Zebra Annual Report 2004

Plain-text annual report

What’s in it? Are you a member? Is it under warranty? How much did you pay? Does he have access? Is it on sale? How many are there? Who approved hen will it arrive? Where is it from? Is it authentic? How much does it cost? What is it? Who owns it? Where is it going? Who is it? When was it made? When does it expire? What needs to be done? Where was it found? What does he look like? What is her rank? How much does it weigh? Who is the doctor F I N A N C I A L S U M M A R Y 2004 % change 2003 % change 2002 ( In thousands, except per share data and percentages) Operating Results Net sales $ 663,054 23.6% $ 536,397 12.8% $ 475,611 Gross profit Operating income Net income 343,159 175,170 120,643 Diluted earnings per share 1.66 25.7 35.6 31.6 29.7 273,077 129,218 91,696 1.28 18.3 26.9 28.1 25.5 230,747 101,805 71,595 1.02 Capitalization Cash & cash equivalents and investments in marketable securities Working capital Total assets Total stockholders’ equity $ 557,993 665,062 862,222 797,654 $ 447,848 535,816 701,611 651,915 $ 348,577 427,676 573,088 534,155 Zebra Technologies delivers specialty digital printing solutions to targeted high-growth markets. We are a leading global provider of on-demand thermal bar code label and receipt printers and supplies, plastic card printers, radio frequency identiﬁ cation (RFID) smart label printer/encoders, smart media, and digital photo printers. Business, governments and other organizations depend on Zebra products to improve business processes, deliver better customer service, increase productivity, and strengthen security. Our commitment to industry leadership, ﬁ nancial strength and growth helps Zebra build long-term value for its customers, partners and stockholders. it? When r? A more effective Zebra organization is capturing more business in a broader spectrum of high- growth specialty digital printing applications. 2 Edward Kaplan Chairman and Chief Executive Officer L E T T E R T O S T O C K H O L D E R S By any measure, 2004 was an outstanding year. We achieved record financial results, as virtually all dimensions of our business attained new performance records. Our activities during the year extended our industry leadership and demonstrated the effectiveness of our strategy to deliver specialty digital printing solutions to targeted high-growth markets. We enter 2005 with more sources of growth than ever and great capacity to increase stockholder value further over the long term. Net sales of $663.1 million were up 24%, the highest sales growth for Zebra since 1996. Higher profitability leveraged this growth into a 32% increase in net income to $120.6 million, or $1.66 per diluted share. In August, we distributed the second three-for-two stock split in two years to enhance the liquidity of Zebra stock and broaden the company’s stockholder base. A year-end position in cash and investments of $558 million and no long-term debt gives us substantial capacity to make acquisitions, which are an important element in our strategy to grow stockholder value. Zebra’s growth came from a variety of sources: All product lines, geographies, and channels contributed to our record results. A broad portfolio of innovative printers, supplies and connectivity tools to support specialty printing applications remained the foundation for our success. Mobile printers stood out, enabling more enterprise mobility solutions, with large deployments in retail venues and finding new application in ware- housing, distribution, and hospitality. In addition, Zebra’s printer/encoders and recognized technical leadership enabled the first companies to adopt radio frequency identification technology to comply with new labeling mandates. More Zebra representatives placed in high-growth territories over the past several years extended global reach. This expansion has made Zebra a truly global company, with now nearly half of our business generated outside North America. Stronger channel partnerships aided in our goal to gain market share. With improved business execution, we delivered greater value in products, solutions, and services to our partners and customers on a global basis. Several drivers support ongoing high growth for Zebra. Global business expansion and competition are leading companies to implement barcoding and automatic identification technologies deeper in the enterprise for business process improvement. In addition, with the industry’s broadest product line and our clear global leadership, we are well positioned to assist companies comply with radio frequency identification mandates from large retailers and the U.S. Department of Defense. Introductions of additional products will support wider adoption for both current compliance labeling activities and emerging applications beyond supply chain management. Mandates and initiatives by the Food and Drug Administration and other agencies are now leading to wider use of auto-ID technologies in health care. Zebra is at the forefront of this trend to improve patient safety in ways that reduce errors and save lives. Heightened concern for personal safety and the protection of assets sustain further growth of card printing solutions. Our expertise in color imaging from card printing enhances our prospects in digital photo printing. With digital camera sales now exceeding film-based camera sales, we have extended opportunities in this area. A sharper focus on vertical market applications adds to our favorable outlook. Opportunities in retail remain high, as more companies deploy productivity-enhancing technologies to lower costs and improve customer satisfaction. Mobile and wireless printing support growth in several vertical market applications. We are also moving aggressively into new areas with innovative products. The RW 420, the first thermal printer optimized for route accounting and direct store delivery, has already opened several new incremental sales opportunities since its introduction late last year. avenues for growth. By extending our global reach, we will help more companies improve business processes in developing market economies around the world. Zebra’s future is bright. Thanks to the hard work and commitment of all Zebra associates, our business strategy is working and building stockholder value. Favorable underlying forces support high adoption rates of barcoding and automatic identification technologies worldwide. A more effective Zebra organization is capturing more business in a broader spectrum of high-growth specialty digital printing applications. With industry-leading products, brand equity, financial strength, and global reach, all of this makes us look to 2005 and beyond with great optimism for further growth and success. Thank you for your continuing investment in Zebra. Further deployments of Zebra representatives in international regions continue to offer substantial Edward Kaplan Chairman and Chief Executive Officer P R O D U C T L I N E E V O L U T I O N DIGITAL PHOTO RFID MOBILE PLASTIC CARD DESKTOP MIDRANGE HIGH PERFORMANCE 85 92 98 00 03 The breadth of printer devices feeds more printer applications on a global basis. 