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Zebra Technologies 10-Q 2010

Documents found in this filing:

  1. 10-Q
  2. Ex-10.1
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32.1
  6. Ex-32.2
  7. Ex-32.2
Form 10-Q
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended October 2, 2010

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number: 000-19406

Zebra Technologies Corporation

(Exact name of registrant as specified in its charter)

 

Delaware   36-2675536
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)

475 Half Day Road, Suite 500, Lincolnshire, IL 60069

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (847) 634-6700

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of October 29, 2010, there were 56,528,911 shares of Class A Common Stock, $.01 par value, outstanding.


Table of Contents

 

ZEBRA TECHNOLOGIES CORPORATION AND SUBSIDIARIES

QUARTER ENDED OCTOBER 2, 2010

INDEX

 

           PAGE  

PART I - FINANCIAL INFORMATION

  

Item 1.

   Consolidated Financial Statements   
  

Consolidated Balance Sheets as of October 2, 2010 (unaudited) and December 31, 2009

     3   
  

Consolidated Statements of Earnings (unaudited) for the three and nine months ended October 2, 2010 and October 3, 2009

     4   
  

Consolidated Statements of Cash Flows (unaudited) for the nine months ended October 2, 2010 and October 3, 2009

     5   
  

Notes to Consolidated Financial Statements

     6   

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     22   

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

     36   

Item 4.

  

Controls and Procedures

     37   

PART II - OTHER INFORMATION

  

Item 1.

  

Legal Proceedings

     38   

Item 1A.

  

Risk Factors

     38   

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     38   

Item 5.

  

Other Information

     38   

Item 6.

  

Exhibits

     39   

SIGNATURES

     40   

 

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PART I - FINANCIAL INFORMATION

 

Item 1. Consolidated Financial Statements

ZEBRA TECHNOLOGIES CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Amounts in thousands)

 

     October 2,
2010
    December 31,
2009
 
     (Unaudited)        
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 47,447      $ 38,943   

Restricted cash

     1,615        1,725   

Investments and marketable securities

     123,058        114,064   

Accounts receivable, net

     165,423        150,992   

Inventories, net

     95,842        79,926   

Deferred income taxes

     11,282        10,792   

Income taxes receivable

     —          4,724   

Prepaid expenses and other current assets

     11,043        9,771   
                

Total current assets

     455,710        410,937   
                

Property and equipment at cost, less accumulated depreciation and amortization

     84,809        77,589   

Long-term deferred income taxes

     32,234        35,842   

Goodwill

     152,418        153,225   

Other intangibles, net

     51,592        55,982   

Long-term investments and marketable securities

     90,076        91,989   

Other assets

     4,806        4,915   
                

Total assets

   $ 871,645      $ 830,479   
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 33,908      $ 28,137   

Accrued liabilities

     66,486        52,591   

Deferred revenue

     22,292        24,082   

Income taxes payable

     5,752        —     
                

Total current liabilities

     128,438        104,810   

Deferred rent

     2,853        4,108   

Other long-term liabilities

     9,647        9,432   
                

Total liabilities

     140,938        118,350   
                

Stockholders’ equity:

    

Preferred Stock

     —          —     

Class A Common Stock

     722        722   

Additional paid-in capital

     128,068        136,104   

Treasury stock

     (430,515     (385,831

Retained earnings

     1,042,756        969,195   

Accumulated other comprehensive loss

     (10,324     (8,061
                

Total stockholders’ equity

     730,707        712,129   
                

Total liabilities and stockholders’ equity

   $ 871,645      $ 830,479   
                

See accompanying notes to consolidated financial statements.

 

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ZEBRA TECHNOLOGIES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS

(Amounts in thousands, except per share data)

(Unaudited)

 

     Three Months Ended     Nine Months Ended  
     October 2,
2010
    October 3,
2009
    October 2,
2010
    October 3,
2009
 

Net sales:

        

Net sales of tangible products

   $ 221,795      $ 175,334      $ 632,198      $ 503,947   

Revenue from services and software

     24,712        25,444        76,475        77,116   
                                

Total net sales

     246,507        200,778        708,673        581,063   
                                

Cost of sales:

        

Cost of sales of tangible products

     117,502        98,682        341,815        291,117   

Cost of services and software

     10,291        10,398        29,630        30,703   
                                

Total cost of sales

     127,793        109,080        371,445        321,820   
                                

Gross profit

     118,714        91,698        337,228        259,243   
                                

Operating expenses:

        

Selling and marketing

     30,365        26,395        88,193        73,992   

Research and development

     26,746        21,454        75,189        64,552   

General and administrative

     20,302        22,447        60,889        61,881   

Amortization of intangible assets

     2,444        2,649        7,147        7,857   

Exit, restructuring and integration costs

     —          3,515        2,392        9,455   

Asset impairment charges

     —          —          —          (1,058
                                

Total operating expenses

     79,857        76,460        233,810        216,679   
                                

Operating income

     38,857        15,238        103,418        42,564   
                                

Other income (expense):

        

Investment income

     635        813        2,111        2,238   

Foreign exchange gain (loss)

     (325     575        235        (840

Other, net

     (216     (286     (1,052     (622
                                

Total other income (expense)

     94        1,102        1,294        776   
                                

Income before income taxes

     38,951        16,340        104,712        43,340   

Income taxes

     12,800        5,229        31,151        13,866   
                                

Net income

   $ 26,151      $ 11,111      $ 73,561      $ 29,474   
                                

Basic earnings per share

   $ 0.46      $ 0.19      $ 1.28      $ 0.49   

Diluted earnings per share

   $ 0.46      $ 0.19      $ 1.28      $ 0.49   

Basic weighted average shares outstanding

     56,739        58,954        57,405        59,548   

Diluted weighted average and equivalent shares outstanding

     56,998        59,083        57,657        59,643   

See accompanying notes to consolidated financial statements.

 

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ZEBRA TECHNOLOGIES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

(Unaudited)

 

     Nine Months Ended  
     October 2,
2010
    October 3,
2009
 

Cash flows from operating activities:

    

Net income

   $ 73,561      $ 29,474   

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

    

Depreciation and amortization

     23,698        24,409   

Equity-based compensation

     8,155        8,687   

Excess tax benefit from equity-based compensation

     (83     (11

Loss (Gain) on sale of assets

     (58     357   

Asset impairment charges

     —          (1,058

Deferred income taxes

     3,208        4,259   

Changes in assets and liabilities:

    

Accounts receivable, net

     (14,463     13,797   

Inventories, net

     (15,972     22,632   

Other assets

     (1,192     178   

Accounts payable

     6,747        (21,216

Accrued liabilities

     13,861        (19,389

Deferred revenue

     (1,530     2,674   

Income taxes

     9,197        (2,394

Other operating activities

     (3,391     584   
                

Net cash provided by operating activities

     101,738        62,983   
                

Cash flows from investing activities:

    

Purchases of property and equipment

     (23,752     (19,499

Payments for patents and licensing arrangements

     (2,882     (425

Purchases of investments and marketable securities

     (312,201     (236,520

Maturities of investments and marketable securities

     230,715        194,939   

Sales of investments and marketable securities

     74,371        49,899   
                

Net cash used in investing activities

     (33,749     (11,606
                

Cash flows from financing activities:

    

Purchase of treasury stock

     (67,384     (49,609

Proceeds from exercise of stock options and stock purchase plan purchases

     7,772        3,250   

Excess tax benefit from equity-based compensation

     83        11   
                

Net cash used in financing activities

     (59,529     (46,348
                

Effect of exchange rate changes on cash

     44        752   
                

Net increase in cash and cash equivalents

     8,504        5,781   

Cash and cash equivalents at beginning of period

     38,943        33,267   
                

Cash and cash equivalents at end of period

   $ 47,447      $ 39,048   
                

Supplemental disclosures of cash flow information:

    

Income taxes paid

   $ 17,162      $ 9,764   

See accompanying notes to consolidated financial statements.

 

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ZEBRA TECHNOLOGIES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 – Basis of Presentation

Management prepared these unaudited interim consolidated financial statements for Zebra Technologies Corporation and subsidiaries (“Zebra”) according to the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by United States generally accepted accounting principles (“GAAP”) for complete financial statements. Therefore, these consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in Zebra’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009.

