Zebra Annual Report 2003

Plain-text annual report

2003 Annual Report RAISING THE BAR I N 2 0 0 3 , A N I N V E S T M E N T I N Z E B R A R E T U R N E D 7 4 % T O S T O C K H O L D E R S 74% Zebra is delivering stockholder value Z E B R A S T O C K A P P R E C I A T E D 2 4 6 % O V E R T H E 1 9 9 9 - 2 0 0 3 F I V E - Y E A R P E R I O D 246% 2003 % change 2002 % change 2001 ( In thousands, except per share data and percentages) Operating Results Net sales $536,397 12.8% $475,611 5.7% Gross profit Operating income Net income Diluted earnings per share 273,077 129,218 91,696 1.92 18.3 26.9 28.1 25.5 Capitalization Cash and cash equivalents and investments in marketable securities Working capital Total assets Total stockholders’ equity $449,964 537,932 701,611 651,915 9.9 10.1 16.4 15.1 230,747 101,805 71,595 1.53 $348,577 427,676 573,088 534,155 $450,008 209,893 92,459 61,529 1.33 $249,349 330,510 479,556 445,007 Zebra Technologies delivers specialty printing solutions that improve the speed and accuracy of business processes. Businesses, governments and other organizations worldwide depend on Zebra to deliver innovative, reliable products that help them reduce costs, increase productivity, deliver better customer service, and strengthen security. Zebra uses its technology portfolio to manufacture products for a wide range of applications in on-demand barcoding, radio frequency identification (RFID), plastic card imaging, and digital photo printing. Our commitment to industry leadership, financial strength, and growth helps Zebra build long-term value for its customers, partners, and stockholders. L E T T E R T O S T O C K H O L D E R S We are fortunate to operate in an attractive specialty printing business with outstanding growth prospects. Zebra achieved record sales which helped deliver record and earnings in 2003, as our international sales. growth strategy yielded its New product introductions intended results. The strength of extended our product leadership our business spanned nearly all and supported further product dimensions of our organization, differentiation. We had growth in as companies and governments all major product lines, especially accelerated the adoption of in mobile printers, as businesses barcoding and other automatic took increased advantage of identification technologies to wireless technology to enhance improve business processes and work force productivity. increase security. We extended For 2003, our record results our leading strategic position, derived from the strength of added to our technology portfolio, our core bar code labeling and pursued a larger set of high- business, card printer sales, growth on-demand specialty mobile and wireless solutions, printing opportunities. and international expansion. Net Our greater focus on delivering income advanced 28% to $91.7 business improvement solutions, million, or $1.92 per diluted building stronger and broader share, on 13% sales growth to channels, and strengthening our $536.4 million, exceeding $500 powerful brand helped turn North million for the first time in the America, our largest territory, company’s history. In August, we into a source of strength in 2003. distributed a three-for-two stock In addition, we expanded our split to enhance the liquidity of presence in Eastern Europe, Zebra stock and to broaden the Asia Pacific, and Latin America, company’s stockholder base. We 2 Edward Kaplan Chairman and Chief Executive Officer Zebra stock performance versus the market indices (August 15,1991* through December 2003) *Zebra’s initial public offering price In 2003, Zebra achieved 26.9% growth in operating income 12.8% growth in net sales 28.1% growth in net income ended the year with $450 million favorable outlook. A sharper of our core thermal printing in financial results and build in cash and investments and no focus on delivering applications technology and enabled us on our impressive record of long-term debt, with another to high-growth vertical markets to enter the emerging area of increasing stockholder value year of exceptional free cash is yielding new avenues of digital photo printing. We now over the long term. Zebra’s flow generation. opportunity. Targeted solutions have an OEM relationship with market reach, financial and Just as our 2003 financial are enhancing productivity, the Eastman Kodak Company, management strength, and performance resulted from a security, and customer service which markets the ML-500 product and technology growth strategy focused on new in a variety of vertical markets, Professional Photo Printer, a portfolio have never been product development, worldwide including in law enforcement, high-speed thermal printer. greater. Nor has our outlook expansion, and innovative life sciences, and retail. We are also at the beginning been more positive. Zebra is sales and marketing initiatives, Further investments in global of widespread adoption of radio a clear leader in an attractive continued investments give us expansion, including China, also frequency identification, or business. We operate with optimism for further growth continue to enhance Zebra’s RFID. As following pages in this high profitability and cash in 2004 and beyond. Adoption prospects. Zebra employees in report describe, Zebra is well flow generation. We have a rates of barcoding technology 18 countries supporting channel positioned to benefit from this demonstrated, effective growth remain high, as companies partners in approximately 100 exciting technology. It is a natural strategy. More opportunities respond to competitive pressures countries improve our ability to extension of our rich heritage are ahead of us than ever with investments in a proven serve the worldwide needs of as a leader in specialty printing. before, as emerging uses for technology with predictable, international customers. They Our RFID printer/encoders enable our technologies supplement meaningful returns. Our card also help deliver Zebra products companies to comply with the growth in our core markets. imaging printer business remains to domestic companies for local growing number of mandates We appreciate your support positive supported by the greater requirements, as countries with by retailers and others who and confidence as a stockholder demand for personal identification, developing economies build want to use RFID to improve the in Zebra Technologies. and we expect further deployment infrastructure to support domestic efficiency of their supply chains. of mobile and wireless products. needs and export markets. All of these activities give More widespread adoption Our acquisition of Atlantek in us confidence in our ability to of our technology enhances this November extended the range deliver further improvements S&P 500 186% NASDAQ Composite Dow Jones Industrial Average Zebra stock 288% 249% 1,185% 3 E N A B L I N G E N A B L I N G E N A B L I N G E N A B L I N G B U S I N E S S P R O C E S S I M P R O V E M E N T Zebra is helping companies solve real business problems. W H E N T H E L A B E L C O U N T S By delivering solutions that improve productivity, enhance customer service, and strengthen security, we enable our customers to achieve their business goals. Solutions incorporating Zebra printers offer users a compelling investment proposition. Customers rely on Zebra to help them solve their most challenging labeling problems. Optimized with Zebra printers, we design custom solutions when media failure is not an option. Unique media solu- tions save time, labor and money. They help companies comply with regulatory and commercial labeling requirements. Brand protection and product authenti- cation are ensured, and counter- feit goods more easily identified, with high-performance labeling solutions from Zebra. R x F O R P R O C E S S E F F I C I E N C Y The accuracy barcoding provides helps save lives and reduces costly errors. Zebra is ready to help companies comply with the recent U.S. Food and Drug Administration mandate requiring bar code labeling of drugs and biological products. Health care workers will use automatic identification systems to conduct a reliable bedside match of medication and patient, who is identified with a bar coded wristband. Zebra’s new Z-band® direct thermal poly wristband addresses HIPPA privacy legislation and is ideally suited for patient identification. 4 S U P P LY C H A I N E X E C U T I O N Increasing efficiency of the supply chain, or the movement of goods from the factory through distribution to the end user, is vital in a global competitive environment. Zebra’s broad range of bar code label printers give businesses tools to integrate solutions that track products and materials more accurately, reduce cycle times, and improve employee productivity, increasingly with wireless technology embedded in Zebra products. FA S T C A R R E T U R N S Car rental companies speed customers on their way using wireless Zebra mobile printers to produce receipts at the point of car return, one of a growing number of specialty applications incorporating Zebra printers. 5 E X T E N D I N G T H E R E A C H O F TTTT TTechnology echnology By adding to our technology portfolio, we have expanded our opportunity set for growth. Increasingly, Zebra is moving beyond barcoding to encompass a greater number of specialty printing solutions. These solutions incorporate advanced technologies that deliver tangible benefits and real value in the pursuit of business improvement. R F I D S M A R T L A B E L S T H E R F I D S U P P L Y C H A I N P R O C E S S Radio Frequency Identification, or RFID, uses radio waves to “read” data put on a chip embedded within a tag. When these tags are combined with traditional bar code and human-readable labels, they form “smart labels,” because they can be read automatically and, in some cases, updated with new information — in real time — as they move through the supply chain. Leading retailers, the U.S. Department of leadership in bar code labeling Defense (DoD) and others are turning to technology and more than eight years’ the productivity-enhancing and tracking experience in RFID. With Zebra smart capabilities of RFID to squeeze costs out label printers/encoders and supplies, of their supply chains. Zebra is pioneering companies can conveniently add RFID the adoption of RFID based on our tag encoding to their existing bar code 6 AT T H E F A C T O R Y T H R O U G H D I S T R I B U T I O N R F P I C T U R E P E R F E C T Our Atlantek acquisition built on our core thermal printing technology and gave us products to serve the growing area of digital photo printing. Jointly developed with and marketed by Eastman Kodak, photographers use the Kodak ML-500 Professional Photo Printer in the lab, studio or at events to print stunning large-format photographs with exceptional speed, on demand. and human-readable label formats and be compliant with current RFID mandates. Zebra is a member of the DoD AIT RFID Vendor Advisory Group and a technology sponsor of EPCglobal, a standards- setting organization. T O T H E S T O R E I D I T ’ S I N T H E C A R D S Zebra’s family of card printers uses a variety of technologies, such as micro printing, smart card encoding, and hologram overlays, to produce plastic cards, at the point of issuance. These capabilities address a broad and expanding range of identification and security applications, driven by heightened concern over personal safety and the protection of property and assets the world over. 7 Companies are equipping their employees with more productivity- es ar aesn om mm qui e e e pp ng ee enhancing tools. More than ever, we are seeing systems incorporating than e an t to re M ol i in h . hand-held computers and Zebra mobile printers communicating over ompu and ld Ze te w wireless networks. In the factory, at retail, or on the road, Zebra ess rks wo ne th In e t f t l Going E M O B I L E LL LL U N L E A S H I N G B U S I N E S S P R O D U C T I V I T Y bm mobile printers provide accurate, real-time con control of printing operations wherever labels, receipts, or other specialty printing applications are needed. In addition to citation ticketing, the QL 320 mobile printer is ideally suited for applications involving roving cashiers; finished goods labeling; in-store merchandise re-labeling; drug labeling; return processing; car rental receipts; lift tickets/park passes; and parking passes. 8 V E R T I C A L M A R K E T F O C U S : L A W E N F O R C E M E N T By delivering applications to under- replacing pen and pad with electronic penetrated vertical markets, we are ﬁ nding citation writing for moving and parking additional high-growth opportunities violations. Automated ticketing systems, for Zebra’s printing and connectivity which incorporate wireless Zebra mobile technologies. Zebra vertical market printers, reduce paper work, processing specialists work with channel partners and time, and administrative and staff support. end users to deliver robust solutions that They also boost ofﬁ cer productivity and solve particular business problems. simplify ticketing operations over paper- based systems. Software lowers data Zebra is helping law enforcement agencies entry errors and improves ticket legibility, around the world improve their processes which leads to higher collection rates and and efﬁ ciency. Automated systems speed a faster collection cycle. information processing and record keeping, reduce paper work, improve security, Zebra printers are also used in solutions and enable more accurate tracking of that assist law enforcement agencies evidence, property, and samples. An in evidence tracking, forms and asset increasing number of jurisdictions are management, and personal identiﬁ cation. D E F E N S E L O G I S T I C S Governments use rugged Zebra printers such as the PT 403 to strengthen security, manage personnel, and transport mission- critical goods to equip people and help save lives. The PS 2100 series is designed for businesses on the go. Transportable and uniquely modular, the PS 2100 series printing solution on wheels can be conﬁ gured with one printer or two. It gives personnel the ﬂ exibility to perform multiple tasks with a single unit to increase efﬁ ciency and overall productivity. QL 420 Warehousing; shipping; receiving; pick and run; in-store transfers; warehouse pick tickets; cross-docking; work-in- process tags; put-away; shelf talkers; work orders QL 220 Lab samples; Price markdowns; shelf edge labeling; postal/ parcel logistics; bin label- ing; pharmacy labeling; inspection labels; patient chart labeling; diagnostics labeling TR 220 Shelf labeling; parts labeling; price markdowns CAMEO 3 Meter reading; route accounting; parking tickets/violations; airline roving ticket agent; roving betting agents; field force automation; lottery tickets; cycle count (audit slips) CAMEO 2 Bus tickets; table-side credit card transactions; mobile point of sale; queue busting; admission ticket printing; mobile concessions; passenger ticketing; mobile box office CAMEO PEP Hotel guest check-in; security badge encoding 9 E X P A N D I N G G L O B A L P R E S E N C E With greater sales representation and expanding channel relationships, Zebra serves more of the barcoding and specialty printing needs of local businesses and global organizations in high-growth regions around the world. I N T E R N A T I O N A L S A L E S 2000 2001 2002 2003 2000 2001 2002 2003 37.4% 40.0% 43.2% 45.5% $0 50,000 100,000 150,000 200,000 250,000 0% 10% 20% 30% 40% 50% B Y R E G I O N (in thousands) A S A P E R C E N T A G E O F T O T A L S A L E S Europe Asia Pacific Latin America International Growth Sales to international customers comprised more than 45% of Zebra’s total sales for 2003, up from only 37% for 2000. Zebra is well positioned to serve the expanding needs of businesses around the world with its network of valued reseller and integration partners in approximately 100 countries. We support our entire business with 23 manufacturing, warehousing and sales facilities worldwide. 10 T R A I N A N D B U S T I C K E T I N G R E T A I L Q U E U E B U S T I N G I N T E R N A T I O N A L S O L U T I O N S D R I V E R ’ S L I C E N S I N G P O S T A L / P A R C E L D E L I V E R Y 11 F I N A N C I A L T A B L E O F C O N T E N T S 14 Management’s discussion and and analysis 32 Consolidated statements 37 Notes to consolidated financial statements 54 Independent auditors’ report 55 Board of directors and corporate officers 56 Stockholder information S E L E C T E D C O N S O L I D A T E D F I N A N C I A L D A T A Z E B R A T E C H N O L O G I E S C O R P O R A T I O N (In thousands, except per share amounts) Year Ended December 31, Consolidated statements of earnings data Net sales Cost of sales Gross profit 2003 2002 2001 2000 1999 $536,397 $475,611 $450,008 $481,569 $402,213 263,320 244,864 240,115 249,141 273,077 230,747 209,893 232,428 198,942 203,271 Total operating expenses 143,859(1) 128,942(3)(4) 117,434(4) 123,758(4) 99,487(5) Operating income 129,218(1) 101,805(3)(4) 92,459(4) 108,670(4) 103,784(5) Income before income taxes 135,992(1) 110,883(3)(4) 96,139(4) 111,911(4) 108,800(5) Net income $91,696(1) $71,595(3)(4) $61,529(4) $71,622(4) $69,632(5) Earnings per share Basic Diluted $ 1.95(1) $ 1.54(2)(3)(4) $ 1.34(2)(4) $ 1.59(2)(4) $ 1.49(2)(5) $ 1.92(1) $ 1.53(2)(3)(4) $ 1.33(2)(4) $ 1.57(2)(4) $ 1.47(2)(5) Weighted average shares outstanding Basic Diluted 47,098 47,663 45,452(2) 45,949(2) 45,049(2) 46,870(2) 46,305(2) 45,593(2) 46,762(2) 47,281(2) (In thousands) December 31, Consolidated balance sheet data Cash and cash equivalents and investments and marketable securities $449,964 $348,577 $249,349 $156,714 $235,568 Working capital Total assets Long-term obligations Stockholders’ equity 537,932 427,676 330,510 256,799 701,611 573,088 479,556 418,896 2,853 1,613 408 513 302,804 394,643 664 651,915 534,155 445,007 371,288 349,307 (1) Includes pretax charges of $1,232 related to the closure of the Varades, France facility and $701 for integration and in-process research and development costs related to the acquisition of Atlantek, Inc. (2) Restated for a 3-for-2 stock split in 2003 that was paid in the form of a 50% stock dividend. (3) Includes $3,300 in operating expenses related to the terminated acquisition of Fargo Electronics, Inc. (4) Includes pretax charges for integration costs relating to the acquisition of Comtec Information Systems, Inc., and the merger with Eltron International, Inc. of $73 in 2002, $1,838 in 2001 and $11,066 in 2000. (5) Includes a pretax charge for integration costs of $6,341 in 1999 relating to the merger with Eltron International, Inc. 13 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S of Financial Condition and Results of Operations Results of Operations: Fourth Quarter of 2003 versus Fourth Quarter of 2002, Year ended December 31, 2003 versus Year ended December 31, 2002 Geographical Region Three Months Ended December 31, 2003 2002 Europe, Middle East and Africa $ 47,893 $ 39,595 Sales Latin America Asia-Pacific Sales by product category, percent change, and percent of total sales for the three Total International months and year ended December 31, 2003, and