3 Product Excellence Superior Reputation Advanced Technology Best-of-breed Solutions Outstanding Customer Service Knowledgeable Associates Trusted Brand Global Distribution 4 Many companies talk about creating stockholder value. Few actually do it. Since our initial public offering in 1991, Zebra’s market capitalization, a measure of stockholder value, increased from $186 million to $4 billion at the end of 2004 for a 25% average annual return. Few companies can boast Zebra’s 23% average annual sales growth and 21% growth in earnings, with returns on invested capital often exceeding 50%. With effective technology, product leadership, broad-based distribution and support, and global reach, Zebra has a unique set of competitive advantages. We use these advantages to provide best-of-breed products for solutions that deliver real value to our customers and end-users. Our focus on clear global leadership in specialty digital printing solutions for targeted niche markets offers abundant opportunities for Zebra to deliver further growth in stockholder value. 5 C O M P L I A N C E L A B E L I N G R F I D Solutions A pioneer in the targeted adoption of radio frequency identiﬁ cation technology, Zebra is building on its leadership in bar code labeling solutions to assist companies charged with meeting the new wave of compliance labeling mandates. Zebra’s broad line of RFID printer/ encoders and smart labels offer customers the quality, reliability and ease of integration that is vital to mission-critical situations. Technology expertise, product leadership, and key alliances reinforce the trust companies place in Zebra as a partner in implementing this emerging technology. R 110 Xi 6 D I G I T A L C O L O R P R I N T I N G Positive Identiﬁ cation The world of color expands Zebra’s on-demand specialty printing opportunities. Zebra plastic card printers create customized driver’s licenses, credit cards, membership cards, and employee badges right at the point of issuance. These cards incorporate a wide range of security features. New digital photo printers build on our core thermal printing technology and enable users to print high-quality keepsakes for enduring memories. Kodak 880 0 Photo Printer 7 B U S I N E S S I M P R O V E M E N T Supply Chain Logistics Global competition demands the greatest efﬁ ciency in moving goods through the supply chain, from farms and factories through distribution to the end user. Zebra’s bar code labeling solutions improve the speed and accuracy of data management, and integrate with enterprise applications to increase asset visibility and control. Real-time tracking of raw materials, work in process and customer orders reduces cycle time, improves employee productivity and lowers costs. Z4 Mp lus TM 8 V E R T I C A L M A R K E T A P P L I C A T I O N S Patient Safety Accurate patient identiﬁ cation is essential to prevent errors in the delivery of medication and other health care services. Zebra printers and specialized Z-band® direct thermal poly wristbands give health care workers the ability to conduct a reliable bedside match of patient and medication, and to meet HIPPA privacy laws. Printing solutions from Zebra, a pioneer in bar code solutions for life sciences, provide a foundation to extend safeguards throughout the health care delivery system. 44-Z 9 M O B I L E A N D W I R E L E S S Route Accounting Mobile and wireless printing extends the beneﬁ ts of barcoding, labeling, ticketing and receipt printing beyond the walls of an enterprise. Field service and route drivers can serve customers on the spot, making this one of the fastest- growing applications in the world of enterprise mobility. Zebra’s new line of mobile printers, optimized for route accounting and direct store delivery, save time, improve quality and cash ﬂ ow, and help provide better customer service. 10 R W 420 G L O B A L R E A C H New Markets Every day, Zebra is helping people in more organizations improve business processes. Global competition, developing market economies and the ongoing drive for innovation offer Zebra abundant opportunities for growth worldwide. We are capturing these opportunities with an expanding portfolio of specialty digital printing solutions to feed more printer applications, along with the systematic delivery of greater value in products and services to our partners and customers on a global basis. 11 S T O C K P R I C E Zebra Technologies Corp. [ZBRA] N E T S A L E S In millions D I L U T E D E P S In dollars $65 60 55 50 45 40 35 30 25 20 15 10 5 0 $650 600 550 500 450 400 350 300 250 200 150 100 50 0 $1.95 1.80 1.65 1.50 1.35 1.20 1.05 .90 .75 .60 .45 .30 .15 0 00 01 02 03 04 00 01 02 03 04 00 01 02 03 04 Indicates closing price 12 SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 □X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the ﬁ scal year ended December 31, 2004 OR □ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Indicate by check mark whether the registrant (1) has ﬁ led all reports required to be ﬁ led by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to ﬁ le such reports) and (2) has been subject to such ﬁ ling requirements for the past 90 days. Yes X No __ Indicate by check mark if disclosure of delinquent ﬁ lers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in deﬁ nitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated ﬁ ler (as deﬁ ned in Exchange Act Rule 12b-2). Yes X No __ As of February 25, 2005, the aggregate market value of each of the registrant’s Class A Common held by non-afﬁ liates was approximately $3,598,923,000. The closing price of the Class A Common Stock on February 25, 2005, as reported on the Nasdaq Stock Market, was $50.07 per share. As of February 25, 2005, the registrant had outstanding 71,877,827 shares of Class A Common Stock, par value $.01 per share Documents Incorporated by Reference Certain sections of the registrant’s Notice of Annual Meeting of Stockholders and Proxy Statement for its Annual Meeting of Stockholders to be held on May 17, 2005 are incorporated by reference into Part III of this report. Commission File Number 000-19406 Zebra Technologies Corporation (Exact name of registrant as speciﬁ ed in its charter) Delaware (State or other jurisdiction of incorporation or organization) 36-2675536 (I.R.S. Employer Identiﬁ cation No.) 333 Corporate Woods Parkway, Vernon Hills, IL 60061 (Zip Code) (Address of principal executive ofﬁ ces) Registrant’s telephone number, including area code: (847) 634-6700 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Class A Common Stock, par value $.01 per share ZEBRA TECHNOLOGIES CORPORATION AND SUBSIDIARIES PART I INDEX PAGE References in this document to “Zebra,” “we,” “us,” or “our” refer to Zebra Technologies Corporation and its subsidiaries, unless the context speciﬁ cally states otherwise. PART I Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . 8 PART II Item 5. Market for Registrant’s Common Stock and Related Stockholder Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Item 6. Selected Consolidated Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Item 7A. Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . 20 Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Item 9A. Controls and Procedures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 PART III Item 10. Directors and Executive Ofﬁ cers of the Registrant . . . . . . . . . . . . . . . . . . . . . . . 24 Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Item 12. Security Ownership of Certain Beneﬁ cial Owners and Management and Related Stockholder Matters . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . . . 24 Item 14. Principal Accounting Fees and Services. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 PART IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K . . . . . . . . . 24 SIGNATURES Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 EXHIBITS Index to Exhibits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE Index to Consolidated Financial Statements and Schedule . . . . . . . . . . . . . . . . . . . . . . . . F-1 1 Safe Harbor Forward-looking statements contained in this ﬁ ling are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995 and are highly dependent upon a variety of important factors which could cause actual results to differ materially from those reﬂ ected in such forward looking statements. These factors include market acceptance of Zebra’s printer and software products and competitors’ product offerings. They also include the effect of market conditions in North America and other geographic regions on our ﬁ nancial results. Proﬁ ts will be affected by our ability to control manufacturing and operating costs. Because of a large investment portfolio, interest rate and ﬁ nancial market conditions will also have an impact on results. Foreign exchange rates will have an effect on ﬁ nancial results due to the large percentage of our international sales. When used in this document and documents referenced, the words “anticipate,” “believe,” “estimate,” “will” and “expect” and similar expressions as they relate to Zebra or its management are intended to identify such forward-looking statements. We encourage readers of this report to review the Risk Factors portion of Management’s Discussion and Analysis of Financial Condition and Results of Operations, which discusses additional risks. Zebra undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances or any other reason after the date of this annual report. Item 1. Business The Company Zebra Technologies is in the business of making products that enable companies and organizations to improve productivity, deliver better customer service and provide more effective security. We design, manufacture and support a broad range of direct thermal and thermal transfer label and receipt printers, radio frequency identiﬁ cation (RFID) printer/encoders, dye sublimation card printers, and digital photo printers. We also sell related accessories and support software. Manufacturers, service organizations, and governments worldwide use our products in automatic identiﬁ cation, data collection and personal identiﬁ cation applications. We design our products to operate at the user’s location or on a mobile basis to produce and dispense high-quality labels, plastic cards, and photographs at the point of issuance on demand. The exceptional diversity of applications using our printer products for barcoding and personal identiﬁ cation is comprised of routing and tracking, transactions processing, and identiﬁ cation and authentication. They include applications that require high levels of data accuracy and where speed and reliability are critical. They also include specialty printing for receipts and tickets where improved customer service and productivity gains may be the primary reason for printing, rather than a barcoding application. Plastic cards are used for secure, reliable personal identiﬁ cation or access control. Digital photo printers are sold on an OEM basis to professional photographers. Applications for our technology span most industries and geographies. They include inventory control, small package delivery, baggage handling, automated warehousing, JIT (Just-In-Time) manufacturing, employee time and attendance records, ﬁ le management systems, hospital information systems, medical specimen labeling, shop ﬂ oor control, in-store product labeling, employee ID cards, driver’s licenses, and access control systems. As of December 31, 2004, management estimates that Zebra has sold more than 4,000,000 printers to users in approximately 100 countries. We believe competitive forces on businesses worldwide to strengthen security, reduce costs, improve quality, deliver better customer service, and increase productivity support the growth of bar code labeling solutions and specialty printing. Industry-mandated standardization for compliance labeling is an important catalyst in the deployment of bar code systems. We also believe that companies are adopting automatic identiﬁ cation systems that incorporate barcoding for business improvement applications. Many of these applications make increasing use of enterprise-wide resource planning (ERP) and other process improvement systems in manufacturing and service organizations. Greater emphasis on supply chain management, the drive to reduce errors in health care, and heightened concern over safety and security will lead to increased use of automatic identiﬁ cation systems. Still other applications are taking advantage of recent advances in wireless and hand-held computing technologies. Concern for safety and security and personal identiﬁ cation contribute to demand for our card printer products. This concern has heightened interest in systems that provide personal