Laboratories; MS/DOS and Windows, registered trademarks of Microsoft; SAP, a registered trademark of SAP AG; Linux, a registered trademark of Linus Torvalds; and Accelio Present Central, a registered trademark of Accelio. Bluetooth is a trademark owned by Bluetooth SIG and used by Zebra under license.
As of February 25, 2006, Zebra employed approximately 2,500 persons. None of these employees is a member of a union. We consider our employee relations to be very good.
Investors should carefully consider the risks, uncertainties and other factors described below, as well as other disclosures in Managements Discussion and Analysis of Financial Condition and Results of Operations, because they could have a material adverse effect on Zebras business, financial condition, operating results, and growth prospects.
Zebra could encounter difficulties in any acquisition it undertakes, including unanticipated integration problems and business disruption. Acquisitions could also dilute stockholder value and adversely affect operating results. Proposed acquisitions that are not consummated may result in the write-off of certain acquisition costs.
Zebra may acquire or make investments in other businesses, technologies, services or products. The process of integrating any acquired business, technology, service or product into operations may result in unforeseen operating difficulties and expenditures. Integration of an acquired company also may consume considerable management time and attention, which could otherwise be available for ongoing development of the business. The expected benefits of any acquisition may not be realized. Moreover, Zebra may be unable to identify, negotiate or finance future acquisitions successfully. Future acquisitions could result in potentially dilutive issuances of equity securities or the incurrence of debt, contingent liabilities or amortization expenses. To the extent that a proposed acquisition is not consummated, Zebra may be required to write off certain costs associated with the acquisition, which could be significant.
Zebra may not be able to continue to develop products to address user needs effectively in an industry characterized by rapid technological change.
To be successful, Zebra must adapt to rapidly changing technological and application needs by continually improving its products as well as introducing new products and services to address user demands.
Zebras industry is characterized by:
Rapidly changing technology
Evolving industry standards
Frequent new product and service introductions
Evolving distribution channels
Changing customer demands
Future success will depend on Zebras ability to adapt in this rapidly evolving environment. Zebra could incur substantial costs if it has to modify its business to adapt to these changes, and may even be unable to adapt to these changes.
Zebra competes in a highly competitive market, which is likely to become more competitive. Competitors may be able to respond more quickly to new or emerging technology and changes in customer requirements.
Zebra faces significant competition in developing and selling its systems. Principal competitors have substantial marketing, financial, development and personnel resources. To remain competitive, Zebra believes it must continue to provide:
Technologically advanced systems that satisfy the user demands,
Superior customer service,
High levels of quality and reliability, and
Dependable and efficient distribution networks.
Zebra cannot assure it will be able to compete successfully against current or future competitors. Increased competition in printers or supplies may result in price reductions, lower gross profit margins and loss of market share, and could require increased spending on research and development, sales and marketing and customer support. Some competitors may make strategic acquisitions or establish cooperative relationships with suppliers or companies that produce complementary products. Any of these factors could reduce Zebras earnings.
Zebra sources some of its component parts from sole source suppliers.
A disruption in the supply of such component parts could have a material adverse effect on our operations and financial results.
Infringement on the proprietary rights of others could put Zebra at a competitive disadvantage, and any related litigation could be time consuming and costly.
Third parties may claim that Zebra violated their intellectual property rights. To the extent of a violation of a third partys patent or other intellectual property right, Zebra may be prevented from operating its business as planned, and may be required to pay damages, to obtain a license, if available, or to use a non-infringing method, if possible, to accomplish its objectives. Any of these claims, with or without merit, could result in costly litigation and divert the attention of key personnel. If such claims are successful, they could result in costly judgments or settlements. In this regard, Zebra is involved in costly patent litigation with Paxar Americas, Inc. and an unfavorable outcome could be materially adverse to Zebra. See Note 16 to the Financial Statements included in this Form 10-K. Also, as new technologies emerge, such as RFID, the intellectual property rights of parties in such technologies can be uncertain. As a result, products involving such technologies may have higher risk of claims of infringement of the intellectual proprietary rights of third parties.