The consolidated balance sheet as of December 31, 2009 in this Form 10-Q is taken from the audited consolidated balance sheet in our Form 10-K. These interim financial statements include all adjustments (of a normal, recurring nature) necessary to present fairly Zebra’s consolidated financial position as of October 2, 2010, the consolidated statement of earnings for the three and nine months ended October 2, 2010 and October 3, 2009, and consolidated statement of cash flows for the nine months ended October 2, 2010 and October 3, 2009. These results, however, are not necessarily indicative of results for the full year.

Reclassifications. Certain amounts in the prior years’ financial statements have been reclassified to conform to the current year’s presentation. For the three and nine months ended October 3, 2009, general and administrative expenses of $602,000 and $1,799,000 were reclassified to selling and marketing expenses. For the three and nine months ended October 3, 2009, general and administrative expenses of $299,000 and $979,000 were reclassified to research and development expenses. These reclassifications were made to better reflect costs as they relate to their functional areas. In addition, write-offs of an equity investment in an international technology company in the amount of $88,000 and $855,000 for the three and nine months ended October 3, 2009 that were previously presented netted against asset impairment charges were reclassified to investment income in order to be consistent with the 2009 year end presentation. Prior period amounts will differ in the above categories from amounts previously reported.

Note 2 – Fair Value Measurements

Financial assets and liabilities are to be measured using inputs from three levels of the fair value hierarchy. Fair value is based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Zebra uses a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels:

Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.

Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.

Level 3: Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.

In determining fair value, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as consider counterparty credit risk in the assessment of fair value.

Included in our investment portfolio are three auction rate security instruments. These instruments are classified as available-for-sale securities and are reflected at fair value. Due to events in credit markets, however, the auction events for the instruments held by Zebra as of October 2, 2010, are failed. Therefore, the fair values of these securities are estimated utilizing broker quotations, discounted cash flow analysis or other types of valuation adjustment methodologies at October 2, 2010. These analyses consider, among other items, the collateral underlying the security instruments, the creditworthiness of the counterparty, the timing of expected future cash flows, estimates of the next time the security is expected to have a successful auction, and Zebra’s intent and ability to hold such securities until credit markets improve.

 

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These securities were also compared, when possible, to other securities with similar characteristics. In June 2010, one of the four auction rate securities held at the end of the first quarter of 2010 was called by the issuer and redeemed at par value. Zebra received proceeds in the amount of $1,650,000 and adjusted other comprehensive income by $200,000. See Level 3 table below for more details.

Of the three auction rate security instruments still held, Zebra deemed one to be other than temporarily impaired and recorded the market value decline in 2008. The decline in the market value of the other securities is considered temporary and has been recorded in accumulated other comprehensive income (loss) on Zebra’s balance sheet. Since Zebra has the intent and ability to hold these securities until they are sold at auction, redeemed at carrying value or reach maturity, we have classified them as long-term investments on the balance sheet.

Financial assets and liabilities carried at fair value as of October 2, 2010, are classified below (in thousands):

 

     Level 1      Level 2      Level 3      Total  

Assets:

           

U.S. government and agency securities

   $ 19,231       $ —         $ —         $ 19,231   

Obligations of government-sponsored enterprises (1)

     7,999         —           —           7,999   

State and municipal bonds

     140,782         —           2,683         143,465   

Corporate securities

     39,489         —           2,914         42,403   

Other investments

     36         —           —           36   
                                   

Investments subtotal

     207,537         —           5,597         213,134   

Money market investments related to the deferred compensation plan

     3,196         —           —           3,196   
                                   

Total assets at fair value

   $ 210,733         —         $ 5,597       $ 216,330   
                                   

Liabilities:

           

Forward contracts (2)

   $ 5,295         578         —         $ 5,873   

Liabilities related to the deferred compensation plan

     3,185       $ —         $ —           3,185   
                                   

Total liabilities at fair value

   $ 8,480       $ 578       $ —         $ 9,058   
                                   

Financial assets and liabilities carried at fair value as of December 31, 2009, are classified below (in thousands):

 

     Level 1      Level 2      Level 3      Total  

Assets:

           

U.S. government and agency securities

   $ 12,811       $ —         $ —         $ 12,811   

Obligations of government-sponsored enterprises (1)

     10,666         —           —           10,666   

State and municipal bonds

     161,839         —           4,133         165,972   

Corporate securities

     13,654         —           2,914         16,568   

Other investments

     36         —           —           36   
                                   

Investments subtotal

     199,006         —           7,047         206,053   

Forward contracts (2)

     851         —           —           851   

Money market investments related to the deferred compensation plan

     3,155         —           —           3,155   
                                   

Total assets at fair value

   $ 203,012       $ —         $ 7,047       $ 210,059   
                                   

Liabilities:

           

Liabilities related to the deferred compensation plan

   $ 3,155       $ —         $ —         $ 3,155   
                                   

Total liabilities at fair value

   $ 3,155       $ —         $ —         $ 3,155   
                                   

 

(1) Includes investments in notes issued by the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Bank.

 

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(2) The fair value of forward contracts are calculated as follows:

 

  a. Fair value of forward collar contract associated with forecasted sales hedges are calculated using the midpoint of ask and bid rates for similar contracts.
  b. Fair value of regular forward contracts associated with forecasted sales hedges are calculated using the period-end exchange rate adjusted for the discount rate (3 month LIBOR rate).
  c. Fair value of balance sheet hedges are calculated at the period end exchange rate adjusted for current forward points unless the hedge has been traded but not settled at period end. If this is the case, the fair value is calculated at the rate at which the hedge is being settled.

The following table presents Zebra’s activity for assets measured at fair value on a recurring basis using significant unobservable inputs, Level 3, for the three month periods (in thousands):

 

     Nine Months Ended  
     October 2, 2010     October 3, 2009  

Balance at beginning of the year

   $ 7,047      $ 7,047   

Transfers to Level 3

     —          —     

Total losses (realized or unrealized):

    

Included in earnings

     —          —     

Included in other comprehensive income (loss)

     200        —     

Purchases and settlements (net)

     (1,650     —     
                

Balance at end of period

   $ 5,597      $ 7,047   
                

Total gains and (losses) for the period included in earnings attributable to the change in unrealized losses relating to assets still held at end of period

   $ —        $ —     
                

The following is a summary of short-term and long-term investments at October 2, 2010 and December 31, 2009 (in thousands):

 

     As of October 2, 2010  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair Value
 

U.S. government and agency securities

   $ 19,084       $ 153       $ (6   $ 19,231   

Obligations of government-sponsored enterprises

     7,877         122         —          7,999   

State and municipal bonds

     143,225         638         (398     143,465   

Corporate securities

     42,516         303         (416     42,403   

Other investments

     36         —           —          36   
                                  

Total investments

   $ 212,738       $ 1,216       $ (820   $ 213,134   
                                  
     As of December 31, 2009  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair Value
 

U.S. government and agency securities

   $ 12,931       $ 45       $ (165   $ 12,811   

Obligations of government-sponsored enterprises

     10,589         82         (5     10,666   

State and municipal bonds

     165,366         1,177         (571     165,972   

Corporate securities

     16,680         306         (418     16,568   

Other investments

     36         —           —          36   
                                  

Total investments

   $ 205,602       $ 1,610       $ (1,159   $ 206,053   
                                  

 

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The maturity dates of investments are as follows (in thousands):

 

     As of October 2, 2010  
     Amortized
Cost
     Estimated
Fair Value
 

Less than 1 year

   $ 122,785       $ 123,058   

1 to 5 years

     88,892         88,995   

6 to 10 years

     1,061         1,081   

Thereafter

     —           —     
                 

Total

   $ 212,738       $ 213,134   
                 

The carrying value for Zebra’s financial instruments classified as current assets (other than short-term investments) and current liabilities approximate fair value due to short maturities.

Note 3 – Investments and Marketable Securities

We classify our investments in marketable debt securities as available-for-sale. As of October 2, 2010, all of our investments in marketable debt securities with maturities greater than one year are classified as long-term investments on the balance sheet due to our ability and intent to hold them until maturity.