identiﬁ cation and access control, including secure ID systems for driver’s licenses, employee and visitor badges, national identiﬁ cation cards, event passes, club membership cards, and keyless entry systems. Acquisitions are an important part of Zebra’s growth strategy. Since 1998, we have made three acquisitions. On October 28, 1998, Zebra merged with Eltron International, Inc., which manufactured and marketed low-cost direct thermal and thermal transfer label and receipt printers, card printers, and related accessories. On April 3, 2000, Zebra acquired Comtec Information Systems, Inc. Comtec was a privately held company that produced a complete line of mobile wireless thermal printing solutions. On November 17, 2003, we acquired all of the outstanding stock of Atlantek, Inc. Located in Wakeﬁ eld, RI, Atlantek produced a variety of thermal digital printers, including digital photo and card printers. Zebra completed its initial public offering in August 1991. We are organized under the laws of the State of Delaware, and our principal ofﬁ ces are located at 333 Corporate Woods Parkway, Vernon Hills, Illinois 60061. Our main telephone number is (847) 634- 6700 and our primary Internet Web site address is www.zebra.com. You can ﬁ nd all of Zebra’s ﬁ lings with the SEC free of charge through the investor page on this Web site, immediately upon ﬁ ling. Products Our broad line of computerized printers is used to produce bar code labels, RFID “smart” labels, receipts and tags, plastic cards, and photographs. We also sell related specialty label- ing materials, ink ribbons, and bar code label design software. These products are used to provide bar code labeling, personal identiﬁ cation, and specialty printing solutions princi- pally in the manufacturing, retail, service, and government sectors of the economy. We work closely with distributors, resellers and end users of our products to design and implement labeling solutions that meet their technical demands. To achieve this ﬂ exibility, we provide our customers with a broad selection of printer models, each of which can be conﬁ gured for a speciﬁ c application. Additionally, we will select and, if necessary, create appropriate labeling stock, ink ribbons and adhesives to suit a particular application. In-house engineering person- nel in software, mechanical, electronic and chemical engineering participate in the creation and development of bar code labeling solutions for particular applications. Sales of hardware (printers and replacement parts) and supplies were as follows (in thousands): Hardware Percent of sales Supplies Percent of sales Year Ended December 31, 2004 2003 $518,556 78.2 $116,849 17.6 $409,144 76.3 $ 98,519 18.4 2002 $360,185 75.7 $ 87,981 18.5 Label and Receipt Printers We produce the industry’s broadest range of on-demand thermal transfer and direct thermal label printers. Our printing systems include hundreds of optional conﬁ gurations that can be selected to meet particular customer needs. We believe this breadth of product is a unique and signiﬁ cant competitive strength, because it allows Zebra to satisfy the widest variety of thermal printing applications. Management believes that of the major printing technologies, which include ink jet, laser and impact dot matrix, direct thermal and thermal transfer are best suited for most bar code labeling applications. Thermal transfer printing produces dark, solid blacks and sharply deﬁ ned lines that are important for printing readily scannable bar codes. These images can be printed on a wide variety of labeling materials, which enable users to afﬁ x bar code labels to virtually any object. This capability is very important in the industrial and service sectors Zebra serves. Direct thermal printing is best suited where simplicity, light weight and cost are important factors in the application. Accordingly, this technology is found principally in Zebra’s wireless and desktop units. We offer 36 bar code printer models with numerous variations, including: Performance Tabletop Printers. Zebra produces high-end printers targeted at applications requiring continuous operation in high output, mission-critical settings. These units provide a wide variety of optional conﬁ gurations, features, print widths, speeds and dot densities. We offer four models under the XiIII Plus Series line. List prices range from $2,995 to $7,495. RFID Printer/Encoders. Zebra also manufactures and markets a growing line of printer/ encoders used for radio frequency identiﬁ cation (RFID) in the retail supply chain, for defense logistics, and other applications. These units are used to print and encode “smart labels” in a single pass. Smart labels are printable labels embedded with an ultra-thin radio frequency transponder. Information encoded in these transponders can then be read and modiﬁ ed by a radio frequency reader. As of December 31, 2004, we offered six RFID and one RFID-ready printer/encoders, which have list prices from $1,695 to $6,995. Products in this category consist of the R110Xi, R170Xi, R402, R2844-Z, R-140, R4Mplus, and R110XiIII Plus. 2 Mid-Range Tabletop Printers. We offer ﬁ ve printer models designed for less demanding applications. These units have fewer option conﬁ gurations and features for a lower price. Products in this category consist of the Zebra Stripe®, S and Z Series as well as the TLP 2746e printers. List prices range from $1,395 to $3,490. Desktop Printers. Applications with low volume suit Zebra’s desktop printers. We currently offer six desktop models consisting of the Ht-146, LP/TLP 2844, LP/TLP 2844-Z, TLP 3842, TLP 3844-Z, and LP/TLP 2824 printers. List prices range from $395 to $995. Mobile Printing Solutions. Zebra makes 12 mobile printer models, which provide durability, light weight and wireless connectivity interfaces. These printers print in 2-, 3- and 4-inch widths and are marketed under the Cameo, QL, TR, PS, PA/PT and RW lines. List prices range from $550 to $4,795. Print Engines. Zebra’s 170PAX3 and 110PAX3 print engines are sold to manufacturers of high-speed automatic label applicator systems. We also offer the R110PAX3 RFID print engine targeted at emerging packaged goods RFID labeling applications. In addition to their use in on-demand automatic identiﬁ cation applications, our thermal printers can also be used for on-site batch production of custom bar code labels and other graphics. This capability results in shorter lead times, reduced inventory and more ﬂ exibility than can be provided with traditional off-site printing. Card Printers Zebra makes 11 card printer models for printing national identity cards, driver’s