Zebra may incur liabilities as a result of Zebra installed product failures due to design or manufacturing defects.
Zebra generally has insurance for such risks and also seeks to limit such risk though product design, manufacturing quality control processes, product testing and contractual limitations. However, due to the large and growing size of Zebras installed printer base, a design or manufacturing defect attributable to this large installed printer base could result in product recalls or customer service costs that could have material adverse effects on Zebras financial results.
The inability to protect intellectual property could harm Zebras reputation, and its competitive position may be materially damaged.
Zebras intellectual property is valuable and provides Zebra with certain competitive advantages. Copyrights, patents, trade secrets and contracts are used to protect these proprietary rights. Despite these precautions, it may be possible for third parties to copy aspects of Zebras products or, without authorization, to obtain and use information which Zebra regards as trade secrets.
Zebra sells a significant portion of its products internationally and purchases important components from foreign suppliers. These circumstances create a number of risks.
Zebra sells a significant amount of its products to customers outside the United States. Shipments to international customers are expected to continue to account for a material portion of net sales. Risks associated with sales and purchases outside the United States include:
Fluctuating foreign currency rates could restrict sales, or increase costs of purchasing, in foreign countries.
Foreign governments may impose burdensome tariffs, quotas, taxes, trade barriers or capital flow restrictions.
Political and economic instability may reduce demand for our products, or put our foreign assets at risk.
Restrictions on the export or import of technology may reduce or eliminate the ability to sell in or purchase from certain markets.
Potentially limited intellectual property protection in certain countries may limit recourse against infringing products or cause Zebra to refrain from selling in certain geographic territories.
Staffing and managing international operations may be unusually difficult.
Economic factors, which are outside Zebras control, could lead to deterioration in the quality of Zebras accounts receivables.
Zebra sells its products to customers in the United States and several other countries around the world. Sales are typically made on unsecured credit terms, which are generally consistent with the prevailing business practices in a given country. A deterioration of economic or political conditions in a country could impair Zebras ability to collect on receivables in the affected country.
Zebra depends on the ongoing service of its senior management and ability to attract and retain other key personnel.
Future success of Zebra is substantially dependent on the continued service and continuing contributions of senior management and other key personnel. The loss of the service of any executive officer or other key employees could adversely affect business. Zebra has no long-term employment agreements with key personnel and maintains minimal key man life insurance policies on its key employees.
The ability to attract, retain and motivate highly skilled employees is important to Zebras long-term success. Competition for personnel in Zebras industry is intense, and Zebra may be unable to retain key employees or attract, assimilate or retain other highly qualified employees in the future.
Terrorist attacks or war could lead to further economic instability and adversely affect Zebras stock price, operations, and profitability.
The terrorist attacks that occurred in the United States on September 11, 2001 caused major instability in the U.S. and other financial markets. Possible further acts of terrorism and current and future war risks could have a similar impact. The United States continues to take military action against terrorism and is currently engaged in a costly occupation of Iraq. These events may lead to additional armed hostilities or to further acts of terrorism and civil disturbance in the United States or elsewhere, which may further contribute to economic instability. Any such attacks could, among other things, cause further instability in financial markets and could directly, or indirectly through reduced demand, negatively affect Zebras facilities and operations or those of its customers or suppliers.
Taxing authority challenges may lead to tax payments exceeding current reserves.
Zebra is subject to ongoing tax examinations in various jurisdictions. As a result, we may record incremental tax expense based on expected outcomes of such matters. In addition, we may adjust previously reported tax reserves based on expected results of these examinations. Such adjustments could result in an increase or decrease to Zebras effective tax rate.