Changes in the market value of available-for-sale securities are reflected in the accumulated other comprehensive income caption of stockholders’ equity in the balance sheet, until we dispose of the securities. Once these securities are disposed of, either by sale or maturity, the accumulated changes in market value are transferred to investment income. On the statement of cash flows, changes in the balances of available-for-sale securities are shown as purchases, sales and maturities of investments and marketable securities under investing activities.

Changes in market value of trading securities would be recorded in investment income as they occur, and the related statement of cash flows would include changes in the balances of trading securities as operating cash flows.

Change in unrealized gains and losses on available-for-sale securities are included in these financial statements as follows (in thousands):

 

     Three Months Ended      Nine Months Ended  
     October 2,
2010
     October 3,
2009
     October 2,
2010
    October 3,
2009
 

Changes in unrealized gains and losses on available- for-sale securities, net of tax, recorded in accumulated other comprehensive income

   $ 8       $ 289       $ (34   $ 814   
                                  

Note 4 – Inventories

The components of inventories are as follows (in thousands):

 

     As of  
     October 2,
2010
    December 31,
2009
 

Raw material

   $ 30,916      $ 27,953   

Work in process

     614        162   

Deferred costs of long-term contracts

     427        1,937   

Finished goods

     73,060        58,928   
                

Total inventories, gross

     105,017        88,980   

Inventory reserves

     (9,175     (9,054
                

Total inventories, net

   $ 95,842      $ 79,926   
                

 

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Note 5 – Goodwill and Other Intangible Assets

Intangible asset data are as follows (in thousands):

 

     As of October 2, 2010  
     Gross
Amount
     Accumulated
Amortization
    Net
Amount
 

Amortized intangible assets

       

Current technology

   $ 31,918       $ (19,887   $ 12,031   

Patent and patent rights

     16,545         (8,618     7,927   

Customer relationships

     44,727         (13,093     31,634   
                         

Total

   $ 93,190       $ (41,598   $ 51,592   
                         

Amortization expense for the nine months ended October 2, 2010

  

   $ 7,147     
             
     As of December 31, 2009  
     Gross
Amount
     Accumulated
Amortization
    Net
Amount
 

Amortized intangible assets

       

Current technology

   $ 32,038       $ (17,071   $ 14,967   

Patent and patent rights

     13,663         (6,774     6,889   

Customer relationships

     44,822         (10,696     34,126   
                         

Total

   $ 90,523       $ (34,541   $ 55,982   
                         

Amortization expense for the year ended December 31, 2009

  

   $ 10,466     
             

 

     As of  

Goodwill

   October 2, 2010     December 31, 2009  

Goodwill at gross cost

   $ 265,799      $ 265,799   

Impairment charges

     (112,184     (112,184

Foreign exchange impact

     (1,197     (390
                

Goodwill

   $ 152,418      $ 153,225   
                

During the second quarter of 2010, Zebra entered into an agreement with an international technology provider to acquire patents and patent rights related to card printer solutions technology. The agreement requires total consideration in the amount of € 2,400,000. Zebra has paid € 1,950,000 or $2,399,000 in accordance with the agreement through the end of September 2010, and has an obligation to pay an additional € 450,000 in the fourth quarter upon completion of the agreement. This agreement provides Zebra with a new distribution partner and enhanced technology solutions and software.

Certain of our intangible assets including goodwill are denominated in foreign currency and, as such, include the effects of foreign currency translation.

We test goodwill for impairment on an annual basis or more frequently if we believe indicators of impairment exist.

Factors considered that may trigger an impairment review consist of:

 

   

Significant underperformance relative to historical or projected future operating results,

 

   

Significant changes in the manner of use of the acquired assets or the strategy for the overall business,

 

   

Significant negative industry or economic trends,

 

   

Significant decline in Zebra’s stock price for a sustained period, and

 

   

Significant decline in market capitalization relative to net book value.

If we believe that one or more of the above indicators of impairment have occurred, we perform an impairment test. The performance of the test involves a two-step process. The first step of the impairment test involves comparing the fair values of the applicable reporting units with their aggregate carrying values, including goodwill. We generally determine the fair value of our reporting units using three valuation methods: Income Approach – Discounted Cash Flow Analysis, Market Approach – Guideline Public Company Method and Market Approach – Comparative Transactions Method. If

 

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the carrying amount of a reporting unit exceeds the reporting unit’s fair value, we perform the second step of the goodwill impairment test to determine the amount of impairment loss. The second step of the goodwill impairment test involves comparing the implied fair value of the affected reporting unit’s goodwill with the carrying value of that goodwill.

We performed our annual impairment test in June 2010 and determined that our goodwill was not impaired as of the end of May 2010.

Note 6 – Costs Associated with Exit or Disposal Activities

In 2008, we announced plans to establish regional distribution and configuration centers, consolidate our supplier base, and transfer final assembly of thermal printers to Jabil Circuit, Inc., a global third-party electronics manufacturer. These actions are intended to optimize our global printer product supply chain by improving responsiveness to customer needs and increasing Zebra’s flexibility to meet emerging business opportunities. As a result, substantially all printer manufacturing in our Vernon Hills, Illinois, and Camarillo, California, facilities has been transferred to Jabil’s facility in Guangzhou, China, and there are no further related exit costs that are expected to be incurred.

As of October 2, 2010, we have incurred the following exit costs (in thousands):

 

Type of Cost

   Cost incurred
through
December 31,
2009
     Costs
incurred for
the nine months
ended October  2,
2010
     Total costs
incurred as of
October 2, 2010
 

Severance, stay bonuses, and other employee-related expenses

   $ 7,633       $ 103       $ 7,736   

Professional services

     5,915         115         6,030   

Relocation and transition costs

     8,802         1,959         10,761   

Other exit costs

     30         215         245   
                          

Total

   $ 22,380       $ 2,392       $ 24,772   
                          

For the nine months ended October 2, 2010, we have incurred the following exit costs by segment (in thousands):

 

Type of Cost

   Specialty
Printing
Group
(SPG) costs
     Zebra
Enterprise
Solutions
(ZES) costs
     Total costs
incurred  for

the nine months
ended October 2,
2010
 

Severance, stay bonuses, and other employee-related expenses

   $ 94       $ 9       $ 103   

Professional services

     110         5         115   

Relocation and transition costs

     1,959         0         1,959   

Other exit costs

     0         215         215   
                          

Total

   $ 2,163       $ 229       $ 2,392   
                          

For the nine months ended October 3, 2009, we incurred the following exit, restructuring and integration costs by segment (in thousands):

 

Type of Cost

   Specialty
Printing
Group

(SPG) costs
     Zebra
Enterprise
Solutions
(ZES) costs
     Total costs
incurred for
the nine months
ended October  3,
2009
 

Severance, stay bonuses, and other employee-related expenses

   $ 1,530       $ 969       $ 2,499   

Professional services

     54         1         55   

Relocation and transition costs

     4,526         0         4,526   

Other exit costs

     0         10         10   

Integration costs

     0         2,365         2,365   
                          

Total

   $ 6,110       $ 3,345       $ 9,455   
                          

 

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Liabilities and expenses related to exit activities were as follows (in thousands):

 

     Nine Months Ended  
     October 2, 2010     October 3, 2009  

Balance at beginning of period

   $ 3,038      $ 6,378   

Charged to earnings

     2,392        7,090   

Cash paid

     (4,159     (9,991
                

Balance at the end of period

   $ 1,271      $ 3,477   
                

Liabilities related to exit activities are included in the accrued liabilities line item on the balance sheet. All current exit costs are included in operating expenses under the line item exit, restructuring and integration costs.

Note 7 – Derivative Instruments

In the normal course of business, portions of our operations are subject to fluctuations in currency values. We manage these risks using derivative financial instruments. We conduct business on a multinational basis in a wide variety of foreign currencies. Our exposure to market risk for changes in foreign currency exchange rates arises from international financing activities between subsidiaries, foreign currency denominated monetary assets and liabilities and transactions arising from international trade. Our objective is to preserve the economic value of non-functional currency denominated cash flows. We attempt to hedge transaction exposures with natural offsets to the fullest extent possible and, once these opportunities have been exhausted, through foreign exchange forward and option contracts with third parties.