December 31, 2002, were (in thou- sands, except percentages): North America Total sales 7,978 14,215 70,086 77,114 7,291 10,267 57,153 69,171 $147,200 $126,324 Year Ended December 31, Geographical Region 2003 2002 Europe, Middle East and Africa $170,544 $142,273 Latin America Asia-Pacific Total International North America Total sales 29,406 43,904 243,854 292,543 28,097 34,953 205,323 270,288 $536,397 $475,611 Percent of Total Sales 2003 Percent of Total Sales 2002 32.5 5.4 9.7 47.6 52.4 31.3 5.8 8.1 45.2 54.8 100.0 100.0 Percent Change 21.0 9.4 38.5 22.6 11.5 16.5 Percent of Total Sales 2003 Percent of Total Sales 2002 Percent Change 19.9 4.7 25.6 18.8 8.2 12.8 31.8 5.5 8.2 45.5 54.5 29.9 5.9 7.3 43.1 56.9 100.0 100.0 We have consistently invested in sales, marketing and product development to support long-term sales growth including: (cid:127) Expanding our geographic presence by placing Zebra representatives in high- growth geographic markets to expand channel relationships and to support the work of existing reseller partners. During 2002, we put new Zebra representatives in Poland, Dubai, Russia, Australia, Brazil and Argentina. We also added represen- tatives in Mexico and China during 2003. These additions are an important reason for the increase in the Asia-Pacific and the Latin American regions during the fourth quarter and the full year of 2003. Product Category Hardware Supplies Service and software Shipping and handling Cash flow hedging activities Three Months Ended December 31, 2003 2002 $113,263 $ 96,031 26,738 6,165 1,184 (150) 23,945 5,451 897 — Percent of Total Sales 2003 Percent of Total Sales 2002 76.9 18.2 4.2 0.8 (0.1) 76.0 19.0 4.3 0.7 — Percent Change 17.9 11.7 13.1 32.0 — Total sales $147,200 $126,324 16.5 100.0 100.0 Year Ended December 31, Product Category 2003 2002 Hardware Supplies Service and software Shipping and handling Cash flow hedging activities $409,144 $360,185 98,519 24,355 4,113 266 87,981 23,301 4,144 — Percent of Total Sales 2003 Percent of Total Sales 2002 76.3 18.4 4.5 0.8 — 75.7 18.5 4.9 0.9 — Percent Change 13.6 12.0 4.5 (0.7) — Total sales $536,397 $475,611 12.8 100.0 100.0 Sales to customers by geographic region, percent changes and percent of total sales for the three months and year ended December 31, 2003, and December 31, 2002, were (in thousands, except percentages): 14 Z E B R A T E C H N O L O G I E S C O R P O R A T I O N (cid:127) Increasing our European representation in mobile and business development Although management cannot forecast the future direction of foreign exchange manager resources in Germany, Italy, France, and Spain during 2003. rate movements, if rates remain near the levels experienced during 2003, Zebra (cid:127) Building infrastructure to deliver business improvement applications to high- may continue to benefit from exchange rate gains during 2004. However, it is pos- growth vertical markets. During 2003, we also added marketing resources to sup- sible that a continued weak dollar versus the pound and euro may cause our cur- port emerging radio frequency identification (RFID) opportunities. rent pricing to be uncompetitive and require price reductions. These reductions would decrease the benefits of the current favorable exchange rates. New printer products (defined as printers released within 18 months prior to the end of the applicable fiscal period) accounted for 21.8% of printer sales in the During 2003, we began a program to hedge a portion of our forecasted euro- fourth quarter of 2003 and 2002. For the full year, new printer products accounted denominated sales, so that if exchange rate trends reverse, we will still achieve for 23.3% of printer sales in 2003, compared with 22.2% in 2002. some benefit from the current favorable rates. See Note 14 to the financial state- ments for a more detailed discussion of this hedging program. Our international sales are denominated in multiple currencies, primarily the dol- lar, pound and euro, which causes our reported sales to be subject to fluctuations Printer unit volumes and average selling price information is summarized below: based on changes in currency rates. When significant currency rate fluctuations occur, we review our pricing and make appropriate changes in order to maintain our competitive position. Since the third quarter of 2002, the dollar has weakened significantly against both the euro and pound. As a result, our fourth quarter sales translated into dollars increased by $6,253,000 or 4.9 percentage points compared to translating the same sales using the exchange rates that prevailed a year ago. Competitive pricing adjustments caused by the currency situation reduced sales by $3,590,000 or 2.8 percentage points. In total, the net increase related to exchange rate fluctuations was $2,663,000 during the quarter. Three Months Ended December 31, 2003 2002 Percent Change Year Ended December 31, 2003 2002 Percent Change Total printers shipped 145,834 129,299 12.8 540,431 491,111 10.0 Average selling price of printers shipped $640 $617 3.7 $627 $614 2.1 For the fourth quarter of 2003, mobile printers accounted for 9.3 percentage points of the total 12.8% volume increase. This increase is a result of more companies adopting technology for wireless networks. The increase in the average unit sell- ing prices was a result of higher average prices for mid-range tabletop printers and print engines, offset by the higher mobile printer volumes. For the full year of 2003, sales translated into dollars increased by $24,783,000 or 5.2 percentage points compared to translating the same sales using the exchange rates that prevailed in 2002. We adjusted our pricing to remain competitive in mar- kets experiencing currency strength against the dollar. These competitive pricing adjustments reduced sales by $12,610,000 or 2.7 percentage points. In total, the net increase related to exchange rate fluctuations was $12,173,000 during 2003. For the full year of 2003, the increase in printer volume was due to higher sales vol- ume of desktop and mobile printers similar to the increases for the fourth quarter. Average unit selling price increases were related to increases in the average unit selling prices of mid-range desktop printers, portable printers and print engines. Average unit selling prices were also being reduced by the increased volume of the lower priced mobile printers. 15 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S of Financial Condition and Results of Operations Gross Profit quarter were advertising, publications and market research, travel and enter- Gross profit information is summarized below (in thousands, except percentages): tainment, and demonstration units. Year to-date, in addition to increases in the December 31, 2003 2002 Three months ended $ 74,397 $ 62,564 Year ended 273,077 230,747 Percent Change 18.9 18.3 Percent of Total Sales 2003 50.5 50.9 Percent of Total Sales 2002 49.5 48.5 The major contributors to the margin improvement were: (cid:127) Higher capacity utilization related to the higher sales volume, representing $6,008,000 of the total gross profit increase for the fourth quarter of 2003 and $17,417,000 for the full year. (cid:127) Foreign exchange rate movements and related pricing adjustments, which we items mentioned above, we increased market development fund expenses. These increases are largely the result of our focus on vertical market development and international expansion. Research and Development Costs Zebra is committed to a long-term strategy of significant investment in product development. To maintain and build our product pipeline, we made expenditures in research and development, summarized below (in thousands, except percentages): December 31, 2003 2002 Percent Change 30.7 8.7 Percent of Total Sales 2003 5.9 5.9 Percent of Total Sales 2002 5.3 6.1 estimate increased gross profit by $2,276,000 for the fourth quarter of 2003. For Three months ended $ 8,722 $ 6,673 the full year, gross profit is estimated to have been $10,900,000 higher due to for- Year ended 31,759 29,210 eign exchange rate movements, net of related pricing adjustments. (cid:127) Component cost reductions contributed $2,255,000 to the margin improvement Quarterly product development expenses fluctuate widely depending on the during the fourth quarter and $9,371,000 for the full year. status of ongoing projects. For the fourth quarter of 2003, research and develop- Selling and Marketing Expenses ment expenses increased because of an increase in payroll and benefits with related increases in headcounts and increases in project expenses. Higher project Selling and marketing expenses are summarized below (in thousands, except expenses are related to the reduction of expenses in the fourth quarter of 2002 of percentages): December 31, 2003 2002 Three months ended $19,506 $16,354 Year ended 66,635 56,176 Percent Change 19.3 18.6 Percent of Total Sales 2003 13.3 12.4 Percent of Total Sales 2002 12.9 11.8 We continue to make significant investments in demand-generating activities. During the fourth quarter of 2003, increased selling and marketing expenses were $1,092,000 for third party funded engineering costs, which did not reoccur in 2003. This amount represents 16.4% of the total increase in research and development expenses for the fourth quarter. For the full year, project expenses were up $1,669,000 with the majority of that increase related to $1,542,000 in reductions related to third party funded engineer- ing costs that had occurred in 2002 but did not reoccur in 2003. In addition, payroll and benefits were up $1,752,000 over 2002, but consulting expenses were primarily in payroll and benefits. Other costs that increased during the fourth down $945,000. 16 Z E B R A T E C H N O L O G I E S C O R P O R A T I O N We believe that there will be long-term growth in the use of radio frequency identifi- As a percentage of net sales, general and administrative expenses declined, cation (RFID) in supply chain and other applications, and that Zebra is well positioned because we took actions to control costs, including the compliance activities dis- to participate in that growth. We introduced new products that extend RFID technolo- cussed above. As a result, our general and administrative costs have grown slower gies into our bar code label printers, and we anticipate investing a larger portion of than the rate of sales growth. We expect that trend to continue. our future R&D expenditures on the development of RFID printer/encoders. General and Administrative Expenses During the first quarter of 2002, we terminated the acquisition agreement and ten- General and administrative expenses are summarized in the table below (in thou- der offer in which Zebra would acquire all outstanding shares of common stock sands, except percentages): (including associated rights to purchase preferred stock) of Fargo Electronics, Inc. December 31, 2003 2002 Three months ended $11,456 $10,733 Year ended 41,892 38,689 Percent Change 6.7 8.3 Percent of Total Sales 2003 7.8 7.8 Percent of Total Sales 2002 8.5 8.1 for $7.25 per share in cash. During the time that the tender offer was active, we incurred legal, accounting and other expenses related to the proposed acquisition that would have been treated as part of the purchase price had the tender offer been completed. We expensed $3,300,000 of these costs at the cancellation of the Costs Related to Terminated Acquisitions and Merger Costs For the fourth quarter of 2003, general and administrative expenses increased $721,000 and include $477,000 of increased legal expenses, which was primarily tender offer. Exit Costs related to litigation with Paxar described in Note 15 to the consolidated financial During the fourth quarter of 2003, we announced a plan to close our engineer- statements. Other increases were related to personnel costs. ing site in Varades, France. This plan will be accounted for under SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. Included in oper- For the full year of 2003, general and administrative expenses include $596,000 of ating expenses for the fourth quarter of 2003 and the full year are exit costs, con- increased legal expenses related to: (cid:127) Litigation with Paxar (cid:127) Increased intellectual property work (cid:127) International activity (cid:127) General contract review. sisting of primarily severance, in the amount of $1,232,000. During January 2004, we announced plans to consolidate our Warwick, Rhode Island, printer manufacturing and repair service business into our Camarillo, California and Vernon Hills, Illinois locations. Although no costs have been accrued in the fourth quarter of 2003, we anticipate that during 2004 we will incur addi- In addition to legal expenses in 2003, we saw an increase in director and officer lia- tional expenses of $1,648,000 of which approximately $400,000 will be incurred bility insurance and administrative personnel costs. A portion of these costs resulted during the first quarter. See Note 18 to the consolidated financial statements. from new compliance requirements of the Sarbanes-Oxley Act of 2002 and related regulations. Offsetting these increases was a decline in consulting expenses. 17 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S of Financial Condition and Results of Operations Operating Income Higher investment balances resulted in an increase in investment income for the Operating income is summarized in the following table (in thousands, except fourth quarter. While investment balances were higher in 2003, year-to-date invest- percentages): December 31, 2003 2002 Three months ended $ 32,253 $ 28,417 Year ended 129,218 101,805 Percent Change 13.5 26.9 Percent of Total Sales 2003 21.9 24.1 Percent of Total Sales 2002 22.5 21.4 The increase in operating income is attributable to the following factors: (cid:127) Accelerated sales growth compared to 2002, (cid:127) Improved gross margins resulting from increased overhead utilization, ment income decreased from last year, because 2002 results included a $1,953,000 realized gain on the sale of 585,000 shares of Fargo Electronics during the first quarter of 2002. For the fourth quarter of 2003, we had the following two unusual items that increased investment income in relation to the fourth quarter of 2002: (cid:127) Interest income of $422,000 was received, which was related to refunds of taxes from the Internal Revenue Service research and experimentation credit and the (cid:127) Favorable changes in foreign exchange rates for Zebra’s non-dollar State of Illinois tax settlement. denominated business, and (cid:127) Investment income includes a $600,000 increase in realized gains from partner- (cid:127) Cost controls that held operating expense growth slightly below the rate ship interests during the fourth quarter. of sales growth. Income Taxes As a result of these actions, operating income increased by 3.0 percentage points The effective income tax rate for the fourth quarter was 31.2%, compared with more than the rate of sales growth during the fourth quarter, and 14.1 percentage 35.0% for the same quarter last year. This rate is lower than the 35.0% effective tax points more than the rate of sales growth for the full year. rate that Zebra has recorded since early 2002, because of the net effect of a nonre- curring tax item during the quarter. Non-operating Income and Expenses Zebra’s non-operating income and expense items are summarized in the following During the fourth quarter, Zebra settled its long-standing dispute with the Illinois Three Months Ended December 31, Year Ended December 31, 2003 2002 2003 2002 Department of Revenue. We recorded a decrease to income tax expense of $1,342,000, because our reserves for this tax dispute exceeded the amount of the settlement. See Note 11 to the consolidated financial statements for more details. Without the effect of this settlement, our effective income tax rate would have $4,079 $2,422 $8,553 $10,004 been 35% for the quarter. table (in thousands): Investment income Interest expense Foreign exchange gains (losses) Other, net (38) (304) (524) (118) 673 (121) (154) (552) (1,073) (319) 347 (954) Total other income (expense) $3,213 $2,856 $6,774 $ 9,078 18 During the third quarter of 2003, we eliminated a reserve related to research and experimentation tax credits that were claimed and recorded a reduction to income tax expense of $1,947,000. During the first two quarters of 2003, we filed refund applications totaling $1,947,000 with the Internal Revenue Service and Z E B R A T E C H N O L O G I E S C O R P O R A T I O N Departments of Revenue for Illinois and California related to research and experi- Sales to customers by geographic region, related percent changes, and percent of mentation tax credits for 1998 to 2001. Because of the uncertainty of receiving total sales for 2002 and 2001 were as follows: the credits, which require significant subjective analysis, we established a 100% reserve against the contingent receivable for the refunds during each of the first Year Ended December 31, two quarters of 2003. In September 2003 the IRS approved our refund applications. Geographic Region 2002 2001 Because California and Illinois law mirror the Federal Tax Code, we now expect to Europe, Middle East and Africa $142,273 $128,348 have those refunds approved as well. For 2003, the effective income tax rate was 32.6% versus 35.4% for 2002. Excluding the two tax adjustments discussed above, our effective tax rate would have been 35% for 2003. With the settlement of the Illinois tax dispute, we anticipate our tax Latin America Asia-Pacific Total International North America Total sales 28,097 34,953 205,323 270,288 21,752 29,953 180,053 269,955 $475,611 $450,008 Percent of Total Sales 2002 Percent of Total Sales 2001 Percent Change 10.8 29.2 16.7 14.0 0.1 5.7 29.9 5.9 7.3 43.1 56.9 28.5 4.8 6.7 40.0 60.0 100.0 100.0 provision rate will be 34.75% beginning in the first quarter of 2004. During 2002 and 2001, despite an economic downturn, Zebra implemented a Net Income growth strategy including: Zebra’s net income is summarized below (in thousands, except per share amounts): (cid:127) New Product Introductions—During 2002, Zebra spent $29 million on new prod- Three Months Ended December 31, Year Ended December 31, uct development activities, for salaries, benefits, consulting and legal services, market research, and related activities. Fourteen new products or derivative 2003 2002 2003 2002 products were introduced during 2002, compared to 11 new products introduced Net income Diluted earnings per share $24,395 $ 0.51 $20,328 $ 0.43 $91,696 $ 1.92 $71,595 $ 1.53 Comparison of Years Ended December 31, 2002 and 2001 Sales during 2001. Additionally, products introduced within the 18-month period ended December 31, 2002, represented 22% of printer sales for 2002. (cid:127) Expanded International Coverage—We opened six new sales offices during late 2001 through 2002, including Poland, Dubai, Russia, Australia, Brazil, and Argentina. We believe international regions, particularly Asia-Pacific, Latin Sales by product category, related percent changes and percent of total sales for America and Eastern Europe, hold significant growth potential. 