Zebras corporate headquarters are located in Vernon Hills, Illinois, a northern suburb of Chicago. Zebra conducts its operations from a custom-designed facility at this location, which provides approximately 225,000 square feet of space. Approximately 113,000 square feet have been allocated to office and laboratory functions and 112,000 square feet to manufacturing and warehousing. This facility was constructed in 1989 and expanded in 1993, 1995, 1996 and 1999. It is owned and leased to Zebra, under a lease terminating on June 30, 2014, by Unique Building Corporation, a corporation owned in part by Edward Kaplan and Gerhard Cless, both executive officers and directors of Zebra.
Zebras major facilities as of December 31, 2005, are listed below:
Zebra leases various other facilities around the world, which are dedicated to administrative, research and sales functions. The amounts related to these leases, solely or in aggregate, are not material to the consolidated financial statements.
During 1999, Zebra consolidated United Kingdom facilities, moving distribution of its Wokingham and High Wycombe facilities to the Preston location, and transferring Wokingham associates to the renovated High Wycombe location. The vacant Wokingham facility had a lease that would have expired in October 2010. During December 2005, we made a payment to surrender the remaining term of the lease, eliminating it from the properties held as of December 31, 2005.
See Note 16 in the Notes to the Consolidated Financial Statements included in this Form 10-K.
Stock Information: Price Range and Common Stock
Our Class A Common Stock is traded on the NASDAQ Stock Market under the symbol ZBRA. The following table shows the high and low trade prices for each fiscal quarter in 2005 and 2004, as reported by the NASDAQ Stock Market. Share prices were adjusted for the first and second quarter of 2004 for a 50% stock dividend that was distributed on August 25, 2004.
Source: The NASDAQ Stock Market
At February 23, 2006, the last reported price for the Class A Common Stock was $44.10 per share, and there were 387 registered stockholders of record for the Companys Class A Common Stock. In addition, we had approximately 22,000 stockholders who owned Zebra stock in street name.
Since our initial public offering in 1991, we have not declared any cash dividends or distributions on our capital stock. Zebra currently intends to retain its earnings to finance future growth and therefore does not anticipate paying any cash dividends in the foreseeable future.
During 2005, Zebra purchased 1,866,375 shares of Zebra common stock under a purchase authorization by the Board of Directors. In September 2005, the Board authorized the purchase of up to an additional 2,500,000 shares of Zebra common stock. The purchase price is at managements discretion, and there is no expiration on the authorization. During 2005, Zebra purchased shares as follows:
Of the shares purchased, 185,000 shares were purchased in satisfaction of our obligations related to the exercise of put options issued by Zebra.
CONSOLIDATED STATEMENTS OF EARNINGS DATA
CONSOLIDATED BALANCE SHEET DATA
Business for the fourth quarter of 2005 reflected strength in international sales offset by minimal sales growth in North America due to a decline in mobile printer shipments to retailers. We had record sales in Latin America. In our Europe, Middle East and Africa (EMEA) region, unfavorable foreign exchange rate movements reduced sales growth in reported U.S. dollars from a record in local currencies. High growth in supplies sales also had a positive effect on the quarters results. Profitability declined, as lower average unit prices, warranty expenses and the negative effects of foreign exchange reduced gross margin, and higher payroll expenses, intellectual property work, and new product development and IT project costs increased operating expenses.
For 2005, sales growth did not meet our expectations. International regions benefited from having more Zebra representatives serving a broader base of customers in emerging territories. In North America, however, the significant weakness in sales to retailers, versus robust sales to this sector for 2004, contrasted with firm sales into non-retail sectors and improvements in sales of supplies. Delays in new product introductions also restricted sales growth for much of the year. Within this environment, we maintained spending on key strategic activities to extend our global competitive leadership. These activities include expanding geographically, building stronger channel relationships, and advancing our products and technology to serve a broader range of specialty printing applications. Zebra also incurred higher legal costs, warranty expense, and write-offs in product development. Consequently, Zebra experienced declines in annual net income and earnings per share.