Credit and market risk

Financial instruments, including derivatives, expose us to counter party credit risk for nonperformance and to market risk related to interest and currency exchange rates. We manage our exposure to counterparty credit risk through specific minimum credit standards, diversification of counterparties, and procedures to monitor concentrations of credit risk. Our counterparties in derivative transactions are commercial banks with significant experience using derivative instruments. We monitor the impact of market risk on the fair value and cash flows of our derivative and other financial instruments considering reasonably possible changes in interest rates and currency exchange rates and restrict the use of derivative financial instruments to hedging activities.

We continually monitor the creditworthiness of our customers to which we grant credit terms in the normal course of business. The terms and conditions of our credit sales are designed to mitigate or eliminate concentrations of credit risk with any single customer. Our sales are not materially dependent on a single customer or a small group of customers.

Fair Value of Derivative Instruments

Zebra has determined that derivative instruments for hedges that have traded but have not settled are considered Level 1 in the fair value hierarchy, and hedges that have not traded are considered Level 2 in the fair value hierarchy. Derivative instruments are used to manage risk and are not used for trading or other speculative purposes, nor do we use leveraged derivative financial instruments. Our foreign currency exchange contracts are valued using broker quotations or market transactions, in either the listed or over-the-counter markets.

Hedging of Net Assets

We use forward contracts and options to manage exposure related to our pound and euro-denominated net assets. Forward contracts typically mature within three months after execution of the contracts. We record gains and losses on these contracts and options in income each quarter along with the transaction gains and losses related to our net asset positions, which would ordinarily offset each other. Summary financial information related to these activities included in our consolidated statement of earnings as other income (expense) is as follows (in thousands):

 

     Three Months Ended     Nine Months Ended  
     October 2,
2010
    October 3,
2009
    October 2,
2010
    October 3,
2009
 

Change in gains (losses) from foreign exchange derivatives

   $ (6,446   $ (2,149   $ 2,626      $ (1,348

Gain (loss) on net foreign currency assets

     6,121        2,724        (2,391     508   
                                

Foreign exchange gain (loss)

   $ (325   $ 575      $ 235      $ (840
                                

 

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     As of  
     October 2,
2010
    December 31,
2009
 

Notional balance of outstanding contracts:

    

Pound/US dollar

   £ 8,419      £ 7,500   

Euro/US dollar

   42,905      37,000   

Net fair value of outstanding contracts

   $ (212   $ (6

Summary financial information related to the cash flow hedges is as follows (in thousands):

 

     As of  
     October 2,
2010
    December 31,
2009
 

Net unrealized gains (losses) deferred in other comprehensive income:

    

Gross

   $ (3,297   $ 31   

Income tax benefit

     (1,241     12   
                

Net

   $ (2,056   $ 19   
                

Hedging of Anticipated Sales

We can manage the exchange rate risk of anticipated euro-denominated sales using purchased options, forward contracts, participating forwards and option collars. We designate these contracts as cash flow hedges which mature within twelve months after the execution of the contracts. Gains and losses on these contracts are deferred in other comprehensive income until the contracts are settled and the hedged sales are realized, the deferred gains or losses will then be reported as an increase or decrease to sales.

Summary financial information related to the cash flow hedges of future revenues follows (in thousands, except percentages):

 

     As of  
     October 2,
2010
    December 31,
2009
 

Notional balance of outstanding contracts versus the dollar

   62,450      —     

Hedge effectiveness

     100     —     

 

     Three Months Ended     Nine Months Ended  
     October 2,
2010
     October 3,
2009
    October 2,
2010
     October 3,
2009
 

Net gains and (losses) included in revenue

   $ —         $ (629   $ —         $ 724   

Forward contracts

We record our forward contracts at fair value on our consolidated balance sheet as either other assets or other liabilities depending upon the fair value calculation as detailed in Note 2 of Zebra’s financial statements. The amounts recorded on our consolidated balance sheet are as follows (in thousands):

 

     As of  
     October 2,
2010
     December 31,
2009
 

Assets:

     

Other assets

   $ —         $ 851   
                 

Total

   $ —         $ 851   
                 

Liabilities:

     

Other liabilities

   $ 5,873       $ —     
                 

Total

   $ 5,873       $ —     
                 

 

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Note 8 – Warranty

In general, Zebra provides warranty coverage of one year on SPG printers against defects in material and workmanship. SPG printheads are warranted for nine months and batteries are warranted for twelve months. Warranty coverage for most ZES hardware products is similar, with coverage periods ranging from 90 days to one year depending on the nature of the product. Battery based products, such as location tags, are covered by a 30 day warranty. For ZES software products, the warranty period is generally 90 days and provides coverage against defects in material and workmanship as well as performance materially in compliance with the accompanying documentation. A provision for warranty expense is recorded at the time of shipment and adjusted quarterly based on historical warranty experience.

The following table is a summary of Zebra’s accrued warranty obligation (in thousands):

 

     Nine Months Ended  
     October 2, 2010     October 3, 2009  

Balance at the beginning of the year

   $ 3,813      $ 2,814   

Warranty expense

     4,490        3,477   

Warranty payments

     (4,101     (3,033
                

Balance at the end of the period

   $ 4,202      $ 3,258   
                

In the European Union, we have an obligation to recycle printers. We reserve for this obligation based on the number of new printers sold after August 13, 2005, and printers sold prior to that date that are returned to us upon our sale of a new printer to a customer. The following is a summary of Zebra’s accrued recycling obligation (in thousands):

 

     Nine Months Ended  
     October 2, 2010      October 3, 2009  

Balance at the beginning of the year

   $ 1,001       $ 1,207   

Recycling expense

     83         250   

Reserve adjustment

     —           (640

Recycling payments

     —           —     

Other adjustments

     2         138   
                 

Balance at the end of the period

   $ 1,086       $ 955   
                 

Note 9 – Contingencies

We are subject to a variety of investigations, claims, suits and other legal proceedings that arise from time to time in the ordinary course of business, including but not limited to, intellectual property, employment, tort and breach of contract matters. We currently believe that the outcomes of such proceedings, individually and in the aggregate, will not have a material adverse impact on our business, cash flows, financial position, or results of operations. Any legal proceedings are subject to inherent uncertainties, and management’s view of these matters and their potential effects may change in the future.

Note 10 – Changes to Benefit Programs

Zebra has a Retirement Savings and Investment Plan (401(k) Plan), which is intended to qualify under Section 401(k) of the Internal Revenue Code. During the first quarter of 2009, Zebra announced changes to its 401(k) Plan, profit sharing plan and stock purchase plan. Qualified employees may participate in Zebra’s 401(k) Plan by contributing up to 15% of their gross earnings to the plan subject to certain Internal Revenue Service restrictions. Effective March 1, 2009, Zebra reduced the company match to each participant’s contribution from 6% of gross eligible earnings at the rate of 50%, to 3% of gross eligible earnings at the rate of 50%. Effective January 1, 2010, Zebra increased the company match to each participant’s contribution to 4% of gross eligible earnings. Zebra will match 100% of the first 2% of gross eligible earnings, and also match the next 4% of gross eligible earnings at the rate of 50%. Zebra may contribute additional amounts to its 401(k) Plan at the discretion of the Board of Directors, subject to certain legal limits.

Zebra also has a discretionary profit-sharing plan for qualified employees, to which it contributes a percentage of eligible payroll each year. Zebra announced that it will suspend any contributions to the profit sharing plan for the 2009 plan year and plan years going forward. Participants are not permitted to make contributions under the discretionary profit-sharing plan.

 

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Note 11 – Stockholders’ Equity

Share count and par value data related to stockholders’ equity are as follows:

 

     October 2, 2010      December 31, 2009  

Preferred Stock

     

Par value per share

   $ 0.01       $ 0.01   

Shares authorized

     10,000,000         10,000,000   

Shares outstanding

     —           —     

Common Stock – Class A

     

Par value per share

   $ 0.01       $ 0.01   

Shares authorized

     150,000,000         150,000,000   

Shares issued

     72,151,857         72,151,857   

Shares outstanding

     56,519,663         58,318,983   

Treasury stock

     

Shares held

     15,632,194         13,832,874   

During the nine-month period ended October 2, 2010, Zebra purchased 2,449,286 shares of common stock for $67,384,000 under board authorized share repurchase plans compared to the nine-month period ended October 3, 2009, in which Zebra purchased 2,579,630 shares of common stock for $49,609,000.