licenses, employee identiﬁ cation badges, smart cards, on-demand access control cards, and customer loyalty cards. These cards can typically be created in seconds for under one dollar each. Users can select from a number of printer options, including monochrome and color printing, single- and two-sided printing, lamination, and magnetic stripe and smart card encoding. Bar codes, smart chips and magnetic stripe encoding can be used to record such personal data as health records, ﬁ nancial transactions, security access codes and vital statistics. We offer ﬁ ve “P” series and six “i” series card printers. Printers in the “i” series incorporate features that automatically optimize printer settings for a given ribbon. The list prices for all of Zebra’s card printers range from $1,795 to $9,995. Photo Printers With the November 2003 acquisition of Atlantek, we began producing digital photo printers. We currently manufacture a high-speed thermal printer jointly developed with and marketed by Eastman Kodak as the Kodak ML500 Professional Photo Printer. The ML500 can print 8x10 photographs in about 13 seconds and can produce up to 270 8x10 prints per hour. It is designed for professional photographers for event and in-studio printing. Digital photo printing is an extension of our core thermal printing technology. Supplies Supplies products consist of stock and customized thermal labels, wristbands, smart labels and tags, plastic cards, card laminates, and thermal transfer ribbons. Zebra promotes the use of genuine Zebra brand supplies with its equipment. 3 Zebra fully supports its printers, resellers and end users with an extensive line of superior quality, high performance supplies optimized to a particular user’s needs. Supplies are chosen in consultation with the reseller and end user based on the speciﬁ c application, printer and environment in which the labeling system must perform. In the case of bar code labeling solutions, supplies also include proprietary ribbon and label formulations that are designed to maximize printer performance and meet the most demanding end user performance criteria. Factors such as adhesion, resistance to scratches, smudges and abrasion and chemical and environmental exposures are all taken into account when selecting the type of ribbon and labeling materials. The use of supplies that are not carefully matched to speciﬁ c printers can degrade print speed and print quality. Software Zebra offers software packages to its customers to ease integration of Zebra printers into specialty printing systems. Label design and integration software is speciﬁ cally designed to optimize the performance of Zebra bar code label printers. Known as BAR-ONE®, this software provides the capability to design and integrate sophisticated labels from standalone or legacy applications through a powerful, easy-to-use Windows® interface. Our goal is to provide software that enables high levels of connectivity to all major computer network and software systems. Network systems include Ethernet, 802.11 and Bluetooth™ wireless systems. Operating systems include Windows, Unix®, Linux® and various IBM® systems. Zebra also offers BAR-ONE for mySAP® Business Suite for users of the SAP® ERP system and a version of BAR-ONE that supports XML-enabled printing directly with Zebra printers through Oracle’s warehouse management system (WMS), Oracle’s SensorEdge Server for RFID printing and SAP’s Auto ID Infrastructure without the need for middleware. In order to facilitate using Zebra printers with a broad range of software applications, Zebra also offers Windows printer drivers designed to optimize the printer experience. To expand the global applications for its software and printers, we are developing multi-lingual capabilities in our software and user interfaces. ZebraLink, introduced in 2000, gives users the ability to set up and control Zebra printers remotely using Web-enabled devices. It also enables Zebra printers to provide real-time printer error and status notiﬁ cation via e-mail to a wired or wireless device. In addition, ZebraLink’s programming language, ZBI, can be used to control and interpret incoming text and data streams. ZBI gives users the ability to conﬁ gure Zebra printers to interpret various non-Zebra printer based languages. In January 2005, ZebraNet Bridge printer management application was introduced as a ﬁ rst step toward enterprise printer management of all Zebra printers. Leveraging the power of ZebraLink, ZebraNet Bridge merges printer and print server management capabilities with automatic printer discovery “heartbeat” and critical alert monitoring. Maintenance Services For bar code label and receipt printers, we currently provide service at depot repair centers at our Vernon Hills, Illinois, Preston, U.K., and Singapore facilities. Zebra Authorized Service Providers (ZASP) also provide repair services for most Zebra products at their locations. In addition, IBM, Optimal Systems Services and National Service Center (NSC) provide on-site repair services in the United States. We share the revenue for on-site service contracts sold by IBM, Optimal and NSC for Zebra printing systems installed in the United States, and with IBM in Europe. Outside of the United States, Zebra’s resellers in each country may provide maintenance service, either directly as ZASPs or through independent service agents. Zebra also provides service and technical support assistance from in-house support personnel located in the United States, the United Kingdom and Singapore, who are available by telephone hotline ﬁ ve days a week during regular local business hours. Also, for most Zebra products, Zebra provides interactive technical support via the Internet, which can be accessed through Zebra’s Web site, www.zebra.com, 24 hours a day, seven days a week. We perform our North American depot repair services for thermal printers in Vernon Hills, Illinois. The card printer depot repair facilities are located in Camarillo, California, Preston, U.K., and Wakeﬁ eld, Rhode Island. Card printer resellers can receive technical support assistance from in-house support personnel located in the United States, the United Kingdom and Singapore, who are available by telephone during regular business hours. In addition, on-line support for card printers can be accessed through the Web site, www. eltroncards.com, 24 hours a day, seven days a week. Warranties All Zebra printing equipment is warranted against defects in material and workmanship for up to one year. Printheads are warranted for six months. Zebra supplies are warranted against defects in material and workmanship for their stated shelf