Results of Operations: Fourth Quarter of 2005 versus Fourth Quarter of 2004, Year ended December 31, 2005 versus Year ended December 31, 2004
Sales by product category, percent change, and percent of total sales for the three months and year ended December 31, 2005, and December 31, 2004, were (in thousands, except percentages):
Sales to customers by geographic region, percent changes and percent of total sales for the three months and year ended December 31, 2005, and December 31, 2004, were (in thousands, except percentages):
Sales growth for the fourth quarter and full year reflect the effect of investments to expand our global presence and strengthen relationships with value-added resellers and other distribution channels. The success of these efforts was offset by significantly lower sales in North America to large retail accounts, which purchased large quantities of primarily mobile printers the year before, primarily in the preceding fourth quarter.
New printer products (defined as printers released within 18 months prior to the end of the applicable fiscal period) as a percent of total printer product sales were as follows:
The decline in sales of new printer products is the result of technical problems that delayed the introduction of various new products as well as the shifting of some new product engineering resources to environmental compliance. We expect several new printer products to begin shipping early in 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 unfavorable foreign exchange movements of the euro and the pound versus the dollar had a negative impact of $4,002,000 on sales during the fourth quarter and $1,929,000 for the full year.
We currently hedge a portion of anticipated euro-denominated sales to partially protect Zebra against exchange rate movements. For the fourth quarter, this program resulted in a gain of $875,000 and a full-year gain of $1,617,000. See Note 15 to the Financial Statements for a more detailed discussion of this hedging program.
Printer unit volumes and average selling price information is summarized below:
For all of 2005, with the exception of mobile printers, unit volumes increased in all printer product lines, with notable strength in mid-range and desktop printers. For the full year, a mix toward lower priced products resulted in a 2.6% decrease in the average selling price of printers shipped.
Gross profit information is summarized below (in thousands, except percentages):
The decline in gross profit margin for the fourth quarter is related to lower average unit prices, increased warranty costs of $1,411,000 and unfavorable exchange rate movements of $3,684,000, offset by a 2.5% sales increase. For the full year, gross margin decreased largely because of lower average unit prices, increased warranty costs of $3,185,000 primarily related to the recall of a now discontinued product, unfavorable exchange rate movements of $2,327,000 and higher distribution costs of $1,908,000, which were related to the new distribution center in the Netherlands.
Selling and Marketing Expenses
Selling and marketing expenses are summarized below (in thousands, except percentages):
Higher selling and marketing expenses reflect ongoing investments 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 fourth quarter of 2005, selling and marketing expenses increased due to higher payroll costs of $1,264,000 from increased staffing as well as higher advertising and market development funding of $962,000. For the full year, the payroll costs increased $6,836,000 and advertising and market development funding increased $1,976,000. In addition to increases in the items mentioned above, outside commissions, offsite meeting and travel expenses increased during 2005. The increased staffing was primarily focused on increasing our presence in targeted geographical territories to support growth in those regions, building sales and marketing teams to deliver vertical market applications, and strengthening strategic alliances with complementary companies.
Research and Development Costs
The development of new products and enhancement of existing products are important to Zebras business and growth prospects. To maintain and build our product pipeline, we made investments in research and development, summarized below (in thousands, except percentages):
Quarterly product development expenses fluctuate widely depending on the status of ongoing projects. We are committed to a long-term strategy of significant investment in product development. For the fourth quarter of 2005, project expenses increased by $1,594,000 as a result of additional expenditures for new products including radio frequency identification (RFID), and payroll expenses increased $665,000. For the full year, project expenses increased $5,277,000, payroll costs increased $2,130,000, and professional services increased $744,000. Included in the year-to date project expenses are write-offs of tooling and other materials related to product development in the amount of $2,726,000.
For the full year of 2005, we incurred research and development costs to re-engineer our products to make them compliant with new environmental laws that go into effect in 2006. These laws include eliminating the lead content in our products. These environmental compliance costs totaled $1,049,000 for the fourth quarter and $2,882,000 for the full year.