A roll forward of Class A common shares outstanding is as follows:

 

     Nine Months Ended  
     October 2, 2010     October 3, 2009  

Balance at the beginning of the year

     58,318,983        60,861,592   

Repurchases

     (2,449,286     (2,579,630

Stock option and ESPP issuances

     296,512        202,009   

Restricted share issuances

     375,279        406,242   

Restricted share forfeitures

     (14,627     (48,679

Shares withheld for tax obligations

     (7,198     (8,914
                

Balance at the end of the period

     56,519,663        58,832,620   
                

Note 12 – Earnings Per Share

Earnings per share were computed as follows (in thousands, except per share amounts):

 

     Three Months Ended      Nine Months Ended  
     October 2, 2010      October 3, 2009      October 2, 2010      October 3, 2009  

Basic earnings per share:

           

Net income

   $ 26,151       $ 11,111       $ 73,561       $ 29,474   
                                   

Weighted average common shares outstanding

     56,739         58,954         57,405         59,548   
                                   

Per share amount

   $ 0.46       $ 0.19       $ 1.28       $ 0.49   

Diluted earnings per share:

           

Net income

   $ 26,151       $ 11,111       $ 73,561       $ 29,474   
                                   

Weighted average common shares outstanding

     56,739         58,954         57,405         59,548   

Add: Effect of dilutive securities – stock options

     259         129         252         95   
                                   

Diluted weighted average and equivalent shares outstanding

     56,998         59,083         57,657         59,643   
                                   

Per share amount

   $ 0.46       $ 0.19       $ 1.28       $ 0.49   

 

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Potentially dilutive securities that were excluded from the earnings per share calculation consist of options with an exercise price greater than the average market closing price of the Class A common stock during the respective three and nine month periods. These options were as follows:

 

     Three Months Ended      Nine Months Ended  
     October 2, 2010      October 3, 2009      October 2, 2010      October 3, 2009  

Potentially dilutive shares

     1,887,000         2,421,000         1,893,000         2,708,000   

Note 13 – Equity-Based Compensation

Zebra has an equity-based compensation plan and a stock purchase plan available for future grants. Zebra recognizes compensation costs using the straight-line method over the vesting period of 1 month to 5 years.

The compensation expense and the related tax benefit for equity-based payments were included in the Consolidated Statement of Earnings as follows (in thousands):

 

     Three Months
Ended
     Nine Months
Ended
 
     October 2,
2010
     October 3,
2009
     October 2,
2010
     October 3,
2009
 

Cost of sales

   $ 285       $ 321       $ 856       $ 907   

Selling and marketing

     551         605         1,401         1,384   

Research and development

     401         494         1,207         1,317   

General and administrative

     1,763         1,681         4,691         5,079   
                                   

Total compensation

     3,000         3,101         8,155         8,687   
                                   

Income tax benefit

   $ 1,035       $ 992       $ 2,813       $ 2,780   
                                   

Cash flows resulting from the tax benefits from tax deductions in excess of the compensation cost recognized (excess tax benefits) are classified as financing cash flows in the statement of cash flows. The tax benefits classified as financing cash flows for the nine months ended October 2, 2010 was $83,000 and for the nine months ended October 3, 2009, was $11,000.

The fair value of equity-based compensation is estimated on the date of grant using a binomial model. Volatility is based on an average of the implied volatility in the open market and the annualized volatility of Zebra stock prices over our entire stock history. Stock option grants in the table below include both stock options, all of which were non-qualified, and stock appreciation rights (SAR) that will be settled in Zebra stock. The following table shows the weighted-average assumptions used for grants of stock options and SARs as well as the fair value of the grants based on those assumptions:

 

     Nine Months Ended  
     October 2, 2010     October 3, 2009  

Expected dividend yield

     0     0

Forfeiture rate

     9.78     9.92

Volatility

     39.50     43.08

Risk free interest rate

     2.26     2.23

– Range of interest rates

     0.06% - 3.41     0.15% - 3.29

Expected weighted-average life

     5.36 years        5.23 years   

Fair value of options and SARs granted

   $ 6,527,000      $ 5,970,000   

Weighted-average grant date fair value of options and SARs granted

   $ 10.65      $ 8.04   

 

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SAR activity was as follows:

 

     Nine Months Ended October 2, 2010  

SARs

  
Shares
    Weighted-Average
Exercise Price
 

Outstanding at beginning of year

     684,058      $ 19.97   

Granted

     612,681        27.82   

Exercised

     (25,442     19.56   

Forfeited

     (30,678     22.14   

Expired

     (273     19.56   
                

Outstanding at end of period

     1,240,346      $ 23.80   
                

Exercisable at end of period

     154,627      $ 20.15   
                

Intrinsic value of exercised SARs

   $ 252,000     
          

There were no equity grants of SARs during the three months ended October 2, 2010.

The terms of the SARs are established under the 2006 Zebra Technologies Corporation Incentive Compensation Plan (the 2006 Plan) and the applicable SAR agreement. Once vested, a SAR entitles the holder to receive a payment equal to the difference between the per-share base price of the SAR and the fair market value of a share of Zebra stock on the date the SAR is exercised, multiplied by the number of SAR’s exercised. Exercised SARs are settled in whole shares of Zebra stock, and any fraction of a share is settled in cash. The SARs granted during the first nine months of 2010 vest annually in four equal amounts on each of the first four anniversaries of the grant date and expire 10 years after the grant date.

The following table summarizes information about SARs outstanding at October 2, 2010:

 

     Outstanding      Exercisable  

Range of Exercise Prices

   Number
of Shares
     Weighted-Average
Remaining Contractual Life
     Weighted-Average
Exercise Price
     Number
of Shares
     Weighted-Average
Exercise Price
 

$ 19.56-$19.56

     578,598         8.59 years       $ 19.56         127,463       $ 19.56   

$ 19.57-$27.50

     75,686         9.05 years         24.84         27,164         22.95   

$ 27.51-$27.82

     568,938         9.59 years         27.82         0         0.00   

$ 27.83-$29.06

     11,647         9.47 years         28.57         0         0.00   

$ 29.07-$30.08

     5,477         9.45 years         30.08         0         0.00   
                          
     1,240,346               154,627      
                          

 

     Outstanding      Exercisable  

Aggregate intrinsic value

   $ 12,438,000       $ 2,114,000   

Weighted-average remaining contractual term

     9.1 years         8.6 years   

Stock option activity was as follows:

 

     Nine Months Ended October 2, 2010  

Options

  
Shares
    Weighted-Average
Exercise Price
 

Outstanding at beginning of year

     2,767,887      $ 35.98   

Granted

     0        0.00   

Exercised

     (206,507     23.81   

Forfeited

     (55,523     35.23   

Expired

     (67,941     35.54   
                

Outstanding at end of period

     2,437,916      $ 37.01   
                

Exercisable at end of period

     1,969,919      $ 37.14   
                

Intrinsic value of exercised options

   $ 1,207,000     
          

 

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The following table summarizes information about stock options outstanding at October 2, 2010:

 

     Outstanding      Exercisable  

Range of Exercise Prices

   Number
of Shares
     Weighted-Average
Remaining Contractual Life
     Weighted-Average
Exercise Price
     Number
of Shares
     Weighted-Average
Exercise Price
 

$ 1.29-$25.23

     541,675         2.76 years       $ 21.17         497,744       $ 21.28   

$ 25.24-$36.49

     585,099         6.60 years         35.60         337,950         35.34   

$ 36.50-$42.28

     518,941         6.49 years         40.31         394,618         40.31   

$ 42.29-$46.18

     463,998         4.91 years         44.91         411,404         45.03   

$ 46.19-$53.92

     328,203         3.75 years         49.33         328,203         49.33   
                          
     2,437,916               1,969,919      
                          

 

     Outstanding      Exercisable  

Aggregate intrinsic value

   $ 6,983,000       $ 6,354,000   

Weighted-average remaining contractual term

     5.0 years         4.5 years   

Restricted stock award activity, granted under the 2006 Plan, was as follows:

 

     Nine Months Ended October 2, 2010  

Restricted Stock Awards

  
Shares
    Weighted-Average
Grant Date Fair Value
 

Outstanding at beginning of year

     507,984      $ 23.90   

Granted

     375,279        27.84   

Released

     (22,325     29.11   

Forfeited

     (14,627     25.88   
                

Outstanding at end of period

     846,311      $ 25.48   
                

There were no equity grants of restricted stock awards during the three months ended October 2, 2010.