life or twelve months, whichever ends ﬁ rst. Defective equipment and supplies may be returned for repair, replacement or refund during the applicable warranty periods. Zebra’s Technology Our products use thermal transfer, direct thermal and thermal dye sublimation technologies. Each technology has characteristics that provide speciﬁ c beneﬁ ts to the end user. Thermal transfer printing is used in all performance and some mid-range, desktop and portable bar code label printers, as well as high-speed print engines. This technology creates an image by applying an electrically heated printhead to a ribbon that releases ink onto labeling/ticketing media. The beneﬁ ts of thermal transfer printing include superior image quality, the ability to print on a wide variety of smooth-surfaced materials, no requirement for specially coated or formulated labeling/ticketing media and the ability to use inks that are not viable with alternative printing technologies. Direct thermal printing is used in some mid-range, desktop and portable printer products. Direct thermal printing creates an image by applying the heated printhead directly to specially treated paper, which changes color when heated. Direct thermal technology is preferable where image durability is less critical and where the application does not require specialty-labeling materials such as plastics or metal foils. Our card printers and digital photo printers incorporate thermal dye sublimation for color printing. This capability allows for the creation of personalized full color, photographic quality plastic cards and high-quality photographs. Traditional photographic processes are both more expensive and time consuming. We believe that personalized card applications such as driver’s licenses, loyalty cards, school and work identiﬁ cation cards, security access cards and ﬁ nancial transaction cards are well suited to this technology. The growing acceptance of digital photography, over traditional halide-based technology, offers growth opportunities for Zebra in certain areas of photo printing. Zebra’s printing systems incorporate Company-designed computer hardware, electrical mechanisms and software, which operate the printing functions of the system and communicate with the host computer. Zebra’s bar code label printers operate using Zebra Programming Language (ZPL®), Zebra Programming Language II (ZPL II®), Eltron Programming Language (EPL) or Comtec Printer Control Language (CPCL), each of which is a proprietary printer driver language. These languages are compatible with virtually all computer operating systems, including UNIX, MS/DOS® and Windows. Zebra guarantees backward compatibility in ZPL and ZPL II to allow users to replace older Zebra printers with newer equipment without costly reprogramming of label design programs. This compatibility also allows users to operate multiple Zebra printers in different applications using standardized programs and to integrate these printers into a local area network. We believe that ZPL and ZPL II give us a competitive advantage by ensuring compatibility across a broad range of present and future printer products and by facilitating system upgrades and customer loyalty to Zebra products. Some independent software vendors have written label preparation programs with ZPL and ZPL II drivers speciﬁ cally for Zebra printers. ZPL and ZPL II label format programs can be run on a personal computer with ordinary word processing programs, making ZPL and ZPL II particularly adaptable to PC-based systems. Users of Zebra’s instant-issuance card printers typically operate these printers with software programs designed and sold by independent vendors. Sales and Marketing Sales. We sell our products primarily through distributors, value-added resellers (VARs), and original equipment manufacturers (OEMs). We also sell our products directly to a select number of designated accounts. For media and consumables, we also have a limited amount of sales directly to end users through the Internet and telesales operations. Distributors and VARs purchase, stock and sell a variety of automatic identiﬁ cation components from different manufacturers and customize systems for end-user applications using their systems and application integration expertise. Because these sales channels provide speciﬁ c software, conﬁ guration, installation, integration and support services required by end users within various market segments, these relationships allow Zebra to reach end users throughout the world in a wide variety of industries. Zebra experiences a minor amount of seasonality in sales, depending on the geographic region and/or vertical market. We functionally classify our direct VARs as Premier Partners, Advanced Partners, or Associate Partners, depending on their business competencies, depth and breadth of their sales teams, customer support capabilities, contribution to Zebra’s strategic goals, and sales commitment to Zebra. In addition, we offer VARs the opportunity to earn certiﬁ cations for mobile/wireless printers, supplies, service and radio frequency identiﬁ cation (RFID) expertise. We also sell through distributors, which in turn sell to an extended VAR community. All VARs, as well as OEMs and systems integrators, provide customers with a variety of automatic identiﬁ cation components including scanners, accessories, applications software and systems integration expertise, and, in the case of some OEMs, resell the Zebra-manufactured products under their own brands as part of their own product offering. We believe that the breadth of this indirect channel network, both in terms of variety and geographic scope, enhances our ability to compete. 