General and Administrative Expenses
General and administrative expenses are summarized in the table below (in thousands, except percentages):
For the fourth quarter of 2005, general and administrative expenses increased due to higher information systems expenses of $797,000 and higher legal expenses of $1,280,000, primarily related to work on intellectual property matters, including the litigation with Paxar as described in Note 16 to the Financial Statements. We expect higher legal expenses to continue for subsequent quarters. For the full year of 2005, general and administrative expenses increased due to higher information system expenses of $1,220,000, increased relocation expenses of $572,000, higher payroll costs of $930,000 and higher legal expenses of $6,628,000 primarily related to intellectual property expenses including the Paxar litigation.
Operating income is summarized in the following table (in thousands, except percentages):
Non-operating Income and Expenses
Zebras non-operating income and expense items are summarized in the following table (in thousands):
The effective income tax rate for the fourth quarter was 32.7% compared with 34.3% for the same quarter last year. For the full year of 2005, the effective income tax rate was 33.8% versus 34.6% for 2004. During the fourth quarter, we reduced tax reserves as a result of favorable resolution of certain tax audits. In addition, we took advantage of the deduction for qualified domestic production activities included in the American Jobs Creation Act of 2004.
Zebras net income is summarized below (in thousands, except per share amounts):
Comparison of Years Ended December 31, 2004 and 2003
Sales by product category, related percent changes and percent of total sales for 2004 and 2003 were as follows:
Sales to customers by geographic region, related percent changes, and percent of total sales for 2004 and 2003 were as follows:
Sales growth for 2004 reflected the success of sales and marketing programs to improve demand for Zebra products, strengthen distribution channel relationships, and increase the awareness of Zebra products and the Zebra brand in targeted markets. This growth was well balanced across geographies, products, and channels. We experienced notable sales growth in mobile printers, as the mainstream adoption of wireless technology had expanded the uses of mobile printing in applications across an increasing number of vertical markets. In addition, channel programs implemented in North America strengthened and expanded channel partner relationships. More Zebra sales representatives in international territories helped increase the number of channel relationships in overseas regions and support sales growth.
Our international sales were benefited in 2004 by favorable exchange rates. For the full year of 2004, sales translated into dollars increased by $17,626,000 compared to translating the same sales using exchange rates that prevailed in 2003.
Printer unit volumes and average selling price information is summarized below:
For all of 2004, unit volumes increased in nearly all product lines and all regions, with notable strength in mobile printers. In addition, a favorable product mix toward higher priced products and a richer feature set within product segments, on balance, supported a 3.0% increase in the average selling price of printers shipped.
Gross profit information is summarized below (in thousands except percentages)
Gross profit increased due to:
Higher capacity utilization related to the higher sales volume, representing $34,010,000 of the total gross profit increase for 2004.
Foreign exchange rate movements, which we estimate increased gross profit by $16,239,000 for 2004.
Changes in product mix, cost reductions and other items accounted for $19,833,000 of the margin improvement during 2004.
Selling and Marketing Expenses
Selling and marketing expenses are summarized below (in thousands, except percentages):
The increase in selling and marketing expenses for 2004 resulted from our investments 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). Advertising and market development funding increased $2,475,000. Payroll costs increased $4,052,000 due to placement of more Zebra representatives in high-growth international regions and better coverage of strategic accounts. Increases also occurred in outside commissions, consulting and legal expenses.
Research and Development Costs
Research and development costs are summarized below (in thousands, except percentages):
For 2004, research and development expenses increased primarily due to increases in payroll and benefits of $3,253,000 over 2003. Project expenses and consulting expenses also increased as a result of additional expenditures for new products including radio frequency identification (RFID).
General and Administrative Expenses
General and administrative expenses are summarized below (in thousands, except percentages):
For 2004, general and administrative expenses include $4,111,000 of increased legal expenses related to:
Litigation with Paxar,
Increased intellectual property work, and
International expansion activity.