As of October 2, 2010, there was $20,576,000 of unearned compensation cost related to awards granted under Zebra’s equity-based compensation plans, which is expected to be recognized over a weighted-average period of 2.6 years.

The fair value of the purchase rights of all Zebra employees issued under the stock purchase plan is estimated using the following weighted-average assumptions for purchase rights granted. Expected lives of three months to one year have been used along with these assumptions.

 

     Nine Months Ended  
     October 2, 2010     October 3, 2009  

Fair market value

   $ 26.34      $ 20.60   

Option price

   $ 25.02      $ 18.62   

Expected dividend yield

     0     0

Expected volatility

     27     38

Risk free interest rate

     0.13     0.16

Note 14 – Income Taxes

Zebra has identified, evaluated, and measured the amount of income tax benefits to be recognized for all of our income tax positions. Included in deferred tax assets are amounts related to federal and state net operating losses that resulted from our acquisition of WhereNet Corp. Zebra’s intention is to utilize these net operating loss carryforwards to offset future income taxes owed.

Zebra has concluded all U.S. federal income tax audits for years through 2006. The tax years 2006 through 2009 remain open to examination by multiple state taxing jurisdictions. Tax authorities in the United Kingdom have completed income tax audits for tax years through 2006.

Zebra’s continuing practice is to recognize interest and/or penalties related to income tax matters as part of income tax expense. For the three and nine month periods ended October 2, 2010 and October 3, 2009, we did not accrue any interest or penalties into income tax expense.

 

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The effective income tax rate for the third quarter of 2010 was 32.9% compared with 32.0% for the third quarter of 2009. The effective income tax rate for the first nine months of 2010 was 29.7% compared to 32.0% for the first nine months of 2009. Zebra’s effective tax rate for the first quarter of 2010 included a $2,764,000 reduction of federal taxes related to prior years’ adjustments for intercompany profit in ending inventory which reduced our effective rate for the first nine months of 2010 by 2.6%.

Note 15 – Other Comprehensive Income

Stockholders’ equity includes certain items classified as accumulated other comprehensive income, including:

 

   

Foreign currency translation adjustment relates to our non-U.S. subsidiary companies that have designated a functional currency other than the U.S. dollar. We are required to translate the subsidiary functional currency financial statements to dollars using a combination of historical, period-end, and average foreign exchange rates. This combination of rates creates the foreign currency translation adjustment component of other comprehensive income.

 

   

Unrealized gains (losses) on foreign currency hedging activities relate to derivative instruments used to hedge the currency exchange rates for forecasted euro sales. These hedges are designated as cash flow hedges, and we have deferred income statement recognition of gains and losses until the hedged transaction occurs. See Note 7 for more details.

 

   

Unrealized gains (losses) on investments classified as available-for-sale are deferred from income statement recognition until the gains or losses are realized. See Note 3 for more details.

The Consolidated Statements of Comprehensive Income are as follows (in thousands):

 

     Three Months Ended     Nine Months Ended  
     October 2,
2010
    October 3,
2009
    October 2,
2010
    October 3,
2009
 

Net income

   $ 26,151      $ 11,111      $ 73,561      $ 29,474   

Other comprehensive income (loss):

        

Foreign currency translation adjustment

     1,237        (660     (173     4,137   

Changes in unrealized gains (losses) on hedging transactions, net of tax

     (2,185     352        (2,056     (57

Changes in unrealized gains (losses) on investments, net of tax

     8        289        (34     814   
                                

Comprehensive income

   $ 25,211      $ 11,092      $ 71,298      $ 34,368   
                                

The components of other comprehensive income gross and net of income tax are as follows (in thousands):

 

     Three Months Ended      Nine Months Ended  
     October 2,
2010
    October 3,
2009
     October 2,
2010
    October 3,
2009
 

Changes in unrealized gains and losses on foreign currency hedging activities:

         

Gross

   $ (3,504   $ 565       $ (3,297   $ (91

Income tax (benefit)

     (1,319     213         (1,241     (34
                                 

Net

   $ (2,185   $ 352       $ (2,056   $ (57
                                 

Changes in unrealized gains and losses on investments classified as available-for-sale:

         

Gross

   $ 13      $ 463       $ (55   $ 1,305   

Income tax (benefit)

     5        174         (21     491   
                                 

Net

   $ 8      $ 289       $ (34   $ 814   
                                 

 

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The components of accumulated other comprehensive income (loss) included in the Consolidated Balance Sheets are as follows (in thousands):

 

     As of  
     October 2,
2010
    December 31,
2009
 

Foreign currency translation adjustments

   $ (8,515   $ (8,342
                

Unrealized gains and (losses) on hedging transactions:

    

Gross

   $ (3,298   $ (1

Income tax (benefit)

     (1,241     —     
                

Net

   $ (2,057   $ (1
                

Unrealized gains and (losses) on investments classified as available-for-sale:

    

Gross

   $ 397      $ 452   

Income tax (benefit)

     149        170   
                

Net

   $ 248      $ 282   
                

Note 16 – Segment Information

Zebra has two reportable segments: Specialty Printing Group (SPG) and Zebra Enterprise Solutions (ZES).

SPG includes direct thermal and thermal transfer label and receipt printers, passive radio frequency identification (RFID) printer/encoders and dye sublimation card printers. Also included in this group is 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.

ZES has evolved since the beginning of 2007 with the acquisitions of WhereNet Corp., proveo AG, Navis Holdings, LLC and Multispectral Solutions, Inc. The solutions that these companies provide are generally sold on a contract basis and are typically installed over several quarters. These contracts cover a range of services, including design, installation and ongoing maintenance services.

Segment information is as follows (in thousands):

 

     As of  
     October 2,
2010
     December 31,
2009
 

Identifiable assets:

     

SPG

   $ 378,380       $ 336,428   

ZES

     184,037         185,495   

Corporate and other

     309,228         308,556   
                 

Total

   $ 871,645       $ 830,479   
                 

 

     Three Months Ended     Nine Months Ended  
     October 2,
2010
    October 3,
2009
    October 2,
2010
    October 3,
2009
 

Net sales:

        

SPG Tangible products

   $ 213,406      $ 171,977      $ 616,493      $ 493,491   

SPG Service & software

     9,413        8,780        27,380        25,943   
                                

SPG Net Sales

     222,819        180,757        643,873        519,434   

ZES Tangible products

     8,389        3,357        15,705        10,456   

ZES Service & software

     15,299        16,664        49,095        51,173   
                                

ZES Net Sales

     23,688        20,021        64,800        61,629   
                                

Total

   $ 246,507      $ 200,778      $ 708,673      $ 581,063   
                                

Operating profit (loss):

        

SPG

   $ 60,084      $ 36,682      $ 167,457      $ 100,769   

ZES

     (4,928     (2,912     (14,191     (9,839

Corporate and other

     (16,299     (18,532     (49,848     (48,366
                                

Total

   $ 38,857      $ 15,238      $ 103,418      $ 42,564   
                                

 

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Zebra records its federal and state deferred tax assets and liabilities in corporate and other as reflected above. Intersegment sales are not significant. Corporate and other includes corporate administration costs or assets that support both reporting segments.

Note 17 – New Accounting Pronouncements

In October 2009, the FASB issued update 2009-13, ASC 605, Revenue Recognition: Multiple –Deliverable Revenue Arrangements-a consensus of the FASB Emerging Issues Task Force. The revised guidance provides for two significant changes to existing multiple element arrangement guidance. The first relates to the determination of when the individual deliverables included in a multiple-element arrangement may be treated as separate units of accounting. This change is significant as it may result in the requirement to separate more deliverables within an arrangement, ultimately leading to less revenue deferral. The second change modifies the manner in which the transaction consideration is allocated across the separately identifiable deliverables. These changes may result in earlier recognition of revenue for multiple-element arrangements than under previous guidance. This standard is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. We have not yet determined the effect of this standard upon our consolidated financial statements.