2002 and 2001 were as follows: Year Ended December 31, Product Category 2002 2001 Hardware Supplies Service and software Shipping and handling $360,185 $339,895 87,981 23,301 4,144 85,266 19,336 5,511 Percent of Total Sales 2002 Percent of Total Sales 2001 75.7 18.5 4.9 0.9 75.6 18.9 4.3 1.2 Percent Change 6.0 3.2 20.5 (24.8) Total sales $475,611 $450,008 5.7 100.0 100.0 (cid:127) New sales and marketing programs—We organized sales and marketing efforts to support a sales strategy that demonstrates the business benefits associated with implementing bar code labeling and specialty printing solutions. In North America, we recorded positive sales growth in the second, third and fourth quarters of 2002, compared with the corresponding periods of 2001. Overall, however, the slow U.S. economy continued to limit sales growth of bar code label and receipt printers to rates below our historical average. 19 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S of Financial Condition and Results of Operations Total printers shipped Year Ended December 31, 2003 2002 491,111 441,300 Average selling price of printers shipped $614 $641 Percent Change 11.3 (4.2) All three of our international regions – Europe, Asia Pacific, and Latin America—had record sales and contributed to the significant growth in international sales in 2002. Increased numbers of Zebra representatives in these regions, including the forma- tion of a sales team in Europe for mobile printing solutions in 2001, was an impor- tant factor in the growth of international sales. On a dollar-volume basis, the largest increase occurred in the European region. The strength of the pound and the euro versus the dollar increased sales for Zebra’s European region by approximately $5,565,000, compared with exchange rates that prevailed during 2001. Gross Profit Gross profit information is summarized below (in thousands except percentages) December 31, 2002 December 31, 2001 Percent Change Year Ended $230,747 $209,893 9.9 Percent of Total Sales 48.5 46.6 Gross profit increased due to: (cid:127) Higher capacity utilization related to the higher sales volume, representing $8,514,800 of the total gross profit increase for 2002. (cid:127) Foreign exchange rate movements, which we estimate increased gross profit by $4,377,000 for 2002, compared with the exchange rates that prevailed during 2001. (cid:127) Cost reductions, which represented $3,798,000 of the gross profit increase for 2002. Selling and Marketing Expenses Selling and marketing expenses are summarized below (in thousands, except percentages): December 31, 2002 December 31, 2001 Percent Change Year Ended $56,176 $49,688 13.1 Percent of Total Sales 11.8 11.0 The increase in selling and marketing expenses resulted from: (cid:127) Increased headcount in selling and marketing staff, including the new interna- tional offices opened in late 2001 and through 2002. (cid:127) Performance-related payroll expenses, specifically commissions and bonuses related to Zebra’s growth in net sales. (cid:127) Trade show, travel and consulting expenses. Research and Development Costs Research and development costs are summarized below (in thousands, except percentages): December 31, 2002 December 31, 2001 Percent Change Year Ended $29,210 $28,184 3.6 Percent of Total Sales 6.1 6.3 Printer products introduced over an 18-month period that ended December 31, 2002 accounted for approximately 22% of printer sales for 2002, compared with 20% for the comparable period ending December 31, 2001. Higher project and personnel expenses were partially offset by lower expenditures for consulting services. We consider our ability to develop and introduce new products to be a significant competitive factor. Accordingly, we expect to continue high levels of expenditures on the development of a broad range of printers and related items. 20 Z E B R A T E C H N O L O G I E S C O R P O R A T I O N General and Administrative Expenses Costs Related to Terminated Acquisitions and Merger Costs General and administrative expenses are summarized below (in thousands, except During 2002, we terminated the acquisition agreement and tender offer in which percentages): December 31, 2002 December 31, 2001 Percent Change Year Ended $38,689 $32,491 19.1 Percent of Total Sales 8.1 7.2 Zebra would acquire all outstanding shares of common stock (including associated rights to purchase preferred stock) of Fargo Electronics, Inc. for $7.25 per share in cash. During the time that the tender offer was active, we incurred legal, account- ing and other expenses related to the proposed acquisition that would have been treated as part of the purchase price had the tender offer been completed. We expensed $3,300,000 of these costs at the cancellation of the tender offer. The increase in general and administrative expenses was due to: (cid:127) Higher bonus payments related to the growth in net sales and profits, (cid:127) Consulting expenses for the development and implementation of growth strategies, (cid:127) Information systems, and (cid:127) Increased insurance costs. Amortization of Intangible Assets During 2002, Zebra recorded $1,494,000 in amortization of intangible assets, compared with $5,233,000 for 2001. During the first quarter of 2002, Zebra imple- mented SFAS No. 142, Goodwill and Other Intangible Assets, which replaces the requirements to amortize intangible assets with indefinite lives and goodwill with a requirement for an annual impairment test. SFAS No. 142 also establishes require- We incurred merger costs of $73,000 in 2002 and $1,838,000 in 2001. These costs related to the acquisition of Comtec Information Systems in April 2000. These costs and the related activities were completed during 2002. Operating Income Operating income is summarized in the following table (in thousands, except percentages): December 31, 2002 December 31, 2001 Percent Change Year Ended $101,805 $ 92,459 10.1 Percent of Total Sales 21.4 20.5 ments for identifiable intangible assets. As a result, during the first quarter of 2002 The increase in operating income is attributable to the following factors: Zebra reclassified $21,272,000 of intangible assets into goodwill, as such assets, (cid:127) Sales growth, which included assembled workforce and customer lists, did not meet the criteria (cid:127) Improved gross margins resulting from increased overhead utilization, for recognition as an asset apart from goodwill under SFAS No. 142. Operating (cid:127) Favorable changes in foreign exchange rates for Zebra’s non-dollar denominated income for 2001 includes $3,835,000 of amortization of goodwill and other intan- business, and gible assets that are not included in the 2002 results due to the implementation of (cid:127) Cost controls that held operating expense growth slightly below the rate of SFAS No. 142. sales growth. As a result of these actions, operating income increased by 4.4 percentage points more than the rate of sales growth during 2002. 21 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S of Financial Condition and Results of Operations Non-operating Income and Expenses America. These principles require the use of estimates, judgments and assump- Zebra’s non-operating income and expense items are summarized in the following tions. We believe that the estimates, judgments and assumptions we used are rea- table (in thousands): Year Ended December 31, Investment income Interest expense Foreign exchange gains (losses) Other, net 2002 $10,004 (319) 347 (954) 2001 $5,419 (231) (896) (612) sonable, based upon the information available. Our estimates and assumptions affect the reported amounts in our financial state- ments. The following accounting policies comprise those that we believe are the most critical in understanding and evaluating Zebra’s reported financial results. Total other income (expense) $ 9,078 $3,680 Revenue Recognition Favorable investment income was a result of a $1,953,000 pre-tax gain on the sale of of title, which are generally the same. Other items that affect our revenue 585,000 shares of common stock of Fargo Electronics, in addition to the absence of a recognition include: Zebra recognizes sales from product sales at the time of shipment and passage $2,242,000 pre-tax write-down of a long-term investment that occurred in 2001. The write-down occurred because the decline in the asset’s value was viewed as other than temporary. This write-down reduced 2001 diluted earnings by $0.03 per share. Zebra recorded an additional write-down of $193,000 for this investment in 2002. Income Taxes The effective income tax rate for 2002 was 35.4% versus 36.0% in 2001. This change is the result of implementing tax minimization strategies during the third quarter of 2002. Net Income Zebra’s net income is summarized below (in thousands, except per share amounts): Year Ended December 31, Net income Diluted earnings per share 2002 $71,595 $ 1.53 2001 $61,529 $ 1.33 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 Customer returns Customers have the right to return products that do not function properly within a limited time after delivery. We monitor and track product returns and record a provision for the estimated future returns based on historical experience and any notification received of pending returns. Returns have historically been within expectations and the provisions established, but Zebra cannot guarantee that it will continue to experience return rates consistent with historical patterns. A sig- nificant increase in product failure rates and the resulting credit returns could have a material effect on our operating results. A 10% increase (decrease) in returns above historical levels would have decreased (increased) operating income for the fourth quarter of 2003 by $132,000, or 0.4% of operating income. Volume Rebates Some of our customers are offered incentive rebates based on the volume of product 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 outstand- ing volume rebates and establish a reserve for them based on shipment history. Historically, actual volume rebates have been in line with our estimates. 22 Z E B R A T E C H N O L O G I E S C O R P O R A T I O N Price Protection Investments and Marketable Securities Some of our customers are offered price protection by Zebra as an incentive to Investments and marketable securities at December 31, 2003, consisted of U.S. gov- carry inventory of our product. These price protection plans provide that if we ernment securities (44.8%), state and municipal bonds (45.4%), corporate bonds lower prices, we will credit them for the price decrease on inventory they hold. We (4.6%), partnership interests (4.4%) and equity securities (0.8%). We classify our estimate future payments under price protection programs quarterly and establish debt and marketable equity securities in one of three categories: trading, available- a reserve, which is charged against revenue. Our customers typically carry limited for-sale or held-to-maturity. Trading securities are bought and held principally for amounts of inventory, and Zebra infrequently lowers prices on current products. the purpose of selling them in the near term. Held-to-maturity securities are those As a result, the amounts paid under theses plans have been minimal. We cannot securities that Zebra has the ability and intent to hold until maturity. All securities guarantee that this minimal level will continue. not included in trading or held-to-maturity are classified as available-for-sale. Software Revenue We sell three types of software and record revenue as follows: (cid:127) 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. (cid:127) We sell a limited amount of prepackaged, or off-the-shelf, software for the cre- ation 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 as this prepackaged software is shipped. (cid:127) We sometimes provide custom software as part of a printer installation project. We bill custom software development services separate from the related hard- ware. Revenue related to custom software is recognized once the custom soft- ware development services have been completed and accepted by the customer. Shipping and Handling Trading and available-for-sale securities are recorded at fair value. Held-to-matu- rity securities are recorded at amortized cost, adjusted for the amortization or accretion of discounts or premiums. Unrealized holding gains and losses on trad- ing 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. During the first quarter of 2003, we changed the classification of certain of our investments and marketable securities from the trading category to the available- for-sale category, because we are no longer buying securities with the intent of selling them in the near-term. In accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, the market value as of the date of the change is now the new cost basis, and all future unrealized gains and losses will be reflected in the accumulated other comprehensive income section of stock- We charge our customers for shipping and handling services based upon our holders’ equity in the balance sheet. This change was made because of changes internal price list for these items. The amounts billed to customers are recorded as in our investment strategies and is consistent with the classification of our invest- revenue when the product ships. Any costs incurred related to these services are ments and marketable securities as defined in SFAS No. 115. Approximately included in cost of sales. $256,000,000 of our $330,159,000 of investments was transferred from the trading category to the available-for-sale category. 23 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S of Financial Condition and Results of Operations Accounts Receivable Our forecasted product demand may prove to be inaccurate, in which case the We have standardized credit granting and review policies and procedures for all provision required for excess and obsolete inventory may be understated or over- customer accounts, including: stated. If inventories were determined to be overvalued, we would recognize such (cid:127) Credit reviews of all new customer accounts, costs in cost of goods sold at the time of such determination. We make every effort (cid:127) Ongoing credit evaluations of current customers, to ensure the accuracy of our forecasts of product demand; however, any signifi- (cid:127) Credit limits and payment terms based on available credit information, cant unanticipated changes in demand or technological developments could have a (cid:127) Adjustments to credit limits based upon payment history and the customer’s cur- significant impact on the value of inventories and reported operating results. rent credit worthiness, and (cid:127) An active collection effort by regional credit functions, reporting directly to the Over the last three years, our reserves for excess and obsolete inventories have corporate financial officers. ranged from 10.1% to 13.1% of gross inventory. As of December 31, 2003, reserves for excess and obsolete inventories were $6,408,000, or 13.1% of gross inventory. We reserve for estimated credit losses based upon historical experience and spe- Reserves increased during 2003 due to products which are in the process of being cific customer collection issues. Over the last three years, accounts receivable discontinued. reserves varied from 1.7% to 2.9% of total accounts receivable. Accounts receivable reserves as of December 31, 2003, were $1,388,000, or 1.7% of the balance due. Valuation of Long-Lived and Intangible Assets and Goodwill We feel this reserve level is appropriate considering the improved quality of the We test the impairment of identifiable intangibles and goodwill each year or when- portfolio as of December 31, 2003. While credit losses have historically been within ever events or changes in circumstances indicate that the carrying value may not expectations and the provisions established, we cannot guarantee that our credit be recoverable. We completed our last assessment during June 2003. loss experience will continue to be consistent with historical experience. Inventories We value our inventories at the lower of the actual cost to purchase or manufacture We evaluate the impairment of other long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. using the first-in, first-out (FIFO) method, or the current estimated market value. We Factors considered that may trigger an impairment review consist of: review inventory quantities on hand and record a provision for excess and obsolete (cid:127) Significant underperformance relative to expected historical or projected future inventory based on forecasts of product demand and production requirements for operating results the subsequent twelve months. (cid:127) Significant changes in the manner of use of the acquired assets or the strategy A significant increase in the demand for Zebra’s products could result in a short- (cid:127) Significant negative industry or economic trends term increase in the cost of inventory purchases; however, this would be offset by (cid:127) Significant decline in Zebra’s stock price for a sustained period improved overhead utilization resulting from the additional demand. A significant (cid:127) Significant decline in market capitalization relative to net book value decrease in demand could result in an increase in excess inventory quantities on hand. for the overall business 24 Z E B R A T E C H N O L O G I E S C O R P O R A T I O N If we believe that one or more of the above indicators of impairment have On November 25, 2003, Paxar Americas filed a Complaint against ZIH in the United occurred, we measure impairment based on projected discounted cash flows States District Court for the Southern District of Ohio, seeking a declaratory judg- using a discount rate that incorporates the risk inherent in the cash flows. Net ment that the patents asserted by ZIH in its Massachusetts Complaint are not intangible assets, long-lived assets and goodwill amounted to $111,242,000 as of infringed and are invalid and unenforceable. On December 17, 2003, Paxar Americas December 31, 2003. Contingencies amended its complaint to add Zebra Technologies Corporation as a defendant. The parties have filed a motion to stay this action pending the Massachusetts District Court’s ruling on Paxar Corporation’s motion to transfer. The parties have agreed We recorded an estimated liability related to contingencies based on our estimates to file a motion to transfer this action to the Massachusetts District Court if the of the probable outcomes. Quarterly, we assess the potential liability related to Massachusetts District Court denies Paxar Corporation’s pending motion to transfer. pending litigation, tax audits and other contingencies and confirm or revise esti- mates and reserves as appropriate. We are unable at this time to estimate the range of the potential liability that would result from an unsuccessful defense, and consistent with the requirements On April 23, 2003, Paxar Americas, Inc. (Paxar Americas) filed a patent infringe- of SFAS No. 5, Accounting for Contingencies, no liability has been recorded in ment lawsuit in the United States District Court for the Southern District of Ohio Zebra’s consolidated financial statements as of December 31, 2003. against Zebra and certain of its subsidiaries. Paxar Americas’ Complaint alleges that certain of Zebra’s printer products infringe one or more of eight identified Stock-Based Compensation Paxar Americas patents, although not each product is accused of infringing each As of December 31, 2003, Zebra had three stock-based compensation plans avail- patent. Zebra has filed an Answer to Paxar Americas’ Complaint, denying Paxar able for future grants. We account for those plans under the recognition and Americas’ allegations of infringement and asserting several affirmative defenses, measurement principles of APB Opinion No. 25, Accounting for Stock Issued to including the invalidity of Paxar Americas’ asserted patent claims. Employees, and related Interpretations. No stock-based compensation cost is reflected in net income, as all options granted under those plans had an exercise On November 21, 2003, ZIH Corp. (ZIH) filed a Complaint in the United States price equal to the market value of the underlying common stock on the date of District Court for the District of Massachusetts against Paxar Corporation, alleg- grant. The following table illustrates the effect on net income and earnings per ing that Paxar Corporation printers infringe ZIH’s U.S. Patent Nos. 5,813,343 and share if we had applied the fair value recognition provisions of SFAS No. 123, 5,860,753. Paxar Corporation answered ZIH’s Complaint, denying infringement and Accounting for Stock-based Compensation, to stock-based compensation (in thou- seeking a declaratory judgment that ZIH’s patents-in-suit are not infringed and are sands, except per share amounts): invalid and/or unenforceable. Paxar Corporation filed a motion to transfer ZIH’s Massachusetts suit to Ohio federal court. ZIH opposed Paxar Corporation’s motion to transfer, and the parties are awaiting the Court’s ruling on the transfer motion. 