In addition to legal expenses in 2004, we saw an increase in payroll costs and information system expenses.
Operating income is summarized in the following table (in thousands, except percentages):
The increase in operating income is attributable to the following factors:
Accelerated sales growth compared to 2003,
Improved gross margins resulting from increased overhead utilization, and
Favorable changes in foreign exchange rates for Zebras non-dollar denominated business.
As a result of these actions, operating income increased by 11.3 percentage points more than the rate of sales growth during 2003.
Non-operating Income and Expenses
Zebras non-operating income and expense items are summarized in the following table (in thousands):
The effective income tax rate for 2004 was 34.6% versus 32.6% in 2003. The rate for 2003 is lower, because of the resolution of our long-standing dispute with the Illinois Department of Revenue and the related decrease to income tax expense of $1,342,000 during 2003.
Zebras net income is summarized below (in thousands, except per share amounts):
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.
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 Zebras reported financial results.
Product revenue is recognized once four criteria are met: (1) we have persuasive evidence that an arrangement exits; (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:
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.
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 volume rebates and establish a reserve for them based on shipment history. Historically, actual volume rebates have been in line with our estimates.
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 theses plans have been minimal.
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 earning process for that product is complete.
Investments and Marketable Securities
Investments and marketable securities at December 31, 2005, consisted of U.S. government securities (12.1%), state and municipal bonds (75.5%), corporate bonds (4.0%), and partnership interests (8.4%). 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.
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.
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 customers 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 2.8% of total accounts receivable. Accounts receivable reserves as of December 31, 2005, were $1,116,000, or 1.0% of the balance due. We feel this reserve level is appropriate considering the quality of the portfolio as of December 31, 2005. 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.
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.
Over the last three years, our reserves for excess and obsolete inventories have ranged from 10.4% to 13.1% of gross inventory. As of December 31, 2005, reserves for excess and obsolete inventories were $8,755,000, or 12.3% of gross inventory. We feel this reserve level is appropriate considering the quantities and quality of the inventories as of December 31, 2005.
Valuation of Long-Lived and Intangible Assets and Goodwill
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 2005. 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 Zebras 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, 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 $137,742,000 as of December 31, 2005.
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 all current litigation matters, see Note 16 in the Notes to the Consolidated Financial Statements included in the Form 10-K.
As of December 31, 2005, Zebra had three stock-based compensation plans available for future grants. We account for those plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. During the first quarter of 2006, we will begin expensing stock options as required under SFAS No. 123(R), Share-Based Payments. See Notes 2 and 3 of the Notes to the Consolidated Financial Statements included in the Form 10-K for further discussion.
During our quarterly conference call on February 8, 2006, we provided net sales and earnings guidance for the first quarter of 2006 as follows (amounts in thousands, except per share data):
The above expectations include an estimated $0.02 per diluted share for the expensing of stock options as required under SFAS No. 123 (R), Share-Based Payments. The effective tax rate is expected to be 34.5% of income before income taxes.
During the third quarter of 2005, Zebra initiated a program to repurchase our own shares. Under this program, we repurchased a total of 1,866,375 shares for $70,421,000. As a result, Zebras cash and investment balances have decreased to $544,239,000 as of December 31, 2005 compared with $557,993,000 at December 31, 2004. Other factors affecting cash and investment balances during 2005 include (note that changes discussed below include the impact of foreign currency):
Operations provided a net cash increase of $92,730,000 primarily from net income.
Accounts receivable increased $20,422,000 because of higher sales and slower collections. Days sales outstanding increased to 56.8 at the end of 2005 from 50.6 at the end of 2004.
Inventories increased $6,204,000. Compared to the same period a year ago, inventory turns decreased to 5.6 from 5.7.
Accounts payable increased by $3,792,000, in relation to the increase in inventory.