In October 2009, the FASB issued update 2009-14, ASC 985, Software: Certain Revenue Arrangements That Include Software Elements – a consensus of the FASB Emerging Issues Task Force. This updated guidance is expected to significantly affect how entities account for revenue arrangements that contain both hardware and software elements. This standard is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. We have not yet determined the effect of this standard upon our consolidated financial statements.

In January 2010, the FASB issued update 2010-06, ASC 820, Fair Value Measurements and Disclosures: Improving Disclosures about Fair Value Measurements. This updated guidance requires new disclosures related to transfers in and out of Levels 1 and 2. The standard also provides guidance on the disclosures related to Level 3 activities. In addition, existing disclosures related to disaggregation levels and disclosures about inputs and valuation techniques are clarified. This standard is effective for interim and annual periods beginning after December 15, 2009. This standard did not have a material effect upon our consolidated financial statements.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations: Third Quarter of 2010 versus Third Quarter of 2009

Consolidated Results of Operations

(Amounts in thousands, except percentages):

 

     Three Months Ended               
     October 2,
2010
     October 3,
2009
     Percent
Change
    Percent of
Net Sales - 2010
     Percent of
Net Sales - 2009
 

Net Sales

             

Tangible products

   $ 221,795       $ 175,334         26.5        90.0         87.3   

Service & software

     24,712         25,444         (2.9     10.0         12.7   
                                     

Total net sales

     246,507         200,778         22.8        100.0         100.0   

Cost of Sales

             

Tangible products

     117,502         98,682         19.1        47.7         49.1   

Service & software

     10,291         10,398         (1.0     4.1         5.2   
                                     

Total cost of sales

     127,793         109,080         17.2        51.8         54.3   
                                     

Gross profit

     118,714         91,698         29.5        48.2         45.7   

Operating expenses

     79,857         76,460         4.4        32.4         38.1   
                                     

Operating income

     38,857         15,238         155.0        15.8         7.6   

Other income (expense)

     94         1,102         (91.5     —           0.5   
                                     

Income before income taxes

     38,951         16,340         138.4        15.8         8.1   

Income taxes

     12,800         5,229         144.8        5.2         2.6   
                                     

Net income

   $ 26,151       $ 11,111         135.4        10.6         5.5   
                                           

Diluted earnings per share

   $ 0.46       $ 0.19           
                         

Consolidated Results of Operations – Third quarter

Sales

Net sales for the third quarter of 2010 compared with the 2009 quarter increased 22.8% due to a broad-based increase in demand for Zebra products, driven by global economic recovery. This was the third consecutive quarter of strong year-over-year growth. The increase in sales was largely attributable to 36.8% growth in hardware sales (including all printer categories and aftermarket parts). Printer unit volume increased 32.0% for the third quarter of 2010 compared to levels in 2009.

Sales by product category were as follows (amounts in thousands, except percentages):

 

     Three Months Ended               

Product Category

   October 2,
2010
     October 3,
2009
     Percent
Change
    Percent of
Net Sales - 2010
     Percent of
Net Sales - 2009
 

Hardware

   $ 178,991       $ 130,856         36.8        72.6         65.2   

Supplies

     41,644         43,229         (3.7     16.9         21.5   

Service and software

     24,712         25,443         (2.9     10.0         12.7   

Shipping and handling

     1,160         1,250         (7.2     0.5         0.6   
                                     

Total net sales

   $ 246,507       $ 200,778         22.8        100.0         100.0   
                                     

Sales increased in all geographic territories due primarily to the global economic recovery. The sales growth on a percentage basis was greatest in Latin America and Asia Pacific because of higher rates of economic growth in those regions and as a result of greater investment in sales and marketing. Movements in foreign exchange rates decreased sales by $6,633,000 in the Europe, Middle East and Africa regions for the quarter due principally to a stronger euro against the dollar.

 

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Sales to customers by geographic region were as follows (in thousands, except percentages):

 

     Three Months Ended                

Geographic Region

   October 2,
2010
     October 3,
2009
     Percent
Change
     Percent of
Net Sales - 2010
     Percent of
Net Sales - 2009
 

Europe, Middle East and Africa

   $ 82,456       $ 67,591         22.0         33.4         33.7   

Latin America

     22,338         17,452         28.0         9.1         8.7   

Asia-Pacific

     35,453         20,889         69.7         14.4         10.4   
                                      

Total International

     140,247         105,932         32.4         56.9         52.8   

North America

     106,260         94,846         12.0         43.1         47.2   
                                      

Total net sales

   $ 246,507       $ 200,778         22.8         100.0         100.0   
                                      

Gross Profit

Gross profit increased 29.5% due to higher volumes and an improved product mix, with increased sales primarily in mobile, high-performance and mid-range table top printers, partially offset by $3,653,000 in higher freight costs in 2010. Gross profit was affected by unfavorable foreign currency movements which decreased third quarter gross profit by $5,809,000. As a percentage of sales, gross margin improved from 45.7% to 48.2%. The benefit of outsourcing printer production to a third party, higher volumes, improved product mix and continued cost control contributed to the increase in gross margin.

Operating Expenses

Operating expenses for the quarter increased 4.4% due mainly to greater selling and marketing expenses and research and development expenses. Several categories accounted for these increases, including compensation costs which include salaries, benefits, bonuses and commissions. Business development, outside professional services, project expenses, and travel and entertainment expenses all increased over 2009 levels. Exit, restructuring and integration costs decreased $3,515,000 in the third quarter of 2010 as compared to 2009. Zebra’s program for outsourcing its manufacturing operations is complete and the related restructuring costs for this program ended in the second quarter of 2010. Integration costs associated with the Zebra Enterprise Solutions (ZES) businesses were completed in 2009.

Operating expenses are summarized below (in thousands, except percentages):

 

     Three Months Ended            Percent of
Net  Sales 2010
     Percent of
Net  Sales 2009
 

Operating Expenses

   October 2,
2010
     October 3,
2009
     Percent
Change
      

Selling and marketing

   $ 30,365       $ 26,395         15.0        12.2         13.1   

Research and development

     26,746         21,454         24.7        10.7         10.7   

General and administrative

     20,302         22,447         (9.6     8.1         11.2   

Amortization of intangible assets

     2,444         2,649         (7.7     1.0         1.3   

Exit, restructuring and integration costs

     —           3,515         (100.0     0.0         1.8   

Asset impairment charges

     —           —           —          —           —     
                                           

Total operating expenses

   $ 79,857       $ 76,460         4.4        32.0         38.1   
                                     

Other Income

Investment income declined from lower short-term interest rates in the third quarter of 2010 compared with 2009. Zebra recorded a foreign exchange gain in the third quarter of 2009 as the U.S. dollar strengthened against the euro.

Zebra’s non-operating income and expense items are summarized in the following table (in thousands):

 

     Three Months Ended  
     October 2, 2010     October 3, 2009  

Investment income

   $ 635      $ 813   

Foreign exchange gain (loss)

     (325     575   

Other, net

     (216     (286
                

Total other income

   $ 94      $ 1,102   
                

 

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Table of Contents

 

Operating Income

The operating income increase for the third quarter of 2010 was the result of increased sales and gross profit as noted above.

Income Taxes

The effective income tax rate for the third quarter of 2010 was 32.9% compared with 32.0% for the third quarter of 2009.

Business Groups

Specialty Printing Group

(Amounts in thousands, except percentages):

 

     Three Months Ended                      
     October 2,
2010
     October 3,
2009
     Percent
Change
    Percent of
Net Sales - 2010
     Percent of
Net Sales - 2009
 

Net Sales

             

Tangible products

   $ 213,406       $ 171,977         24.1        95.8         95.1   

Service & software

     9,413         8,780         7.2        4.2         4.9   
                                     

Total net sales

     222,819         180,757         23.3        100.0         100.0   

Cost of Sales

             

Tangible products

     110,789         96,918         14.3        49.8         53.6   

Service & software

     4,785         5,008         (4.5     2.1         2.8   
                                     

Total cost of sales

     115,574         101,926         13.4        51.9         56.4   
                                     

Gross profit

     107,245         78,831         36.0        48.1         43.6   

Operating expenses

     47,161         42,149         11.9        21.2         23.3   
                                     

Operating income

   $ 60,084       $ 36,682         63.8        26.9         20.3   
                                     

Specialty Printing Group – Third quarter

Net sales in our Specialty Printing Group (SPG) increased 23.3% with the highest percentage growth in sales occurring in Latin America and Asia Pacific, and the highest dollar growth occurring in Asia-Pacific, North America and the Europe, Middle East and Africa region.