25 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S of Financial Condition and Results of Operations Year Ended December 31, Net income, as reported 2003 $91,696 2002 $71,595 2001 $61,529 (cid:127) Operations provided a net cash increase of $109,144,000 primarily from net income. Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects Pro forma net income Basic earnings per share: As reported Pro forma Diluted earnings per share: As reported Pro forma Expectations (5,374) $86,322 (5,102) $66,493 (3,558) $57,971 $ 1.95 1.83 $ 1.92 1.81 $ 1.54 1.43 $ 1.53 1.42 $ 1.34 1.26 $ 1.33 1.25 During our quarterly conference call on February 18, 2004, we provided net sales and earnings guidance for the first quarter of 2004 as follows (amounts in thou- sands, except per share data): Net sales Gross profit margins Operating expenses Earnings per share First Quarter 2004 $145,000 to $150,000 50.0% to 51.0% $38,000 to $40,000 $0.47 to $0.53 The effective tax rate is expected to be 34.75% of income before income taxes. Liquidity and Capital Resources Zebra continued to generate cash well in excess of its operating requirements. (cid:127) Accounts receivable increased $5,141,000 (net of the effect of foreign currency translation adjustment) because of higher sales. (cid:127) Inventories increased $1,659,000, net of foreign currency translation adjustment. This is due to higher sales offset by improvements in inventory utilization. Compared to the same period a year ago, inventory turns increased slightly to 6.8 from 6.7. (cid:127) Other assets decreased primarily due to the receipt of tax protest deposits returned from the State of Illinois and a decrease in the value of the foreign exchange forward contracts, but these decreases are offset by increases in long-term investments. (cid:127) With the effect of foreign currency translation adjustment being the predominant cause, accounts payable decreased by $3,156,000. (cid:127) Accrued expenses, net of the effect of foreign currency translation adjustment, increased due to higher payroll accruals and unearned revenue. (cid:127) Taxes payable decreased $962,000 because of the timing of tax payments and the settlement of the Illinois tax matter offset by increased profits. In addition, our effective income tax rate decreased to 32.6% in 2003 from 35.4% in 2002. (cid:127) Purchases of property and equipment totaled $8,407,000. (cid:127) Stock option exercises contributed $17,620,000. Zebra’s contractual obligations as of December 31, 2003 were: Contractual Obligations Long-term debt obligations Total N/A Payments due by period Less than 1 year 1-3 years 3-5 years More than 5 years Capital lease obligations $ 705 $ 190 $ 365 $ 63 $ 87 As a result, Zebra’s cash and investment balances have grown over time. As of Operating lease obligations December 31, 2003, Zebra had $449,964,000 in cash, cash equivalents, investments Purchase obligations and marketable securities, compared with $348,577,000 at December 31, 2002. Other long-term liabilities 36,982 38,990 N/A 4,248 38,990 7,146 — 6,486 19,102 — — Factors affecting cash and investment balances during 2003 include: Total $76,677 $43,428 $7,511 $6,549 $19,189 26 Z E B R A T E C H N O L O G I E S C O R P O R A T I O N Purchase obligations are for purchases made in the normal course of business to with characteristics of both liabilities and equity. It requires treating these instru- meet operational requirements, primarily raw materials. ments as a liability (or an asset in some circumstances) because the financial instru- Management believes that existing capital resources and funds generated from these characteristics, and SFAS No. 150 had no effect on our financial statements. ment is an obligation of the issuer. Zebra has issued no financial instruments with operations are sufficient to finance anticipated capital requirements. It is our inten- tion to actively pursue opportunities to acquire other businesses. Risk Factors Recently Issued Accounting Pronouncements described below, as well as other disclosures in Management’s Discussion and In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest Entities. Analysis of Financial Condition and Results of Operations, because they could FIN 46 requires us to consolidate a variable interest entity (VIE) if we have a major- have a material adverse effect on Zebra’s business, financial condition, operating Investors should carefully consider the risks, uncertainties and other factors ity of the risks, rewards or both of that entity. FIN 46 will be effective for most VIEs results, and growth prospects. beginning in the fourth quarter of 2003. Zebra has no investments in variable inter- est entities; therefore, FIN 46 has no effect on our financial statements. Zebra could encounter difficulties in any acquisition it undertakes, including unantici- In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based stockholder value and adversely affect operating results. Proposed acquisitions that Compensation - Transition and Disclosure, amending SFAS No. 123, Accounting for are not consummated may result in the write-off of certain acquisition costs. Zebra Stock-Based Compensation, to provide alternative transition methods for an entity may acquire or make investments in other businesses, technologies, services or that voluntarily changes to the fair value based method of accounting for stock- products. The process of integrating any acquired business, technology, service based employee compensation. Zebra does not currently intend to make this change. or product into operations may result in unforeseen operating difficulties and pated integration problems and business disruption. Acquisitions could also dilute In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on management time and attention, which could otherwise be available for ongoing Derivative Instruments and Hedging Activities. SFAS No. 149 clarifies when a con- development of the business. The expected benefits of any acquisition may not tract with an initial net investment meets the characteristics of a derivative and be realized. Moreover, Zebra may be unable to identify, negotiate or finance future when a derivative contains a financing component that warrants special reporting acquisitions successfully. Future acquisitions could result in potentially dilutive in the statements of cash flows. SFAS No. 149 is generally effective for contracts issuances of equity securities or the incurrence of debt, contingent liabilities or entered into or modified after June 30, 2003, and had no impact on Zebra’s finan- amortization expenses. To the extent that a proposed acquisition is not consum- cial position or results of operations. mated, Zebra may be required to write off certain costs associated with the acqui- expenditures. Integration of an acquired company also may consume considerable In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 sets Zebra may not be able to continue to develop products to address user needs effec- standards for classification and measurement by an issuer of financial instruments tively in an industry characterized by rapid technological change. To be successful, sition, which could be significant. 27 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S of Financial Condition and Results of Operations Zebra must adapt to rapidly changing technological and application needs by con- cooperative relationships with suppliers or companies that produce complemen- tinually improving its products as well as introducing new products and services to tary products. Any of these factors could reduce Zebra’s earnings. address user demands. Zebra’s industry is characterized by: (cid:127) Rapidly changing technology (cid:127) Evolving industry standards (cid:127) Frequent new product and service introductions (cid:127) Evolving distribution channels (cid:127) Changing customer demands The inability to protect intellectual property could harm Zebra’s reputation, and its competitive position may be materially damaged. Zebra’s 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 Zebra’s products or, without authorization, to obtain and use information which Zebra regards as trade secrets. Future success will depend on Zebra’s ability to adapt in this rapidly evolving Zebra sells a significant portion of its products internationally and purchases impor- environment. Zebra could incur substantial costs if it has to modify its business to tant components from foreign suppliers. These circumstances create a number adapt to these changes, and may even be unable to adapt to these changes. of risks. Zebra sells a significant amount of its products to customers outside the Zebra competes in a highly competitive market, which is likely to become more account for a material portion of net sales. Risks associated with sales and pur- competitive. Competitors may be able to respond more quickly to new or emerging chases outside the United States include: technology and changes in customer requirements. Zebra faces significant competi- (cid:127) Fluctuating foreign currency rates could restrict sales, or increase costs of purchas- tion in developing and selling its systems. Principal competitors have substantial ing, in foreign countries. marketing, financial, development and personnel resources. To remain competitive, (cid:127) Foreign governments may impose burdensome tariffs, quotas, taxes, trade barriers Zebra believes it must continue to provide: or capital flow restrictions. (cid:127) Technologically advanced systems that satisfy the user demands, (cid:127) Political and economic instability may reduce demand for our products, or put United States. Shipments to international customers are expected to continue to (cid:127) Superior customer service, (cid:127) High levels of quality and reliability, and (cid:127) Dependable and efficient distribution networks. our foreign assets at risk. (cid:127) Restrictions on the export or import of technology may reduce or eliminate the ability to sell in or purchase from certain markets. (cid:127) Potentially limited intellectual property protection in certain countries, such as Zebra cannot assure it will be able to compete successfully against current or China, may limit recourse against infringing products or cause Zebra to refrain future competitors. Increased competition in printers or supplies may result in from selling in certain geographic territories. price reductions, lower gross profit margins and loss of market share, and could (cid:127) Staffing and managing international operations may be unusually difficult. require increased spending on research and development, sales and marketing and (cid:127) Zebra may not be able to control international distributors working on its behalf. customer support. Some competitors may make strategic acquisitions or establish 28 Z E B R A T E C H N O L O G I E S C O R P O R A T I O N Economic factors, which are outside Zebra’s control, could lead to deterioration in Terrorist attacks or war could lead to further economic instability and adversely affect the quality of Zebra’s accounts receivables. Zebra sells its products to customers in Zebra’s stock price, operations, and profitability. The terrorist attacks that occurred the United States and several other countries around the world. Sales are typically in the United States on September 11, 2001 caused major instability in the U.S. and made on unsecured credit terms, which are generally consistent with the prevail- other financial markets. Possible further acts of terrorism and current and future war ing business practices in a given country. A deterioration of economic or political risks could have a similar impact. The United States continues to take military action conditions in a country could impair Zebra’s ability to collect on receivables in the against terrorism and is currently engaged in a costly occupation of Iraq. These affected country. 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 Infringement on the proprietary rights of others could put Zebra at a competitive economic instability. Any such attacks could, among other things, cause further insta- disadvantage, and any related litigation could be time consuming and costly. Third bility in financial markets and could directly, or indirectly through reduced demand, parties may claim that Zebra violated their intellectual property rights. To the extent negatively affect Zebra’s facilities and operations or those of its customers or suppli- of a violation of a third party’s patent or other intellectual property right, Zebra may ers. 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 pos- Taxing authority challenges may lead to tax payments exceeding current reserves. sible, to accomplish its objectives. Any of these claims, with or without merit, could Zebra operates in multiple tax jurisdictions in the United States and worldwide, and result in costly litigation and divert the attention of key personnel. uses strategies to minimize its tax expense. Local tax authorities may challenge these tax positions from time to time. Adverse outcomes in these situations may exceed Zebra depends on the ongoing service of its senior management and ability to Zebra’s reserves for tax payments and may increase Zebra’s effective tax rate. attract and retain other key personnel. Future success of Zebra is substantially dependent on the continued service and continuing contributions of senior man- Interest Rate Risk agement and other key personnel. The loss of the service of any executive officer Zebra is exposed to the impact of changes in interest rates because of our large or other key employees could adversely affect business. Zebra has no long-term investment portfolio. As stated in our written investment policy, the investment port- employment agreements with key personnel and maintains minimal key man life folio is viewed as a strategic resource that will be managed to achieve above market insurance policies on its key employees. 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 The ability to attract, retain and motivate highly skilled employees is important to an overriding objective to preserve capital across each quarterly reporting cycle. Zebra’s long-term success. Competition for personnel in Zebra’s industry is intense, and Zebra may be unable to retain key employees or attract, assimilate or retain Zebra mitigates interest rate risk with an investment policy that requires the use of other highly qualified employees in the future. outside professional investment managers, investment liquidity and broad diver- sification 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. 29 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S of Financial Condition and Results of Operations The following table sets forth the impact of a one-percentage point movement in interest rates on the value of Zebra’s investment portfolio as of December 31, 2003 Notional balance of outstanding contracts: (in thousands, except per share data). Pound Euro 2003 2002 £8,569 €22,000 £3,293 €26,000 Interest rate sensitive instruments +1 percentage point movement -1 percentage point movement Foreign Exchange Risk Effect on Pretax Income Effect on Diluted EPS (after tax) $(4,976) $ 4,976 $(0.07) $ 0.07 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 and accounts receivable. We also purchase certain raw materials and other items in foreign currencies. We manage these risks using derivative financial instruments. Hedging of Net Assets We use forward contracts and options to manage exposure related to our pound and euro denominated net assets. We record gains and losses on these contracts and options in income each quarter along with the translation gains and losses related to our net euro asset position, which would ordinarily offset each other. Summary financial information related to these activities follows (in thousands): Year Ended December 31, 2003 2002 2001 Change in gains (losses) from foreign exchange derivatives $(3,756) Gain (loss) on net foreign currency assets 3,204 Net foreign exchange gain (loss) $ (552) $(2,579) 2,926 $ 347 $(1,642) 746 $ (896) Hedging of Anticipated Sales During the second quarter of 2003, we began a program to manage the exchange rate risk of anticipated euro denominated sales using forward contracts and des- ignated these contracts as cash flow hedges. Gains and losses on these contracts are deferred in other comprehensive income until the contracts are settled and the hedged sales are realized, at which time the deferred gains or losses will be reported as an increase or decrease to sales. Summary financial information related to the cash flow hedges of future revenues follows (in thousands, except percentages): December 31, Net unrealized losses deferred in other comprehensive income: Gross Tax benefit Net Net gain (loss) included in sales for the following periods ended December 31, 2003: Three months Year Notional balance of outstanding contracts: Hedge effectiveness 2003 $ (1,537) 538 $ (999) $ (150) 266 €30,420 100% 30 Z E B R A T E C H N O L O G I E S C O R P O R A T I O N The following table sets forth the impact of a one-percentage point movement in of investment strategies, some of which involve the use of equity securities. Each the dollar/pound and dollar/euro rates measured as if Zebra did not engage in the investment manager’s portfolio is designed to be market neutral, although an indi- selective hedging practices described above. It is based on the dollar/euro and dol- vidual fund within a portfolio may be exposed to market risk. By policy, manage- lar/pound exchange rates and euro and pound denominated assets and liabilities as ment limits the amount of Zebra’s investments in alternative investment strategies of December 31, 2003 (in thousands, except per share data). to a maximum of 20% of the total investment portfolio, with no single investment Foreign Exchange Dollar/pound Dollar/euro Equity Price Risk Effect on Pretax Income Effect on Diluted EPS (after tax) $107 $314 $0.00 $0.00 exceeding $12,000,000. 