Taxes payable decreased $5,170,000 due to the amount of estimated tax payments made in 2005.
Purchases of property and equipment totaled $14,286,000.
Acquisition of assets of Retail Systems International, Inc. totaled $7,797,000.
Acquisition of intangible assets totaled $13,754,000.
Net sales of investments and marketable securities totaled $11,364,000.
Stock option exercises and purchases under the stock purchase plan contributed $11,753,000.
Zebras contractual obligations as of December 31, 2005 were:
Purchase obligations are for purchases made in the normal course of business to meet operational requirements, primarily raw materials.
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.
In April 2005, the FASB changed the implementation date for SFAS No. 123(R), Share Based Payment, which requires a public entity to measure the cost of employee services received in exchange for the award of equity instruments based on the fair value of the award at the date of grant. The provisions of this statement will now become effective for Zebra during the first quarter of 2006. We plan to adopt the provisions of this statement using the modified retrospective method, which requires the restatement of the financial statements of all prior years as if the fair-value-based method of accounting for awards granted, modified, or settled in cash had been used in all fiscal years beginning after December 15, 1994. Accordingly, we expect the impact on Zebras consolidated financial statements to be consistent with the fair value disclosures included in Note 2 to the Consolidated Financial Statements included in this Form 10-K, with additional restatements made to the balance sheet.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs - an amendment of ARB No. 43, Chapter 4. SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated that these costs may be so abnormal that they would require treatment as current period charges. This statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of so abnormal. This statement also requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This statement describes our current process; therefore, it will not have any impact on our financial position or results of operations.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections - a Replacement of APB Opinion No. 20 and SFAS No. 3, which changes the requirements for the accounting and reporting of a change in accounting principle.
The Statement applies to all voluntary changes in accounting principle and to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. This Statement requires retrospective application to prior periods financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. Zebra is required to adopt this statement during the first quarter of 2006. We do not expect the adoption of this Statement to have a material impact on our financial condition or results of operations.
In November 2005, the FASB issued FSP FAS 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, which addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. This FSP also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The guidance in this FSP amends SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and SFAS No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations, and APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. This FSP is effective for reporting periods beginning after December 15, 2005. We do not expect the adoption of this Statement to have a material impact on our financial condition or results of operations.
Interest Rate Risk
Zebra is exposed to the impact of changes in interest rates because of our large investment portfolio. As stated in our written investment policy, the investment portfolio is viewed as a strategic resource that will be managed to achieve above market rates of return in exchange for accepting a prudent amount of incremental risk, which includes the risk of interest rate movements. Risk tolerance is constrained by an overriding objective to preserve capital across each quarterly reporting cycle.
Zebra mitigates interest rate risk with an investment policy that requires the use of outside professional investment managers, investment liquidity, and broad diversification across investment strategies, and which limits the types of investments that may be made. Moreover, the policy requires due diligence of each investment manager both before employment and on an ongoing basis.
The following table sets forth the impact of a one-percentage point movement in interest rates on the value of Zebras investment portfolio (in thousands, except per share data).
Because these securities are classified as available-for-sale under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, the impact of a one-percentage point movement in interest rates occurs over an extended period of time as investments are sold and the funds are subsequently reinvested.
Foreign Exchange Risk
We conduct business in approximately 100 countries throughout the world and, therefore, are exposed to risk based on movements in foreign exchange rates. We generally invoice customers in their local currency and have a resulting foreign currency denominated revenue transaction and accounts receivable. We also purchase certain raw materials and other items in foreign currencies. We manage these risks using derivative financial instruments. See Note 15 of the Notes to the Consolidated Financial Statements included in this form 10-K for further discussions of hedging activities.
The following table sets forth the impact of a ten percent movement in the dollar/pound and dollar/euro rates measured as if Zebra did not engage in the selective hedging practices described above and in Note 15. It is based on the dollar/euro and dollar/pound exchange rates and euro and pound denominated assets and liabilities (in thousands, except per share data).