4 In some instances, we have designated a customer as a Strategic Account when purchases of Zebra products reach speciﬁ ed levels and support requirements for the account become highly customized. Zebra sales personnel, either alone or together with our partners, manage these Strategic Accounts to ensure their needs, including consistent support for projects and applications, are being met. Sales to international customers as a percent of net sales were as follows: Percent of sales Year Ended December 31, 2003 2002 45.5 43.1 2004 45.8 We believe that international sales have the long-term potential to grow faster than domestic sales because of the lower penetration of automatic identiﬁ cation applications outside North America. As a result, Zebra has invested resources to support our international growth and currently operates facilities and sales ofﬁ ces, or has representation, in 24 different countries. Marketing. Marketing operations encompass marketing communications, product marketing, vertical marketing, solutions marketing, market research, alliance management and channel marketing functions. The product marketing group identiﬁ es, evaluates and recommends new product opportunities and manages product introductions, positioning and demand creation. Product marketing also focuses on strategic planning and market deﬁ nition and analyzes Zebra’s competitive strengths and weaknesses. The vertical marketing group works with reselling and non-reselling partners to develop and promote high-potential application solutions that have signiﬁ cant Zebra content. The vertical marketing group also focuses on industry trends, participates in business development activities at the technical and applications standards levels and provides subject matter expertise. Alliance management directs a limited number of third party relationships that are strategic to new demand creation for speciﬁ c vertical markets and/or speciﬁ c applications. Solutions marketing seeks to identify business solutions that incorporate Zebra products and which are repeatable over a range of like customers. Solutions marketing develops and executes go-to-market and demand creation programs for those applications that are selected. The marketing communications group operates as an internal advertising, event marketing, promotion, internet marketing and public relations resource. This group, working with advertising agencies and contractors, creates advertisements, and brochures, manages trade show exhibits, maintains Zebra’s Web sites, and places articles highlighting Zebra and applications of its products in the trade, industry, business and consumer media. 5 The market research group is a strategic planning, research-oriented group that focuses on market deﬁ nition and analysis of our relative competitive strengths and weaknesses. This group identiﬁ es and analyzes market opportunities for current, planned and potential products and gathers and analyzes competitive and market information. The channel marketing group is responsible for developing programs to push and pull Zebra products through its network of distributors and Value Added Resellers. This group also prepares application and product training programs and on-line information resources, which are available to certiﬁ ed channel partners around the world. Customers Zebra has sold more than 4,000,000 bar code label and card printers to customers in about 100 countries as of December 31, 2004. Sales to ScanSource, Inc. as a percent of net sales were as follows: Percent of sales Year Ended December 31, 2004 14.1 2003 13.8 2002 13.6 No other customer accounted for 10% or more of total net sales during these years. Production and Manufacturing We design our products to optimize product performance, quality, reliability, durability and versatility. These designs combine cost-efﬁ cient materials, sourcing and assembly methods with high standards of workmanship. We assemble our products in-house largely on a conﬁ gure-to-order basis using components that have been sourced from around the world. We have the in-house capability to produce mechanical and electronic assemblies and design many of our own tools, ﬁ xtures and test equipment. Often, our manufacturing engineers coordinate the development of new products with our new product engineers and vendors. This collaboration increases manufacturing efﬁ ciency by specifying and designing manufacturing processes and facilities simultaneously with product design. We buy prefabricated component parts and subassemblies for use in the manufacture of our products. Critical subassemblies include printheads, power supplies, integrated circuits, and stepper motors, which are obtained from domestic and foreign suppliers at competitive prices. Purchase contracts provide for price increases in the event of certain increases in the costs of raw materials. We typically maintain several sources for our component parts and subassemblies to reduce the risk of parts shortages or unavailability. We do not currently believe that we face difﬁ culties in obtaining an adequate supply of these materials. Research and Development Zebra had research and development expenditures as follows (in thousands): Research and development expenditures Percent of sales Year Ended December 31, 2004 2003 2002 $37,093 5.6 $31,759 5.9 $29,210 6.1 We devote signiﬁ cant resources to developing new printing solutions for our target markets and ensuring that our efﬁ ciently manufactured products maintain high levels of reliability. Competition Many companies are engaged in the design, manufacture and marketing of bar code label printers and card personalization solutions. We consider our direct competition in bar code label and receipt printing to be producers of on-demand thermal transfer and direct thermal label printing systems and supplies. We also compete, however, with companies engaged in the design, manufacture and marketing of printing systems that use alternative technologies, such as impact dot matrix, ink-jet and laser printing. Similarly, we consider manufacturers of card personalization systems that are based on a broad range of alternative technologies as competition. Our ability to compete effectively depends on a number of factors. These factors include the reliability, quality and reputation of the manufacturer and its products; hardware and software innovations and speciﬁ cations; breadth of product offerings; information systems connectivity; price; level of technical support; supplies and applications support offered by the manufacturer; available distribution channels; and ﬁ nancial resources to support new product design and innovation. We believe that Zebra presently competes favorably with respect to these factors. No single competitor competes across the entire breadth of our product line. Signiﬁ cant competition, however, is faced in each product segment. For low-cost desktop label printer products, our principal competitors are Argox; Godex; Cognitive Solutions, a subsidiary of Axiohm Transaction Solutions; Tokyo Electric Company (TEC); Taiwan Semiconductor; Microcom; Woosim; and Datamax, a unit of Dover Corporation. In the mid-range printer market, our principal competitors are Datamax; UBI and Intermec, subsidiaries of Unova; Monarch Marking Systems, a subsidiary of Paxar; Sato; and TEC. Principal competition in the high end of the market derives from Sato, TEC, Printronix, and Intermec. For print engines, the principal competitor is Sato. For mobile printers, the principal competitors are Monarch Marking Systems and O’Neil Product Development. The potential