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 one-percentage point change in the From time to time, Zebra has taken direct equity positions in companies. These value of all equity positions held by Zebra’s investment managers (in thousands, investments relate to potential acquisitions and other strategic business opportuni- per share data). ties. 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. Zebra currently employs four investment managers, two of which manage portfo- lios of investment funds (i.e., fund of funds). These investment funds use a variety Equity price sensitive instruments +1 percentage point movement -1 percentage point movement Effect on Pretax Income Effect on Diluted EPS (after tax) $ 189 $(189) $ 0.00 $(0.00) 31 C O N S O L I D A T E D B A L A N C E S H E E T S (In thousands, except share and per share data) December 31, Assets Current assets: Cash and cash equivalents Investments and marketable securities Accounts receivable, net of allowances of $1,388 in 2003 and $1,236 in 2002 Inventories Deferred income taxes Prepaid expenses Total current assets Property and equipment at cost, less accumulated depreciation and amortization Deferred income taxes Goodwill Other intangibles Other assets Total assets Liabilities and Stockholders’ Equity Current liabilities: Accounts payable Accrued liabilities Current portion of obligation under capital lease Income taxes payable Total current liabilities Obligation under capital lease, less current portion Deferred income taxes Deferred rent Other long-term liability Total liabilities Stockholders’ equity: Preferred stock Class A Common Stock Class B Common Stock Additional paid-in capital Treasury stock, at cost Retained earnings See accompanying notes to consolidated financial statements. Accumulated other comprehensive income (loss) Total stockholders’ equity Total liabilities and stockholders’ equity 32 2003 2002 $ 14,266 $ 18,418 435,698 330,159 81,867 42,781 4,507 4,415 583,534 39,286 — 61,150 9,031 8,610 71,299 38,066 4,107 2,531 464,580 39,462 1,722 54,455 3,556 9,313 $701,611 $573,088 $ 16,238 $ 15,447 26,938 153 2,273 45,602 452 723 518 2,401 49,696 — 474 — 62,166 — 585,846 3,429 17,936 145 3,376 36,904 605 — 416 1,008 38,933 — 415 58 56,320 (16,760) 494,150 (28) 651,915 534,155 $701,611 $573,088 C O N S O L I D A T E D S T A T E M E N T S O F E A R N I N G S Z E B R A T E C H N O L O G I E S C O R P O R A T I O N (In thousands, except per share data) Year Ended December 31, Net sales Cost of sales Gross profit Operating expenses: Selling and marketing Research and development General and administrative Amortization of intangible assets Acquired in-process technology Exit costs Costs related to terminated acquisition Merger costs Total operating expenses Operating income Other income (expense): Investment income Interest expense Foreign exchange gain (loss) Other, net Total other income Income before income taxes Income taxes Net income Basic earnings per share Diluted earnings per share See accompanying notes to consolidated financial statements. Diluted weighted average and equivalent shares outstanding Basic weighted average shares outstanding 2003 2002 2001 $536,397 $475,611 $450,008 263,320 244,864 273,077 230,747 240,115 209,893 66,635 31,759 41,892 1,640 692 1,232 — 9 56,176 29,210 38,689 1,494 — — 3,300 73 143,859 128,942 129,218 101,805 49,688 28,184 32,491 5,233 — — — 1,838 117,434 92,459 8,553 10,004 5,419 (154) (552) (1,073) 6,774 (319) 347 (954) 9,078 135,992 110,883 44,296 39,288 (231) (896) (612) 3,680 96,139 34,610 $ 91,696 $ 71,595 $ 61,529 $ 1.95 $ 1.54 $ 1.34 $ 1.92 $ 1.53 $ 1.33 47,098 47,663 46,452 46,870 45,949 46,305 33 C O N S O L I D A T E D S T A T E M E N T S O F C O M P R E H E N S I V E I N C O M E (In thousands) Year Ended December 31, Net income Other comprehensive income (loss): 2003 2002 2001 $91,696 $71,595 $61,529 See accompanying notes to consolidated financial statements. Foreign currency translation adjustment 4,110 Changes in unrealized gain/loss on hedging transactions, net of income taxes (999) 2,968 — (977) — Changes in unrealized holding gains/loss on investments, net of income taxes 346 (1,603) 3,000 Comprehensive income $95,153 $72,960 $63,552 34 C O N S O L I D A T E D S T A T E M E N T S O F S T O C K H O L D E R S ’ E Q U I T Y Z E B R A T E C H N O L O G I E S C O R P O R A T I O N (Dollars in thousands) Balance at December 31, 2000 Conversion of 612,342 shares of Class B Common Stock to 612,342 shares of Class A Common Stock Reissuance of 444,585 treasury shares upon exercise of stock options and purchases under stock purchase plan Tax benefit resulting from exercise of options Loss on put options Net income Unrealized holding gain on investments (net of income taxes) Foreign currency translation adjustment Balance at December 31, 2001 Conversion of 2,462,584 shares of Class B Common Stock to 2,462,584 shares of Class A Common Stock Reissuance of 575,976 treasury shares upon exercise of stock options and purchases under stock purchase plan Tax benefit resulting from exercise of options Net income Unrealized holding loss on investments (net of income taxes) Foreign currency translation adjustment Balance at December 31, 2002 Conversion of 5,829,075 shares of Class B Common Stock to 5,829,075 shares of Class A Common Stock Reissuance of 567,568 treasury shares upon exercise of stock options and purchases under stock purchase plan Issuance of 82,431 common shares upon exercise of stock options and purchases under stock purchase plan Payment for fractional shares in 3-for-2 stock split Tax benefit resulting from exercise of options Net income Unrealized holding gain on investments (net of income taxes) Unrealized holding loss on hedging transactions (net of income taxes) Foreign currency translation adjustment Balance at December 31, 2003 Class A Common Stock $ 385 Class B Common Stock Additional Paid-in Capital Retained Earnings $88 $ 63,333 $ 361,026 (6) — Treasury Stock $(50,128) — 14,646 — — — — — — — — — 61,529 — — — — — 71,595 — — — 18,722 — — — — Accumulated Other Comprehensive Income (Loss) Total $(3,416) $ 371,288 — — — — — 3,000 (977) (1,393) — — — — (1,603) 2,968 — 8,895 1,273 (1) 61,529 3,000 (977) 445,007 — 13,106 3,082 71,595 (1,603) 2,968 58,854 422,555 (35,482) (24) — — — — — — — 82 — — — — — 58 (5,751) 1,273 (1) — — — (5,616) 3,082 — — — 56,320 494,150 (16,760) (28) 534,155 (58) — — — — — — — — — (1,630) 2,631 (142) 4,987 — — — — — — — — — 91,696 — — — — 16,760 — — — — — — — — — — — — — 346 (999) 4,110 — 15,130 2,632 (142) 4,987 91,696 346 (999) 4,110 $474 $ — $62,166 $585,846 $ — $3,429 $651,915 35 6 — — — — — — 391 24 — — — — — 415 58 — 1 — — — — — — C O N S O L I D A T E D S T A T E M E N T S O F C A S H F L O W S (In thousands) Year Ended December 31, Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization Tax benefit from exercise of options Acquired in-process technology Depreciation (appreciation) in market value of investments and marketable securities Write-down of long-term investment Deferred income taxes Changes in assets and liabilities, net of businesses acquired: Accounts receivable, net Inventories Other assets Accounts payable Accrued liabilities Income taxes payable Other operating activities Investments and marketable securities Net cash provided by (used in) operating activities Cash flows from investing activities: Purchases of property and equipment Acquisition of Atlantek, Inc., net of cash acquired Purchases of investments and marketable securities Sales and maturities of investments and marketable securities Net cash used in investing activities Cash flows from financing activities: Proceeds from exercise of stock options and stock purchase plan purchases Payments for obligation under capital lease Other financing activities Net cash provided by financing activities Effect of exchange rate changes on cash Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year Supplemental disclosures of cash flow information: Interest paid Income taxes paid Supplemental disclosures of non-cash transactions: 2003 2002 2001 $91,696 $71,595 $61,529 11,580 4,987 692 — — (697) (5,141) (1,659) 2,466 (3,156) 6,909 (962) (2,196) — 104,519 (8,407) (13,680) (1,057,241) 951,702 (127,626) 17,762 (200) (142) 17,420 1,535 (4,152) 18,418 $14,266 12,259 3,082 — 1,360 193 (616) (1,629) 2,922 3,969 (939) 2,607 (896) 1,241 (108,498) (13,350) (8,481) — — — (8,481) 13,106 (117) — 12,989 932 (7,910) 26,328 $18,418 $ 154 38,779 $ 319 33,840 15,691 1,273 — (1,209) 2,242 2,873 16,223 17,284 (7,895) (9,424) 3,155 (6,792) (1,928) (78,874) 14,148 (9,613) — — — (9,613) 8,895 (103) (1) 8,791 (774) 12,552 13,776 $26,328 $ 231 38,604 6 — 36 See accompanying notes to consolidated financial statements. Conversion of Class B Common Stock to Class A Common Stock Assets under capital lease obligation 58 — 25 333 N O T E S to Consolidated Financial Statements Z E B R A T E C H N O L O G I E S C O R P O R A T I O N Note 1 Description of Business those securities that Zebra has the ability and intent to hold until maturity. All secu- Zebra Technologies Corporation and its wholly-owned subsidiaries (Zebra) design, rities not included in trading or held-to-maturity are classified as available-for-sale. manufacture, sell and support a broad range of direct thermal and thermal transfer bar code label and receipt printers, radio frequency identification printer/encoders, Trading and available-for-sale securities are recorded at fair value. Held-to-maturity card imaging printers, digital photo printers and related accessories and support securities are recorded at amortized cost, adjusted for the amortization or accre- software. These products are used principally in automatic identification (auto ID), tion of discounts or premiums. Unrealized holding gains and losses on trading data collection and personal identification applications and are distributed world- securities are included in earnings. Unrealized holding gains and losses, net of the wide through a network of resellers, distributors and end users representing a related tax effect, on available-for-sale securities are excluded from earnings and wide cross-section of industrial, service and government organizations. are reported as a separate component of stockholders’ equity until realized. Note 2 Summary of Significant Accounting Policies Inventories. Inventories are stated at the lower of cost or market, and cost is deter- Principles of Consolidation. These consolidated financial statements were prepared mined by the first-in, first-out (FIFO) method. on a consolidated basis to include the accounts of Zebra and its wholly owned sub- sidiaries. All significant inter-company accounts, transactions and unrealized profit Property and Equipment. Property and equipment is stated at cost. Depreciation were eliminated in consolidation. and amortization is computed primarily using the straight-line method over the estimated useful lives of the various classes of property and equipment, which are Use of Estimates. These consolidated financial statements were prepared using 30 years for buildings and range from 3 to 10 years for other property. Property estimates and assumptions that affect the reported amounts of assets and liabili- and equipment held under capital leases is amortized using the straight-line ties and disclosure of contingent assets and liabilities as the date of the consoli- method over the shorter of the lease term or estimated useful life of the asset. dated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Income Taxes. Zebra accounts for income taxes under the asset and liability method. Accordingly, deferred tax assets and liabilities are recognized for the Cash and Cash Equivalents. Cash consists primarily of deposits with banks. In addi- future tax consequences attributable to differences between the financial state- tion, Zebra considers highly liquid short-term investments with original maturities ment carrying amounts of existing assets and liabilities and their respective tax of less than seven days to be cash equivalents. bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differ- Investments and Marketable Securities. Investments and marketable securities at ences are expected to be recovered or settled. The effect on deferred tax assets December 31, 2003, consisted of U.S. government securities, state and municipal and liabilities of a change in tax rates is recognized in income in the period that bonds, partnership interests and equity securities, which are held indirectly in includes the enactment date. diversified funds actively managed by investment professionals. Zebra classifies its debt and marketable equity securities in one of three categories: trading, avail- Intangible Assets. Goodwill represents the unamortized excess of the cost of able-for-sale or held-to-maturity. Trading securities are bought and held principally acquiring a business over the fair values of the net assets received at the date of for the purpose of selling them in the near term. Held-to-maturity securities are acquisition. Goodwill is no longer being amortized as required by SFAS No. 142, Goodwill and Other Intangible Assets. 37 N O T E S to Consolidated Financial Statements Other intangible assets consist primarily of current technology and customer rela- From time to time, Zebra will provide engineering and development services to tionships. These assets are recorded at cost and amortized on a straight-line basis third parties on a contract basis. Zebra does not guarantee the outcome of this over 5 to 8 years. Accumulated amortization for these other intangible assets was research and does not retain any obligation to repay third-party funding received $6,197,000 and $3,865,000 at December 31, 2003 and 2002, respectively. for these contract services. Since these services are not part of our standard prod- uct offering, we treat payments received under these arrangements as reductions Revenue Recognition. Revenue includes sales of hardware, supplies, software to research and development costs. and services (including repair services, extended service contracts, and profes- sional services). Product revenue is recognized when product has been shipped, Advertising. Advertising costs are expensed as incurred. Advertising expenses for risk of loss has passed to the purchaser, and Zebra has fulfilled all of its obliga- the years ended December 31, 2003, 2002 and 2001 totaled $3,721,000, $3,965,000 tions. We provide for an estimate of product returns and doubtful accounts based and $4,405,000, respectively. on historical experience. Revenue related to extended warranty and service con- tracts is recorded as deferred income and recognized over the life of the contract. Market Development Funds. Zebra makes market development funds available to Professional services revenue is recorded when performed. Revenue from multiple its resellers to support demand generation activity by the resellers. These funds element arrangements is allocated to the various elements based on the relative require the reseller to provide specific services or benefits to Zebra and sub- fair value of the elements. stantiate the fair value of such. Zebra reimburses resellers for agreed activities up to the fair value of the benefit received by Zebra. These payments are treated Zebra records payments to resellers of its product as reductions to revenue unless as marketing costs consistent with the requirements of EITF 01-9, Accounting these payments meet the requirements for operating expense treatment under EITF for Consideration Given by a Vendor to a Customer (Including a Reseller of the 01-09 Accounting for Consideration Given by a Vendor to a Customer (Including a Vendor’s Products). Any payments to resellers that do not meet these require- Reseller of the Vendor’s Products). See the market development funds accounting ments are recorded as reductions to revenue. policy for further details. Revenue includes all customer billings for shipping and handling charges. The defects in material and workmanship. A provision for warranty expense is related costs of shipping and handling revenue are recorded as cost of goods sold. recorded at the time of shipment and adjusted quarterly based on historical war- ranty experience. The following is a summary of Zebra’s accrued warranty obliga- Research and Development Costs. Research and development costs are expensed tion during the years ended December 31, 2003 and 2002. Warranty. Zebra provides warranty coverage of up to one year on printers against as incurred. These costs include: (cid:127) Salaries, benefits, and other R&D personnel related costs (cid:127) Consulting and other outside services used in the R&D process (cid:127) Engineering supplies (cid:127) Engineering related information systems costs (cid:127) Allocation of building and related costs Accrued warranty – beginning balance Add: warranty expense Deduct: warranty payments Accrued warranty – ending balance 2003 $1,675 3,095 3,419 $1,351 2002 $1,021 3,080 2,426 $1,675 38 Z E B R A T E C H N O L O G I E S C O R P O R A T I O N Fair Value of Financial instruments. Zebra estimates the fair value of its financial Deferred Compensation Plan. Zebra has a deferred compensation plan that per- instruments as follows: Instrument Method for determining fair value Cash, cash equivalents, accounts receivable, accounts payable and accrued liabilities Cost, which approximates fair value due to the short-term nature of these instruments mits management and highly compensated employees to defer portions of their compensation. Zebra immediately pays deferred amounts into a Rabbi Trust, and plan participants select a method of investing these funds. Zebra accrues the cur- rent balance of the deferred compensation obligation in other long-term liabilities. As of December 31, 2003, Zebra’s deferred compensation liability was $2,401,000. Investments and marketable securities Market quotes from independent pricing services Zebra purchases life insurance policies to fund the ultimate payment of the Foreign currency forward contracts Foreign currency option contracts Estimated using market quoted rates for foreign currency at the balance sheet date Estimated using market quoted rates for foreign currency at the balance sheet date and application of such rates subject to the option terms Life insurance policies Cash surrender value deferred compensation. These polices are valued at the cash surrender value and included in investments and marketable securities. Foreign Currency Translation. The consolidated balance sheets of Zebra’s foreign subsidiaries are translated into U.S. dollars using the year-end exchange rate, and statement of earnings items are translated using the average exchange rate for the Stock-based Compensation. At December 31, 2003, Zebra has three stock-based year. The resulting translation gains or losses are recorded in stockholders’ equity compensation plans, which are described more fully in Note 3. Zebra accounts for as a cumulative translation adjustment, which is a component of accumulated those plans under the recognition and measurement principles of APB Opinion No. 25, other comprehensive income. 