Equity Price Risk
Zebra currently employs four investment managers, two of which manage portfolios of investment funds (i.e., fund of funds). These investment funds use a variety of investment strategies, some of which involve the use of equity securities. By policy, management limits the amount of Zebras investments in alternative investment strategies to a maximum of 15% of the total investment portfolio, with no single investment exceeding $15,000,000.
Zebra utilizes a Value-at-Risk (VaR) model to determine the maximum potential one-day loss in the fair value of its interest rate, foreign exchange and equity price sensitive instruments.
The following table sets forth the impact of a ten percent change in the value of all equity positions held by Zebras investment managers (in thousands, per share data).
From time to time, Zebra has taken direct equity positions in companies. These investments relate to potential acquisitions and other strategic business opportunities. To the extent that it has a direct investment in the equity securities of another company, Zebra is exposed to the risks associated with such investments.
The financial statements and schedule of the Company are annexed to this Report as pages F-2 through F-34. An index to such materials appears on page F-1.
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-K. 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 Annual Report on Form 10-K was recorded, processed, summarized and reported within the time periods specified in the SECs 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.
Managements Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of the financial statements for external purposes in accordance with generally accepted accounting principles. Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2005. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on this assessment and those criteria, our management believes that, as of December 31, 2005, our internal control over financial reporting is effective. Our independent registered public accounting firm, Ernst & Young LLP, has issued an attestation report on managements assessment of Zebras internal control over financial reporting. That report is included on page 36 of this Report on Form 10-K.
Changes in Internal Control over Financial Reporting
During 2005, we made changes to our controls and procedures as part of our ongoing monitoring of our controls. However, none of these changes has materially affected, or are reasonably likely to materially affect, our internal control 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 controls will prevent or detect 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 misstatements due to error or fraud will not occur or 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.
Report of Independent Registered Public Accounting Firm
On Internal Control over Financial Reporting
The Board of
Directors and Stockholders
We have audited managements assessment, included in the accompanying Managements Report on Internal Control over Financial Reporting, that Zebra Technologies Corporation and subsidiaries maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Zebra Technologies Corporations management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on managements assessment and an opinion on the effectiveness of the Companys internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitation, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, managements assessment that Zebra Technologies Corporation and subsidiaries maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on COSO criteria. Also, in our opinion, Zebra Technologies Corporation and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Zebra Technologies Corporation and subsidiaries as of December 31, 2005, and the related consolidated statements of earnings, comprehensive income, stockholders equity, and cash flows for the year then ended, and our report dated February 24, 2006 expressed an unqualified opinion thereon.
February 24, 2006
We have adopted a Code of Ethics that applies to Zebras Chief Executive Officer, Chief Financial Officer and the Vice President and Controller. The Code of Ethics is posted on the investor page of Zebras Internet Web site, www.zebra.com, and is available for download.
All other information in response to this item is incorporated by reference from the Proxy Statement sections entitled Election of Directors and Executive Officers.
The information in response to this item is incorporated by reference from the Proxy Statement section entitled Executive Compensation and Certain Transactions.
The information in response to this item is incorporated by reference from the Proxy Statement section entitled Security Ownership of Management and Certain Beneficial Owners and Equity Compensation Plan Information.
The information in response to this item is incorporated by reference from the Proxy Statement section entitled Executive Compensation and Certain Transactions.
The information in response to this item is incorporated by reference from the Proxy Statement section entitled Fees of Independent Auditors.
The financial statements and schedule filed as part of this report are listed in the accompanying Index to Financial Statements and Schedule. The exhibits filed as a part of this report are listed in the accompanying Index to Exhibits.
Pursuant to the requirements of Section 13 or 15(d) 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, on the 27th day of February 2006.
Pursuant to the requirements of the Securities and Exchange Act of 1934, the Report has been signed below by the following persons in the capacities and on the dates indicated.