The increase in sales was largely attributable to increased hardware sales, with notable increases in sales of high-performance and mid-range tabletop, desktop, mobile printers and aftermarket parts.

Gross profit increased due to higher volumes and an improved product mix, with increased sales primarily in mobile, high-performance and mid-range table top printers, partially offset by $3,653,000 in higher freight costs in 2010. Gross profit for SPG was affected by unfavorable foreign currency movements which decreased third quarter gross profit by $5,809,000. As a percentage of sales, gross margin increased. The benefit of outsourcing printer production to a third party, higher volumes, improved product mix and continued cost control contributed to the increase in gross margin.

Printer unit volumes and average selling price information is summarized below:

 

     Three Months Ended  
     October 2,
2010
     October 3,
2009
     Percent
Change
 

Total printers shipped

     265,962         201,713         31.9   

Average selling price of printers shipped

   $ 545       $ 530         2.8   

For the third quarter of 2010, unit volumes increased in nearly all printer product lines compared to the same period of 2009, with notable volume increases in high-performance tabletop, desktop and mobile printers.

 

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Table of Contents

 

Operating expense related changes for SPG are as follows (in thousands):

 

     Three Months Ended         
     October 2,
2010
     October 3,
2009
     Increase /
(Decrease)
 

Payroll and benefit costs

   $ 28,969       $ 24,125       $ 4,844   

Business development

     4,344         3,687         657   

Outside professional services

     2,981         2,277         704   

Project expenses

     1,598         927         671   

Travel and entertainment

     1,940         1,330         610   

Exit and restructuring costs

     —           2,375         (2,375

Other expenses

     7,329         7,428         (99
                          

Total operating expenses

   $ 47,161       $ 42,149       $ 5,012   
                          

Operating expenses for SPG increased primarily to greater selling and marketing expenses from the higher level of business activity and expansion into new geographic markets. Operating expenses are higher due to increases in payroll and benefit costs, advertising and marketing costs, compliance costs, project expenses and travel and entertainment expenses. Exit, restructuring and integration costs were completed in second quarter.

Zebra Enterprise Solutions

(Amounts in thousands, except percentages):

 

     Three Months Ended                    
     October 2,
2010
    October 3,
2009
    Percent
Change
    Percent of
Net Sales - 2010
    Percent of
Net Sales - 2009
 

Net Sales

          

Tangible products

   $ 8,389      $ 3,357        149.9        35.4        16.8   

Service & software

     15,299        16,664        (8.2     64.6        83.2   
                                  

Net sales

     23,688        20,021        18.3        100.0        100.0   

Cost of Sales

          

Tangible products

     6,713        1,764        280.6        28.3        8.8   

Service & software

     5,506        5,390        2.2        23.3        26.9   
                                  

Cost of sales

     12,219        7,154        70.8        51.6        35.7   
                                  

Gross profit

     11,469        12,867        (10.9     48.4        64.3   

Operating expenses

     16,397        15,779        3.9        69.2        78.8   
                                  

Operating loss

   $ (4,928   $ (2,912     69.2        (20.8     (14.5
                                  

Zebra Enterprise Solutions – Third quarter

ZES sales increased 18.3% for the third quarter of 2010 compared to 2009 primarily due to increased hardware revenue. This was offset by a reduction to installation services revenue associated with customer project implementations delays. Gross margin decline for the third quarter of 2010 compared to 2009 was primarily driven by revenue mix change and license revenue being delayed due to customer project implementation delays.

Operating expense changes for ZES are due to the following (in thousands):

 

     Three Months Ended         
     October 2,
2010
     October 3,
2009
     Increase/
(Decrease)
 

Payroll and benefit costs

   $ 9,832       $ 8,960       $ 872   

Business development

     582         178         404   

Outside professional services

     630         482         148   

Travel and entertainment

     974         601         373   

Exit, restructuring and integration costs

     —           1,020         (1,020

Other expenses

     4,379         4,538         (159
                          

Total operating expenses

   $ 16,397       $ 15,779       $ 618   
                          

ZES operating expenses for the third quarter of 2010 are higher than 2009 due to increases in payroll and benefit costs, selling and marketing, consulting, project expenses and travel and entertainment costs. These increases were offset by reductions to exit, restructuring and integration costs which were completed during the second quarter, and lower amortization expense due to an intangible asset being fully amortized at the end of 2009.

 

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Table of Contents

 

Results of Operations: Nine months ended October 2, 2010 versus nine months ended October 3, 2009

Consolidated Results of Operations

(Amounts in thousands, except percentages):

 

     Nine Months Ended               
     October 2,
2010
     October 3,
2009
     Percent
Change
    Percent of
Net Sales - 2010
     Percent of
Net Sales - 2009
 

Net Sales

             

Tangible products

   $ 632,198       $ 503,947         25.4        89.2         86.7   

Service & software

     76,475         77,116         (0.8     10.8         13.3   
                                     

Total net sales

     708,673         581,063         22.0        100.0         100.0   

Cost of Sales

             

Tangible products

     341,815         291,117         17.4        48.2         50.1   

Service & software

     29,630         30,703         (3.5     4.2         5.3   
                                     

Total cost of sales

     371,445         321,820         15.4        52.4         55.4   
                                     

Gross profit

     337,228         259,243         30.1        47.6         44.6   

Operating expenses

     233,810         216,679         7.9        33.0         37.3   
                                     

Operating income

     103,418         42,564         143.0        14.6         7.3   

Other income (expense)

     1,294         776         66.8        0.2         0.2   
                                     

Income before income taxes

     104,712         43,340         141.6        14.8         7.5   

Income taxes

     31,151         13,866         124.7        4.4         2.4   
                                     

Net income

   $ 73,561       $ 29,474         149.6        10.4         5.1   
                                     

Diluted earnings per share

   $ 1.28       $ 0.49           
                         

Consolidated Results of Operations – Year to date

Sales

Net sales for the first nine months of 2010 compared with the same 2009 period increased 22.0% due to a broad-based increase in demand for Zebra products and global economic recovery. The increase in sales was largely attributable to increased hardware sales with notable volume increases in high-performance tabletop, desktop, mobile printers and aftermarket parts. Supplies sales increased from greater shipments of labels and thermal ribbons. Printer unit volume increased 28.9% for the first nine months of 2010 compared to levels in 2009.

Sales by product category were as follows (amounts in thousands, except percentages):

 

     Nine Months Ended               

Product Category

   October 2,
2010
     October 3,
2009
     Percent
Change
    Percent of
Net Sales - 2010
     Percent of
Net Sales - 2009
 

Hardware

   $ 502,500       $ 383,228         31.1        70.9         65.9   

Supplies

     125,914         116,836         7.8        17.8         20.1   

Service and software

     76,475         77,116         (0.8     10.8         13.3   

Shipping and handling

     3,784         3,883         (2.5     0.5         0.7   
                                     

Total net sales

   $ 708,673       $ 581,063         22.0        100.0         100.0   
                                     

Sales increased in all geographic territories due primarily to the global economic recovery. The sales growth on a percentage basis was greatest in Latin America and Asia Pacific because of higher rates of economic growth in those regions and as a result of greater investment in sales and marketing. Movements in foreign exchange rates decreased sales by $7,369,000 in the Europe, Middle East and Africa regions principally due to a stronger euro against the dollar.

 

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Table of Contents

 

Sales to customers by geographic region were as follows (in thousands, except percentages):

 

     Nine Months Ended                

Geographic Region

   October 2,
2010
     October 3,
2009
     Percent
Change
     Percent of
Net Sales - 2010
     Percent of
Net Sales - 2009
 

Europe, Middle East and Africa

   $ 246,773       $ 211,919         16.4         34.9         36.5   

Latin America

     64,063         44,864         42.8         9.0         7.7   

Asia-Pacific

     89,338         60,136         48.6         12.6         10.3   
                                      

Total International

     400,174         316,919         26.3         56.5         54.5   

North America