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 Capitalized Software. Zebra’s investment in software development consists primar- had an exercise price equal to the market value of the underlying common stock on ily of enhancements to its existing E-commerce web-based application, which will the date of grant. The following table illustrates the effect on net income and earnings include the automation of current business activities. Specifically, the activities per share if Zebra had applied the fair value recognition provisions of SFAS No. 123, include the processing of customer orders; the acknowledgement of customer Accounting for Stock-based Compensation, to stock-based compensation. orders and delivery; and the financial invoicing for all of Zebra’s products and will aid in enabling Zebra to create new business efficiencies. Year Ended December 31, Net income, as reported 2003 $91,696 2002 $71,595 2001 $61,529 Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects Pro forma net income Basic earnings per share: As reported Pro forma Diluted earnings per share: As reported Pro forma (5,374) $86,322 (5,102) $66,493 $ 1.95 1.83 $ 1.92 1.81 $ 1.54 1.43 $ 1.53 1.42 (3,558) $57,971 $ 1.34 1.26 $ 1.33 1.25 Costs associated with the planning and design phases of web-based development, including coding and testing activities necessary to establish technological feasi- bility of the functionality of the website, are charged to research and development as incurred. Once technological feasibility has been determined, costs incurred in the construction phase of software development including coding, testing, and product quality assurance are capitalized. Acquisition Costs. Zebra periodically invests in potential acquisitions. Any external costs incurred are recorded as prepaid expenses until such time as Zebra either com- pletes the transaction or abandons the transaction. If the transaction is completed, the costs are treated as part of the cost of the acquisition. If the transaction is abandoned, 39 N O T E S to Consolidated Financial Statements the costs are expensed during the period in which it is abandoned. During 2002, oper- entered into or modified after June 30, 2003, and had no impact on Zebra’s finan- ating expenses included $3,300,000 of costs related to such an abandonment. cial position or results of operations. Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of. Zebra In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial accounts for long-lived assets in accordance with the provisions of SFAS No. 144, Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 sets Accounting for the Impairment or Disposal of Long-Lived Assets. The statement standards for classification and measurement by an issuer of financial instruments requires that long-lived assets and certain identifiable intangibles be reviewed for with characteristics of both liabilities and equity. It requires treating these instru- impairment whenever events or changes in circumstances indicate that the car- ments as a liability (or an asset in some circumstances) because the financial rying amount of an asset may not be recoverable. Recoverability of assets to be instrument is an obligation of the issuer. Zebra has issued no financial instruments held and used is measured by a comparison of the carrying amount of an asset to with these characteristics, and therefore, SFAS No. 150 had no effect on our finan- the sum of the undiscounted cash flows expected to result from the use and the cial statements. eventual disposition of the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying Note 3 Stock Based Compensation amount of the assets exceeds the fair value of the assets. Assets to be disposed of As of December 31, 2003, Zebra has three active stock option and stock purchase are reported at the lower of the carrying amount or fair value less costs to sell. plans, which are described below. Recently Issued Accounting Pronouncements. In January 2003, the FASB issued FIN The Board of Directors adopted the 1997 Stock Option Plan, effective February 46, Consolidation of Variable Interest Entities. FIN 46 requires us to consolidate a 11, 1997, and 6,375,000 shares of Class A Common Stock were reserved for issu- variable interest entity (VIE) if we have a majority of the risks, rewards or both of ance under the plan. The 1997 Stock Option Plan is a flexible plan that provides that entity. FIN 46 will be effective for most VIEs beginning in the fourth quarter of the committee that administers the Plan broad discretion to fashion the terms of 2003. Zebra has no investments in variable interest entities; therefore, FIN 46 has the awards to provide eligible participants with stock-based incentives, including: no effect on our financial statements. (i) nonqualified and incentive stock options for the purchase of Zebra’s Class A Common Stock and (ii) dividend equivalents. The persons eligible to participate in In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based the 1997 Stock Option Plan are directors, officers, and employees of Zebra or any Compensation - Transition and Disclosure, amending SFAS No. 123, Accounting for subsidiary of Zebra who, in the opinion of the committee administering the plan, Stock-Based Compensation, to provide alternative transition methods for an entity are in a position to make contributions to the growth, management, protection and that voluntarily changes to the fair value based method of accounting for stock-based success of Zebra or its subsidiaries. As of December 31, 2003, 1,906,126 shares employee compensation. Zebra does not currently intend to make this change. were available under the plan. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on The options granted under the 1997 Stock Option Plan have an exercise price equal Derivative Instruments and Hedging Activities. SFAS No. 149 clarifies when a con- to the closing market price of Zebra’s stock on the date of grant. The options gener- tract with an initial net investment meets the characteristics of a derivative and ally vest over two- to five-year periods and have a legal life of ten years from the when a derivative contains a financing component that warrants special reporting date of grant. The Compensation Committee of the Board of Directors administers in the statements of cash flows. SFAS No. 149 is generally effective for contracts the plan. 40 Z E B R A T E C H N O L O G I E S C O R P O R A T I O N Zebra’s Board of Directors adopted the 1997 Director Plan, effective February 11, Zebra’s Board of Directors adopted the 2002 Director Plan, effective February 1, 1997. The 1997 Director Plan provides for the issuance of options to purchase up to 2002. The 2002 Director Plan provides for the issuance of options to purchase up 115,500 shares of Class A Common Stock, which shares are reserved and available to 240,000 shares of Class A Common Stock, which shares are reserved and avail- for purchase upon the exercise of options granted under the 1997 Director Plan. able for purchase upon the exercise of options granted under the 2002 Director Only directors who are not employees or officers of Zebra are eligible to participate Plan. Only directors who are not employees or officers of Zebra are eligible to in the 1997 Director Plan. Under the 1997 Director Plan, each non-employee direc- participate in the 2002 Director Plan. Under the 2002 Director Plan, each non- tor was granted, on the effective date of the plan, an option to purchase 22,500 employee director was granted, on the effective date of the plan, an option to pur- shares of Class A Common Stock, and each non-employee director subsequently chase 30,000 shares of Class A Common Stock, and each non-employee director elected to the Board will be granted an option to purchase shares of Class A subsequently elected to the Board will be granted an option to purchase shares of Common Stock on the date of his or her election. Options granted under the 1997 Class A Common Stock on the date of his or her election or appointment. Options Director Plan provide for the purchase of Class A Common Stock at a price equal to granted under the 2002 Director Plan provide for the purchase of Class A Common the fair market value on the date of grant. If there are not sufficient shares remain- Stock at a price equal to the fair market value on the date of grant. If there are not ing and available to all non-employee directors eligible for an automatic grant at sufficient shares remaining and available to all non-employee directors eligible for the time at which an automatic grant would otherwise be made, then each eligible an automatic grant at the time at which an automatic grant would otherwise be non-employee director shall receive an option to purchase a pro rata number of made, then each eligible non-employee director shall receive an option to purchase shares. Unless otherwise provided in an option agreement, options granted under a pro rata number of shares. As of December 31, 2003, 125,288 shares were avail- the 1997 Director Plan shall become exercisable in five equal increments begin- able under the plan. Unless otherwise provided in an option agreement, options ning on the date of the grant and on each of the first four anniversaries thereof. granted under the 2002 Director Plan shall become exercisable in five equal incre- All options expire on the earlier of (a) ten years following the grant date or (b) the ments beginning on the date of the grant and on each of the first four anniversaries second anniversary of the termination of the non-employee director’s directorship thereof. All options expire on the earlier of (a) ten years following the grant date, for any reason other than due to death or disability (as defined in the 1997 Director (b) the first anniversary of the termination of the non-employee director’s director- Plan). A total of 78,750 shares were issued under this plan, which was terminated ship for any reason other than those listed in clause (c) below, or (c) the termina- February 1, 2002. At December 31, 2003, 7,500 options issued under the 1997 tion of the non-employee director’s directorship by Zebra’s stockholders for cause, Director Plan remained outstanding and unexercised. or resignation for cause, in each case as defined in the option agreement. The Board of Directors and stockholders adopted the 2001 Stock Purchase Plan and For purposes of calculating the compensation cost consistent with SFAS No. 123, reserved 750,000 shares of Class A Common Stock for issuance under the plan. the fair value of each stock option grant is estimated on the date of grant using Under this plan, employees who work a minimum of 20 hours per week may elect the Black-Scholes option-pricing model. The following table shows the weighted- to withhold up to 10% of their cash compensation through regular payroll deduc- average assumptions used for stock option grants as well as the fair value of the tions to purchase shares of Class A Common Stock from Zebra over a period not options granted based on those assumptions: to exceed 12 months at a purchase price per share equal to the lesser of: (1) 85% of the fair market value of the shares as of the date of the grant, or (2) 85% of the fair market value of the shares as of the date of purchase. As of December 31, 2003, 156,786 shares have been purchased under the plan. 41 N O T E S to Consolidated Financial Statements Expected dividend yield Volatility Risk free interest rate 2003 0% 53% 3.29% 2002 0% 53% 4.55% 2001 0% 59% 4.38% Expected weighted-average life Six years Six years Five years Fair value of options granted $11,490,000 $19,676,000 $6,670,000 Weighted-average grant date fair value of options granted $21.00 $18.25 $15.47 The fair value of the employees’ purchase rights pursuant to the Stock Purchase Plan are estimated using the Black-Scholes option-pricing model with the following weighted-average assumptions used for purchase rights granted. Expected lives of three months to one year have been used along with these assumptions. Fair market value Option price Expected dividend yield Expected volatility Risk free interest rate 2003 $44.17 $37.54 0% 27% 1.26% 2002 $51.14 $43.47 0% 40% 2.17% 2001 $38.18 $32.45 0% 54% 4.38% Stock option activity for the years ended December 31, 2003, 2002, and 2001 was as follows: Fixed Options Outstanding at 2003 2002 2001 Weighted- Average Exercise Price Shares Weighted- Average Exercise Price Weighted Average Exercise Price Shares Shares beginning of year 2,492,320 $ 29.00 2,120,089 $ 25.58 2,230,931 $ 24.05 Granted Exercised Canceled Outstanding at 547,075 (595,847) (356,342) 39.47 25.80 32.88 1,078,125 (513,011) (192,883) 32.68 21.39 32.24 431,250 27.66 (371,760) 18.92 (170,332) 25.34 end of year 2,087,206 32.00 2,492,320 29.00 2,120,089 25.58 Options exercisable at end of year 466,355 26.45 577,040 23.24 716,013 20.81 42 The following table summarizes information about fixed stock options outstanding at December 31, 2003: Options Outstanding Range of Exercise Prices $16.11-$27.25 $28.75-$31.96 $32.43 $33.79-$37.84 $40.42-$58.91 Number of Shares 600,739 98,692 664,567 446,459 276,749 2,087,206 Weighted- Average Remaining Contractual Life 5.77 years 6.72 years 8.11 years 9.03 years 6.83 years Weighted- Average Exercise Price $22.29 $31.37 $32.43 $37.69 $43.06 Options Exercisable Weighted- Average Exercise Price $19.95 $31.59 $32.43 — Number of Shares 283,109 25,521 72,073 — 85,652 $41.36 466,355 Note 4 Business Combinations Atlantek, Inc. On November 17, 2003, Zebra acquired Atlantek, Inc. (Atlantek), by acquiring all of the outstanding stock of Atlantek for approximately $13,680,000 in cash. Located in Wakefield, Rhode Island, Atlantek had been a privately held company. Atlantek designs and manufactures thermal digital printers. Additional payments are contingent upon future revenue of specific products for a two-year period, the amount for which cannot be reasonably estimated at this time. The con- solidated statements of earnings reflect the results of operations of Atlantek since the effective date of the acquisition. The pro forma impact of this acquisition was not significant. The following table (in thousands) summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. We are still finalizing our valuations of certain intangible assets; thus, the allocation of the purchase price is subject to refinement. We expect this valuation to be completed during the first quarter of 2004. Additionally, when the contingent purchase price payments discussed above are finalized, these amounts will be added to goodwill. Current assets Property and equipment Intangible assets Goodwill Total assets acquired Current liabilities Long-term deferred income taxes Long-term debt Total liabilities assumed Net assets acquired The purchase price has been allocated to identifiable tangible assets and intangible assets acquired and liabilities assumed based on their estimated fair values. Of the $7,808,000 of acquired intangible assets, $692,000 was assigned to in-process technology assets that were written-off at the date of the acquisition in accordance with FASB Interpretation No. 4, Applicability of FASB Statement No. 2 to Business Combinations for by the Purchase Method. The write-off of in-process technology is stated separately in the operating expense section of the consolidated state- ments of earnings. The remaining $7,116,000 of acquired intangible assets consist of current technology of $4,613,000 with useful lives from 5 to 6 years and cus- tomer relationships of $2,503,000 with a useful life of 8 years. The goodwill is not deductible for tax purposes. Acquisition Termination Costs and Sale of Investment. In the first quarter of 2002, Zebra terminated the acquisition agreement and tender offer in which Zebra would acquire all outstanding shares of common stock (including associated rights to pur- chase preferred stock) of Fargo Electronics, Inc. for $7.25 per share in cash. In con- nection with the termination, Zebra recorded $3,300,000 in expenses for capitalized acquisition costs and other acquisition costs that would otherwise have been capi- talized. Also during the quarter ended March 30, 2002, Zebra sold its investment in common stock of Fargo and realized a pre-tax gain of $1,953,000, which is included in investment income. Z E B R A T E C H N O L O G I E S C O R P O R A T I O N At November 17, 2003 Note 5 Stockholders’ Equity Share count and par value data related to stockholders’ equity are as follows: $3,887 670 7,808 6,695 19,060 (2,369) (2,825) (186) (5,380) $13,680 Shares authorized December 31, Preferred Stock Par value per share Shares authorized Shares outstanding Common Stock—Class A Par value per share Shares issued Shares outstanding Common Stock—Class B Par value per share Shares authorized Shares issued Shares outstanding Treasury Stock Shares held 2003 2002 $0.01 $0.01 10,000,000 10,000,000 — — $0.01 $0.01 78,358,189 50,000,000 47,399,302 47,399,302 41,490,699 40,923,130 $0.01 $0.01 — — — — 28,358,189 5,829,075 5,829,075 567,568 Zebra’s Certificate of Incorporation provides that if the outstanding shares of Zebra Class B common stock cease to represent at least 10% of the aggregate number of shares of Zebra common stock then outstanding, each share of Zebra Class B com- mon stock shall automatically convert into one share of Zebra Class A common stock. Class B common stock entitles the holder to ten votes per share while Class A common stock entitles the holder to one vote per share, on each matter submit- ted to a vote of Zebra’s stockholders. Class B shares fell below 10% of the out- standing shares on July 1, 2003, and the required automatic conversion occurred at that time. Upon conversion of the Class B common stock, the number of authorized shares of Class A common stock increased to 78,358,189, and the number of autho- rized shares of Class B common stock decreased to zero. 43 N O T E S to Consolidated Financial Statements On July 24, 2003, the Board of Directors authorized a fifty percent (50%) stock Note 6 Earnings Per Share dividend on each issued share of Class A common stock, payable before the close For the years ended December 31, 2003, 2002, and 2001, earnings per share were of business on August 21, 2003, to holders of record at the close of business on computed as follows (in thousands, except per-share amounts): August 7, 2003. All share counts and per-share amounts were restated to reflect this stock dividend. Stockholder Rights Agreement. Zebra’s Board of Directors adopted a Stockholder Rights Agreement under which stock purchase rights were paid by dividend to stockholders of record on March 15, 2002 at the rate of one Class A Right for each outstanding share of Class A Common Stock. Each Class A Right, other than those Year Ended December 31, Basic earnings per share: Net income 2003 2002 2001 $91,696 $71,595 Weighted average common shares outstanding 47,098 46,452 Per share amount Diluted earnings per share: Net income $ 1.95 $ 1.54 $91,696 $71,595 $61,529 45,949 $ 1.34 $61,529 45,949 356 held by the acquiring person, entitles the registered holder to purchase one ten- Weighted average common shares outstanding 47,098 46,452 thousandth of a share of Series A Junior Participating Preferred Stock, par value Add: Effect of dilutive securities – stock options 565 418 $0.01 per share, at a price of $300 per one ten-thousandth of Class A Preferred Diluted weighted average and equivalent Share after the distribution date. The distribution date is 10 days after the date on which any person or group announces that it has acquired 15% or more of Zebra’s outstanding common stock or 10 days (or a later date as determined by the Board of Directors) after the date on which any person or group announces or com- mences a tender offer that would result in the person or group becoming an owner of 15% or more of the outstanding common stock. shares outstanding Per share amount 47,663 46,870 46,305 $ 1.92 $ 1.53 $ 1.33 The potentially dilutive securities, which were excluded from the earnings per share calculation, consisted of stock options for which the exercise price was greater than the average market price of the Class A Common Stock. For the years ended December 31, the shares amounted to 52,712 in 2003, 194,875 in 2002, and The Rights will expire on March 14, 2012 unless that date has been extended by the 436,325 in 2001. Board of Directors or unless the Rights are redeemed or terminated earlier. A com- mittee of Zebra’s independent directors will review the Rights Plan at least every Note 7 Investments and Marketable Securities three years and decide whether it should continue or be revoked. Zebra generally During the first quarter of 2003, we changed the classification of certain invest- may amend the Rights Plan or redeem the Rights at $0.001 per Right at any time ments and marketable securities from the trading category to the available-for-sale prior to the time a person or group has acquired at least 15% of the outstanding category. We made this change because we are no longer buying securities with common stock. 44 the intent to sell them in the near term. We account for these investments under the rules in SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. SFAS No. 115 requires that changes in the market value of available-for-sale securi- ties are reflected in the accumulated other comprehensive income section of stock- holders’ equity in the balance sheet, until disposed of. Once these securities are disposed of, either by sale or maturity, the accumulated changes in market value are transferred to investment income. Z E B R A T E C H N O L O G I E S C O R P O R A T I O N Changes in market value of trading securities are recorded in investment income as Unrealized gains and losses on investment securities are included in these financial they occur, and the related cash flow statement includes changes in the balances of statements as follows (in thousands): trading securities as operating cash flows. Year Ended December 31, 2003 2002 The amortized cost, gross unrealized holding gains, gross unrealized holding losses and aggregate fair value of investment securities at December 31, 2003, were as follows (in thousands): Unrealized gains (losses) on available-for-sale securities, recorded net of tax, in accumulated other comprehensive income Unrealized gains (losses) on trading securities $346 $(1,603) Available-for-sale: U.S. government and agency securities State and municipal bonds Equity securities (included in other assets) Equity securities Corporate bonds Partnership interests Trading securities: Other Gross Gross Unrealized Unrealized Amortized Cost Holding Gains Holding Losses Fair Value $187,988 197,574 299 3,325 19,900 18,652 427,738 $ 207 464 — — 100 639 1,410 $(696) (224) (28) — — — $187,499 197,814 271 3,325 20,000 19,291 (948) 428,200 7,709 88 (28) 7,769 $435,447 $1,498 $(976) $435,969 The amortized cost, gross unrealized holding gains, gross unrealized holding losses and aggregate fair value of investment securities at December 31, 2002, were as in investment income $ 60 $(1,360) As of December 31, 2003, 29 investments in government securities with market val- ues aggregating $91,406,000 were less than amortized cost. In addition, 23 invest- ments in state and municipal bonds with market values aggregating $30,187,000 were less than amortized cost. These lower market values are caused by short- term fluctuations in interest rates and are not a reflection of the credit worthiness of the issuer. The market value of these securities has been below amortized cost for less than twelve months. Zebra is a limited partner in two non-registered partnerships. The partnerships seek to provide returns to its partners by making strategic investments in a diversi- fied portfolio of investment funds. Zebra’s investment as a limited partner allows it to have liability protection limited to the amount of its investments in the funds. The contractual maturities of debt securities at December 31, 2003, were as follows follows (in thousands): Available-for-sale (included in other assets): Equity securities Trading securities: U.S. government and agency securities State and municipal bonds Corporate bonds Partnership interests Other Gross Gross Unrealized Unrealized Amortized Cost Holding Gains Holding Losses Fair Value $ 365 $ — $ (42) $ 323 (in thousands): Due within one year Due after one year through five years Due after five years Fair Value $178,778 180,638 53,666 $413,082 96,195 174,508 34,316 15,676 7,607 328,302 207 275 149 3,139 28 3,798 (152) (1,565) (196) (12) (16) 96,250 173,218 34,269 18,803 7,619 $328,667 $3,798 $(1,983) $330,482 Realized gains (losses) (1,941) 330,159 Proceeds Using the specific identification method, the proceeds and realized gains on the sales of available-for-sale securities were as follows (in thousands): 2003 $338,557 $ 250 2002 $3,499 $1,760 2001 $ — $(2,242) 45 N O T E S to Consolidated Financial Statements The realized gain of $1,760,000 in 2002 includes a gain on the sale of an available- Note 9 Inventories for-sale stock offset by an additional write-down of an available-for-sale security The components of inventories, net of allowances, are as follows (in thousands): whose decline in value was determined to be other than temporary. The realized loss of $2,242,000 in 2001 is the result of a write-down of an available-for-sale security whose decline in value was determined to be other than temporary. Note 8 Related-Party Transactions Unique Building Corporation (Unique), an entity controlled by certain officers and stockholders of Zebra, leases a facility and equipment to Zebra under a lease described in Note 15. Management believes that the lease payments are substan- tially consistent with amounts that could have been negotiated with third parties on an arm’s-length basis and represent conditions at the time of the negotiations. Lease payments related to the leases, and recorded as a component of all func- tional areas, were included in the consolidated financial statements as follows (in thousands): 2003 2002 2001 Unique Operating Lease Payments $2,198 2,085 2,085 Future minimum lease payments related to this lease as of December 31, 2003, are as follows (in thousands): 2004 2005 2006 2007 2008 Thereafter Total minimum lease payments 46 Operating Leases $ 2,284 2,336 2,336 2,336 2,380 14,962 $26,634 December 31, Raw material Work in process Finished goods Total inventories 2003 $29,127 645 13,009 $42,781 2002 $21,404 1,104 15,558 $38,066 Note 10 Property and Equipment Property and equipment, which includes assets under capital leases, is comprised of the following (in thousands): December 31, Buildings Land Machinery, equipment and tooling Machinery and equipment under capital leases Furniture and office equipment Computers and software Automobiles Leasehold improvements Projects in progress Less accumulated depreciation and amortization Net property and equipment 2003 $ 11,911 1,910 43,674 1,482 6,415 37,486 128 4,878 2,473 110,357 (71,071) $ 39,286 2002 $ 11,499 1,910 38,941 2,757 6,164 33,899 153 4,012 1,274 100,609 (61,147) $ 39,462 Amortization of capitalized software was $2,132,000 in 2003, $2,042,000 in 2002, and $1,834,000 in 2001. Note 11 Income Taxes The geographical sources of earnings before income taxes were as follows (in thousands): Year Ended December 31, United States Outside United States Total 2003 $132,056 3,936 $135,992 2002 $101,454 9,429 $110,883 2001 $90,272 5,867 $96,139 Zebra does not provide for deferred income taxes on undistributed earnings of for- Beginning in 1998, we were involved in a series of tax disputes with the State of eign subsidiaries, which totaled approximately $22,500,000 at December 31, 2003 Illinois covering our Illinois income taxes from 1993 through 2000. Throughout the and $11,600,000 at December 31, 2002. Should such earnings be remitted to Zebra, dispute, we regularly reviewed and updated our reserves based on our estimate foreign tax credits would be available to substantially offset the U.S. income taxes of the final outcome that would be achieved. During the fourth quarter of 2003, we due upon repatriation. reached a settlement with the State of Illinois in the amount of $7,000,000, cover- Z E B R A T E C H N O L O G I E S C O R P O R A T I O N The provision for income taxes consists of the following (in thousands): Year Ended December 31, 2003 2002 2001 ing all disputed issues for 1993 through 2000. As a result of the settlement, we recorded a reduction to income tax expense for the amount our reserves exceeded that settlement, or $1,342,000, during the fourth Current: Federal State Foreign Deferred: Federal State Foreign Total $38,954 $30,660 $25,998 quarter of 2003. In addition, we received interest of $306,000 on the protest funds 3,723 2,561 (261) (35) (646) 5,247 3,254 296 40 (209) 5,319 2,107 1,132 152 (98) we had on deposit with the State of Illinois. This interest was recorded as interest income during the fourth quarter of 2003. Tax effects of temporary differences that give rise to deferred tax assets and liabili- ties are as follows (in thousands): $44,296 $39,288 $34,610 December 31, 2003 2002 The provision for income taxes differs from the amount computed by applying the U.S. statutory Federal income tax rate of 35%. The reconciliation of statutory and effective income taxes is presented below (in thousands): Year Ended December 31, 2003 Provision computed at statutory rate $47,597 State income tax (net of Federal tax benefit) 2,952 Federal tax benefit of state tax settlement (2,450) Tax-exempt interest and dividend income (1,674) Tax benefit of exempt foreign trade income (1,488) Research & experimental credit study Other (1,959) 1,318 2002 $38,809 3,634 — (2,422) (1,575) — 842 2001 $33,649 3,556 — (1,524) (1,438) — 367 Provision for income taxes $44,296 $39,288 $34,610 Deferred income taxes reflect the impact of temporary differences between the amounts of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws. Based on management’s assessment, it is more likely than not that the deferred tax assets will be realized through future taxable earnings. Deferred tax assets: Deferred rent-building Capital equipment lease Accrued vacation Deferred compensation Inventory items Allowance for doubtful accounts Other accruals Acquisition related items Unrealized loss on securities Total deferred tax assets Deferred tax liabilities: Unrealized gain on securities Depreciation and amortization Total deferred tax liabilities Net deferred tax asset $ 205 $ 165 88 643 1,099 2,848 235 3,407 1,886 168 10,579 (11) (6,784) (6,795) $ 3,784 114 647 — 2,008 19 3,424 2,114 189 8,680 — (2,851) (2,851) $ 5,829 47 N O T E S to Consolidated Financial Statements Note 12 Goodwill and Other Intangible Asset Data We evaluate the impairment of long-lived assets whenever events or changes in During the first quarter of 2002, we implemented SFAS No. 142, Goodwill and circumstances indicate that the carrying value may not be recoverable. Other Intangible Assets, which replaces the requirements to amortize intangible assets with indefinite lives and goodwill with a requirement for an annual impair- Factors considered that might trigger an impairment review consist of: ment test. SFAS No. 142 also set requirements for identifiable intangible assets. As (cid:127) Significant underperformance relative to expected historical or projected future a result, during the first quarter of 2002 Zebra reclassified $21,720,000 of intangible operating results assets that did meet the established requirements for goodwill. (cid:127) Significant changes in the manner of use of the acquired assets or the strategy Intangible asset data are as follows (in thousands): December 31, 2003 2002 Gross Gross Carrying Accumulated Carrying Accumulated Amount Amortization Amount Amortization Amortized intangible assets Current technology $12,033 $(5,466) $ 7,422 $(3,866) for the overall business (cid:127) Significant negative industry or economic trends (cid:127) Significant decline in Zebra’s stock price for a sustained period (cid:127) 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 a projected discounted cash flow using a discount rate that incorporates the risk inherent in the cash flows. In-process research and development Customer relationships Unamortized intangible assets 692 2,503 (692) (39) Goodwill $61,150 Aggregate amortization expense For the year ended December 31, 2002 For the year ended December 31, 2003 $ 1,640 Estimated amortization expense For the year ended December 31, 2004 For the year ended December 31, 2005 For the year ended December 31, 2006 For the year ended December 31, 2007 For the year ended December 31, 2008 For the year ended December 31, 2009 For the year ended December 31, 2010 For the year ended December 31, 2011 2,551 1,674 1,086 1,086 1,083 965 313 273 $54,455 $ 1,494 Operating income for 2001 includes $3,835,000 of amortization of goodwill and other intangible assets that are not included in 2002 and 2003 results, because of the implementation of SFAS No. 142. If adjusted for the impact of the implementa- tion of SFAS No. 142 (i.e., if goodwill had not been amortized), net income, basic earnings per share, and diluted earnings per share would have been as follows: Year Ended December 31, Net income Basic earnings per share Diluted earnings per share 2001 $63,983 $ 1.39 $ 1.38 Note 13 401(k) Savings and Profit Sharing Plans Zebra has a Retirement Savings and Investment Plan (the 401(k) Plan), which is intended to qualify under Section 401(k) of the Internal Revenue Code. 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. Zebra matches each participant’s contribution of up to 6% of gross eligible earn- ings at the rate of 50%. Zebra may contribute additional amounts to the 401(k) Plan at the discretion of the Board of Directors, subject to certain legal limits. We test the impairment of identifiable intangibles and goodwill each year or when- ever events or changes in circumstances indicate that the carrying value may not be recoverable. We completed our last assessment during June 2003. 48 Zebra has a discretionary profit-sharing plan for qualified employees, to which Hedging of Anticipated Sales it contributed 2.4% of eligible payroll for 2003, 1.9% for 2002 and 1.9% for 2001. During the second quarter of 2003, we began a program to manage the exchange Participants are not permitted to make contributions under the profit-sharing plan. rate risk of anticipated euro denominated sales using forward contracts and desig- Company contributions to these plans, which were charged to operations, approxi- contracts are deferred in other comprehensive income until the contracts are set- nated these contracts as cash flow hedges. Unrealized gains and losses on these Z E B R A T E C H N O L O G I E S C O R P O R A T I O N mated the following (in thousands): Year Ended December 31, 401(k) Profit sharing Total 2003 $1,572 1,544 $3,116 2002 $1,452 1,146 $2,598 2001 $1,374 1,178 $2,552 tled and the hedged sales are realized, at which time the deferred gains or losses will be reported as an increase or decrease to sales. Summary financial informa- tion related to the cash flow hedges of future revenues follows (in thousands, except percentages): December 31, Net unrealized gains (losses) deferred in other comprehensive income: Note 14 Derivative Instruments In the normal course of business, portions of Zebra’s operations are subject to fluctuations in currency values. We manage these risks using derivative financial Gross Tax benefit Net instruments. Hedging of Net Assets We use forward contracts and options to manage exposure related to our pound Net gain (loss) included in revenue for the following periods ended December 31, 2003: Three months Year and euro denominated net assets. We record gains and losses on these contracts Notional balance of outstanding contracts: and options in income each quarter along with the translation gains and losses Hedge effectiveness 2003 $ (1,537) 538 $ (999) $ (150) 265 €30,420 100% related to our net euro asset position, which would ordinarily offset each other. Summary financial information related to these activities follows (in thousands): Year Ended December 31, 2003 2002 2001 Change in gains (losses) from foreign exchange derivatives $(3,756) Gain (loss) on net foreign currency assets 3,204 Net foreign exchange gain (loss) $ (552) $(2,579) 2,926 $ 347 $(1,642) 746 $ (896) December 31, 2003 2002 Notional balance of outstanding contracts: Pound Euro £8,569 €22,000 £3,293 €26,000 Note 15 Commitments and Contingencies Leases. In September 1989, Zebra entered into a lease agreement for its Vernon Hills facility and certain machinery, equipment, furniture and fixtures with Unique Building Corporation, a related party. The facility portion of the lease is the only remaining portion in existence as of December 31, 2003, and is treated as an operat- ing lease. An amendment to the lease dated July 1997 added 59,150 square feet and extended the term of the existing lease through June 30, 2014. The lease agreement includes a modification to the base monthly rental, which goes into effect if the prescribed rent payment is less than the aggregate principal and interest payments required to be made by Unique under an Industrial Revenue Bond (IRB). 49 N O T E S to Consolidated Financial Statements Minimum future obligations under non-cancelable operating leases and future mini- On November 21, 2003, ZIH Corp. (ZIH) filed a Complaint in the United States mum capital lease payments as of December 31, 2003, are as follows (in thousands): District Court for the District of Massachusetts against Paxar Corporation, alleg- 2004 2005 2006 2007 2008 Thereafter Total minimum lease payments Less amount representing interest Present value of minimum payments Less current portion of obligation under capital lease Long-term portion of obligation under capital lease Operating Leases $ 4,248 3,669 3,477 3,260 3,226 19,102 $36,982 Capital Leases $190 190 175 34 29 87 705 (100) 605 (153) $452 Rent expense for operating leases charged to operations for the years ended December 31, 2003, 2002, and 2001 was $5,591,000, $5,699,000, and $4,917,000, respectively. Letter of credit. In connection with the lease agreements described above, Zebra has guaranteed Unique’s full and prompt payment under Unique’s letter of credit agreement with a bank. The contingent liability of Zebra under this guaranty as of December 31, 2003, is $700,000, which is the limit of Zebra’s guaranty throughout the term of the IRB. Legal proceedings. On April 23, 2003, Paxar Americas, Inc., (Paxar Americas) filed a patent infringement lawsuit in the United States District Court for the Southern District of Ohio against Zebra and certain of its subsidiaries. Paxar Americas’ Complaint alleges that certain of Zebra’s printer products infringe one or more of eight identified Paxar Americas patents, although not each product is accused of infringing each patent. Zebra has filed an Answer to Paxar Americas’ Complaint, denying Paxar Americas’ allegations of infringement and asserting several affirma- tive defenses, including the invalidity of Paxar Americas’ asserted patent claims. ing that Paxar Corporation printers infringe ZIH’s U.S. Patent Nos. 5,813,343 and 5,860,753. Paxar Corporation answered ZIH’s Complaint, denying infringement and seeking a declaratory judgment that ZIH’s patents-in-suit are not infringed and are invalid and/or unenforceable. Paxar Corporation filed a motion to transfer ZIH’s Massachusetts suit to Ohio federal court. ZIH opposed Paxar Corporation’s motion to transfer, and the parties are awaiting the Court’s ruling on the transfer motion. On November 25, 2003, Paxar Americas filed a Complaint against ZIH in the United States District Court for the Southern District of Ohio, seeking a declara- tory judgment that the patents asserted by ZIH in its Massachusetts Complaint are not infringed and are invalid and unenforceable. On December 17, 2003, Paxar Americas amended its complaint to add Zebra Technologies Corporation as a defendant. The parties have filed a motion to stay this action pending the Massachusetts District Court’s ruling on Paxar Corporation’s motion to transfer. The parties have agreed to file a motion to transfer this action to the Massachusetts District Court if the Massachusetts District Court denies Paxar Corporation’s pending motion to transfer. We are unable at this time to estimate the range of the potential liability that would result from an unsuccessful defense, and consistent with the requirements of SFAS No. 5, Accounting for Contingencies, no liability has been recorded in Zebra’s con- solidated financial statements as of December 31, 2003. Note 16 Segment Data and Export Sales Zebra is organized with two internal business units, bar code and card imaging. These business units have similar economic characteristics, products and services, production processes, types of customers, distribution methods, and regulatory environments. Additionally, there are significant shared services supporting both business units. Because of these similarities, we have aggregated our internal busi- ness units and have treated them as one reportable segment as permitted by SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. 50 Z E B R A T E C H N O L O G I E S C O R P O R A T I O N Information regarding Zebra’s operations by geographic area for the years ended for under SFAS No. 146, Accounting for Costs Associated with Exit or Disposal December 31, 2003, 2002, and 2001 is contained in the following table. These amounts Activities. All exit costs associated with this activity will be identified on a separate (in thousands) are reported in the geographic area where the final sale originates. line of our income statement, as part of operating expenses. Our consolidation plan is intended to reduce costs and improve manufacturing efficiency. North America Europe, Middle East & Africa Latin America Asia Total Currently, our Varades facility conducts the product development for our line of card 2003 Net sales $292,543 $170,544 $29,406 $43,904 $536,397 Long-lived assets 102,962 6,415 3 87 109,467 imaging identification printers and includes the European service center for these printers. We will transfer the product development activities to Camarillo, California, where we have manufactured these printers since 2001. We will transfer the European card imaging printer service operation to our Preston, United Kingdom, 2002 Net sales $270,288 $142,273 $28,097 $34,953 $475,611 facility where the Europe, Middle East and African distribution of these printers Long-lived assets 90,873 6,502 — 98 97,473 already occurs. Additionally, we will eliminate the Varades administrative functions 2001 Net sales $269,955 $128,348 $21,752 $29,953 $450,008 including finance, information systems and human resources support. At the com- pletion of the plan, the Varades facility will be closed and no employees will remain. Long-lived assets 93,345 6,749 — 76 100,170 As of December 31, 2003, we expect the following exit costs (in thousands): Note 17 Deferred Compensation Plan Type of Cost Severance, stay bonuses, and other Total expected to be incurred Beginning January 1, 2002, Zebra offered a deferred compensation plan that per- employee-related expenses mits management and highly compensated employees to defer portions of their compensation and to select a method of investing these funds. The salaries that have been deferred since the plan’s inception have been accrued and the only expense, other than salaries, related to this plan is the unrealized gain/loss on the deferred amounts. Investment income includes an unrealized loss of $60,000 for 2003 and $16,000 for 2002 related to this plan. Zebra has included $2,401,000 in other long-term liabilities at December 31, 2003 and $1,008,000 at December 31, 2002, to reflect its liability under this plan. To fund this plan, Zebra purchases cor- porate-owned whole-life insurance contracts on the related employees, of which Zebra is the beneficiary. Investments and marketable securities include the cash surrender value of these policies aggregating $2,116,000 as of December 31, 2003, and $914,000 as of December 31, 2002. Note 18 Costs Associated with Exit or Disposal Activities During the third quarter of 2003, we initiated a plan to close our engineering site in Varades, France. This plan was announced in October 2003 and will be accounted Asset disposal costs Other exit costs Total $1,436 278 650 $2,364 As of December 31, 2003, costs of $990,000 have been accrued that are associated with this program. During the fourth quarter of 2003, $242,000 was paid out for severance and other related expenses. During January 2004, we announced plans to consolidate our Warwick, Rhode Island, printer manufacturing and repair service business into our Camarillo, California and Vernon Hills, Illinois locations. This transition is expected to take 12 to 18 months to complete. The Warwick facility will continue to manufacture and distribute bar code label printer supplies, as well as house engineering, product management, and the key account sales functions for mobile products. We expect the following exit costs: 51 N O T E S to Consolidated Financial Statements Type of Cost Severance, stay bonuses, and other employee-related expenses Asset disposal costs Other exit costs Total Total expected to be incurred The changes in other comprehensive income (loss) are as follows (in thousands): $ 820 275 553 $1,648 Year Ended December 31, 2003 Foreign currency translation adjustments $ 4,110 2002 $ 2,968 2001 $ (977) Changes in unrealized holding losses on foreign currency hedging activities: Gross Income tax (benefit) Net $(1,537) (538) $ (999) — — — — — — As of December 31, 2003, no costs have been accrued that are associated with this program. Note 19 Other Comprehensive Income (Loss) Stockholders’ equity contains certain items classified as other comprehensive income, including: (cid:127) Foreign currency translation adjustments related to our non-U.S. subsidiary Net companies that have designated a functional currency other than the dollar. We are required to translate the subsidiary functional currency financial statements to dollars using a combination of historical, month-end, and average foreign exchange rates. This combination of rates creates the foreign currency translation adjustments component of other comprehensive income. Changes in unrealized gains (losses) on investments classified as available-for-sale: Gross Income tax (benefit) $ 504 158 $ 346 $(2,466) (863) $(1,603) $ 4,688 1,688 $ 3,000 The components of other comprehensive income (loss) appearing in the balance sheet are as follows: December 31, 2003 Unrealized holding gain (loss) on investments (net of tax) $ 318 2002 $(28) — — $(28) (cid:127) Unrealized holding gains (losses) on foreign currency hedging activities relate to Unrealized holding loss on hedging transactions (net of tax) derivative instruments used to hedge the currency exchange rates for forecasted Cumulative translation adjustment euro sales. These hedges are designated as cash flow hedges, and we have deferred income statement recognition of gains and losses until the hedged trans- action occurs. See Note 14 for more details. (cid:127) Unrealized gains (losses) on investments classified as available-for-sale are deferred from income statement recognition. See Note 7 for more details. (999) 4,110 $3,429 52 Z E B R A T E C H N O L O G I E S C O R P O R A T I O N Note 20 Quarterly Results of Operations (unaudited) (Amounts in thousands, except per share data) 2003 Net sales Cost of sales Gross profit First Quarter Second Quarter Third Quarter Fourth Quarter $124,685 $129,863 $134,649 $147,200 60,336 63,305 66,876 72,803 64,349 66,558 67,773 74,397 2002 Net sales Cost of sales Gross profit Selling and marketing Research and engineering General and administrative Amortization of intangibles Acquired in-process technology Exit costs Merger costs 14,504 16,754 15,871 19,506 Selling and marketing 7,579 7,560 7,898 8,722 10,251 10,248 9,937 11,456 371 371 371 — — — — — — — — — 527 692 1,232 9 Research and engineering General and administrative Amortization of intangibles Costs related to terminated acquisition Merger costs Total operating expenses Total operating expenses 32,705 34,933 34,077 42,144 Operating income First Quarter Second Quarter Third Quarter Fourth Quarter $110,185 $115,951 $123,151 $126,324 58,173 52,012 11,949 7,456 9,329 367 3,300 73 32,474 19,538 60,202 55,749 13,531 7,472 9,413 367 — — 30,783 24,966 62,729 60,422 14,343 7,609 9,213 373 — — 63,760 62,564 16,354 6,673 10,733 387 — — 31,538 28,884 34,147 28,417 Operating income 31,644 31,625 33,696 32,253 Investment income (expense) 4,167 1,188 2,227 2,422 Investment income (expense) Interest expense Foreign exchange gain (loss) Other, net Total other income (expense) 2,439 (38) (143) 6 2,264 3,017 (14) (87) (292) (982) 4,079 Interest expense (64) (18) (263) (38) (304) (524) Foreign exchange gain (loss) Other, net Total other income (expense) 2,624 (1,327) 3,213 Income before taxes 33,908 34,249 32,369 35,466 Income taxes Net income 11,868 11,987 9,370 11,071 $ 22,040 $ 22,262 $ 22,999 $ 24,395 Income before taxes Income taxes Net income (55) (158) (155) 3,799 (32) (193) (220) 743 (114) 25 (458) (118) 673 (121) 1,680 2,856 23,337 8,397 25,709 9,249 30,564 10,697 31,273 10,945 $ 14,940 $ 16,460 $ 19,867 $ 20,328 Basic earnings per share $ 0.32(1) $ 0.35(1) $ 0.43(1) $ 0.44(1) Basic earnings per share $ 0.47(1) $ 0.47(1) $ 0.49 $ 0.52 Diluted earnings per share $ 0.32(1) $ 0.35(1) $ 0.42(1) $ 0.43(1) Diluted earnings per share $ 0.47(1) $ 0.47(1) $ 0.48 $ 0.51 (1) Restated for a 3-for-2 stock split in August 2003 paid in the form of a 50% stock dividend. (2) Includes pretax charges of $1,232 related to the closure of the Varades, France facility and $701 for integration and in-process research and development costs related to the acquisition of Atlantek, Inc. (3) First quarter 2002 includes $3,300 in operating expenses related to the terminated acquisition of Fargo Electronics, Inc. (4) Includes pretax charges for integration costs relating to the acquisition of Comtec Information Systems, Inc., of $73 in the first quarter of 2002. Note 21 Major Customers Sales to ScanSource, Inc., accounted for 13.8% of net sales in 2003 and 13.6% in 2002. No customer accounted for 10% or more of net sales in 2001. 53 I N D E P E N D E N T A U D I T O R S ’ R E P O R T The Board of Directors and Stockholders Zebra Technologies Corporation: We have audited the accompanying consolidated balance sheets of Zebra We conducted our audits in accordance with auditing standards generally accepted Technologies Corporation and Subsidiaries as of December 31, 2003 and 2002, and in the United States of America. Those standards require that we plan and perform the related consolidated statements of earnings, comprehensive income, stock- the audit to obtain reasonable assurance about whether the financial statements holders’ equity, and cash flows for each of the years in the three-year period ended are free of material misstatement. An audit includes examining, on a test basis, evi- December 31, 2003. In connection with our audits of the consolidated financial dence supporting the amounts and disclosures in the financial statements. An audit statements, we also have audited the consolidated financial statement schedule of also includes assessing the accounting principles used and significant estimates valuation and qualifying accounts. These consolidated financial statements and the made by management, as well as evaluating the overall financial statement presen- consolidated financial statement schedule are the responsibility of the Company’s tation. We believe that our audits provide a reasonable basis for our opinion. management. Our responsibility is to express an opinion on these consolidated financial statements and the consolidated financial statement schedule based on In our opinion, the consolidated financial statements referred to above pres- our audits. 54 ent fairly, in all material respects, the financial position of Zebra Technologies Corporation and Subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles gen- erally accepted in the United States of America. Also, in our opinion, the related consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. KPMG LLP Chicago, Illinois February 9, 2004 B O A R D O F D I R E C T O R S A N D C O R P O R A T E O F F I C E R S Z E B R A T E C H N O L O G I E S C O R P O R A T I O N Board of Directors Officers Edward L. Kaplan Chairman and Chief Executive Officer Zebra Technologies Corporation Gerhard Cless Executive Vice President and Secretary Zebra Technologies Corporation Christopher G. Knowles (1)(2)(3) Retired Chief Executive Officer Insurance Auto Auctions, Inc. Ross W. Manire (1) Chairman and Chief Executive Officer Clearlinx Network Corporation Dr. Robert J. Potter (2) Principal R.J. Potter Company Michael A. Smith (1)(3) Chairman and Chief Executive Officer FireVision, L.L.C. (1) Member of Audit Committee (2) Member of Compensation Committee (3) Member of Nominating Committee Edward L. Kaplan Chairman and Chief Executive Officer Gerhard Cless Executive Vice President and Secretary Veraje Anjargolian Vice President, General Manager Card Imaging Division Noel Elfant Vice President and General Counsel Hugh K. Gagnier Senior Vice President, Operations Bar Code Business Unit John H. Kindsvater Senior Vice President, Corporate Development Todd R. Naughton Vice President, Controller Michael H. Terzich Senior Vice President Office of the CEO Charles R. Whitchurch Chief Financial Officer and Treasurer 55 S T O C K H O L D E R I N F O R M A T I O N Corporate Headquarters Zebra Technologies Corporation 333 Corporate Woods Parkway Vernon Hills, Illinois 60061-3109 U.S.A. Phone: 847-634-6700 Fax: 847-913-8766 Annual Meeting Zebra’s Annual Meeting of Stockholders will be held on June 3, 2004, Equal Employment Opportunity/Affirmative Action It is the policy of Zebra Technologies Corporation to provide equal opportunity and affirmative action in all areas of its employment practices without regard to race, reli- gion, national origin, sex, age, ancestry, citizenship, disability, veteran status, marital status, sexual orientation or any other reason prohibited by law. Stock Information: Price Range and Common Stock The Company’s 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 10:30 A.M. (Central Time), at the Hilton Northbrook, 2855 North Milwaukee Avenue, quarter in 2003 and 2002, as reported by The NASDAQ Stock Market. Share prices Northbrook, Illinois. Independent Auditors KPMG LLP Chicago, Illinois Corporate Counsel Katten Muchin Zavis Rosenman Chicago, Illinois Transfer Agent and Registrar Mellon Investor Services 85 Challenger Road Ridgefield, New Jersey 07660 Phone: 877-870-2368 www.mellon-investor.com Investor Relations For corporate or product information, please contact the Corporate Headquarters. Form 10-K Report You may receive a free copy of the Zebra Technologies Corporation Form 10-K Report filed with the Securities and Exchange Commission by contacting the Investor Relations Department at the Corporate Headquarters. Web Site Investors are invited to learn more about Zebra Technologies Corporation by access- ing the Company’s web site at www.zebra.com 56 were adjusted for a 50% stock dividend that was distributed on August 21, 2003. 2003 First Quarter Second Quarter Third Quarter Fourth Quarter 2002 First Quarter Second Quarter Third Quarter Fourth Quarter High $43.49 51.93 56.08 67.20 High $39.33 40.10 38.63 45.73 Low $35.87 38.33 48.75 51.30 Low $31.51 31.58 30.08 32.33 Source: The NASDAQ Stock Market At February 20, 2004, the last reported price for the Class A Common Stock was $66.39 per share, and there were 380 registered stockholders of record for the Company’s Class A Common Stock. Dividend Policy Since the Company’s initial public offering in 1991, the Company has not declared any cash dividends or distributions on its capital stock. The Company intends to retain its earnings to finance future growth and therefore does not anticipate paying any cash dividends in the foreseeable future. Number of Employees The Company had approximately 2,200 associates as of February 25, 2004. Zebra Technologies Corporation International Headquarters 333 Corporate Woods Parkway | Vernon Hills, IL | 60061-3109 U.S.A. 847-634-6700 | www.zebra.com

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