for greater competition is increasing, we believe, as companies view mobile printing applications to be an attractive market. Many of the same companies with whom we compete in thermal printing also compete with us in RFID. The notable companies in this area are Printronix, Intermec, Sato and Monarch. Several competitors manufacture card personalization equipment using dye sublimation technology. These competitors include Nisca, Datacard, Fargo Electronics, ColorX, Polaroid, MagiCard, Evolis, LogickaComp, Printherm, CIM, NBS, Matica, Song Woo Electronics, and Victor Data Systems. Dye sublimation, the technology incorporated in our card printers, is only one of several commercially available types of equipment used to personalize cards. We also compete with companies that produce identiﬁ cation cards using alternative technologies, which include ink-jet, thermal transfer, embossing, ﬁ lm-based systems, encoders, laser engrav- ing and large-scale dye sublimation printers. These card personalization technologies offer viable alternatives to Zebra’s card printers and provide effective competition from a variety of companies, many of which are substantially larger than Zebra, including Canon, Hewlett-Packard, Hitachi, and Lexmark International. In addition, service bureaus compete for end user business and provide an alternative to the purchase of our card printing equipment and supplies. Manufacturers also use dye sublimation technology in their digital photo printers. Companies participating in this area include Sony, Mitsubishi, Copal, Shinko, Altech, Olmec, and Olympus. In addition, there are several other companies that participate in producing photo printers using other technologies. These companies include Hewlett- Packard, Xerox, Polaroid, and Fuji. The supplies business is highly fragmented and competition is comprised of numerous competitors of various sizes depending on the geographic area. Alternative Technologies We believe that direct thermal and thermal transfer printing will be the label and receipt printer technology of choice in Zebra’s target applications for the foreseeable future. Among the many advantages of direct thermal and thermal transfer printing is the ability to print high-resolution, durable images on a wide variety of label materials at relatively low costs and very high speeds compared with alternative printing technologies. We continually assess competitive and complementary methods of bar code printing and automatic identiﬁ cation. These technologies include ink jet, laser, impact dot matrix, laser etching, and RFID. We cannot be sure that new technology will not supplant direct thermal and thermal transfer printing for bar code labels and receipts, but we are not aware of any developing technology that offers the advantages of direct thermal and thermal transfer printing for our targeted label and receipt printer applications. To complement thermal printing technology, we produce the printer/encoders for printing and encoding “smart labels,” which are printable labels embedded with an ultra-thin radio frequency transponder. Information encoded in these transponders can then be read and modiﬁ ed by a radio frequency reader. Our printer/encoders are targeted at emerging RFID applications, where line-of-sight reading or scanning a label may not be possible. We view RFID as a complementary technology to barcoding, offering growth opportunities to Zebra as the technology becomes more widely adopted. If other technologies were to evolve or become available to Zebra, it is possible that those technologies would be incorporated into our products. Alternatively, if such technologies were to evolve or become available to our competitors, Zebra’s products may become obsolete. This obsolescence would have a signiﬁ cant negative effect on Zebra’s business, ﬁ nancial position, results of operations and cash ﬂ ows. 6 Intellectual Property Rights Zebra relies on a combination of trade secrets, patents, employee and third party nondisclosure agreements, copyright laws and contractual rights to establish and protect its proprietary rights in its products. We have and actively protect several domestic and international trademarks. We hold 192 United States and foreign patents and have 174 United States and foreign patent applications pending pertaining to products. The duration of these patents ranges from 14 to 20 years. The expiration of any individual patent would not have a signiﬁ cant negative impact on our business. Despite our efforts to protect our intellectual property rights, it may be possible for unauthorized third parties to copy portions of our products or to reverse engineer or otherwise obtain and use some technology and information that we regard as proprietary. Moreover, the laws of some countries do not afford Zebra the same protection to proprietary rights, as do United States laws. There can be no assurance that legal protections relied upon by Zebra to protect its proprietary position will be adequate. While Zebra’s intellectual property is valuable and provides certain competitive advantages, we do not believe that the legal protections afforded to our intellectual property are fundamental to our success. Other trademarks mentioned in this report are the property of their respective holders and include IBM, a registered trademark of International Business Machines; Kodak, a registered trademark of the Eastman Kodak; UNIX, a registered trademark of UNIX Systems Laboratories; MS/DOS and Windows, registered trademarks of Microsoft; SAP, a registered trademark of SAP AG; Linux, a registered trademark of Linus Torvalds; and Accelio Present Central, a registered trademark of Accelio. Bluetooth is a trademark owned by Bluetooth SIG and used by Zebra under license. Employees As of February 25, 2005, Zebra employed approximately 2,300 persons. None of these employees is a member of a union. We consider our employee relations to be very good. 7 Item 2. Properties Zebra’s corporate headquarters are located in Vernon Hills, Illinois, a northern suburb of Chicago. Zebra conducts its operations from a custom-designed facility at this location, which provides approximately 225,000 square feet of space. Approximately 113,000 square feet have been allocated to ofﬁ ce and laboratory functions and 112,000 square feet to manufacturing and warehousing. This facility was constructed in 1989 and expanded in 1993, 1995, 1996 and 1999. It is owned and leased to Zebra, under a lease terminating on June 30, 2014, by Unique Building Corporation, a corporation owned in part by Edward Kaplan and Gerhard Cless, both executive ofﬁ cers and directors of Zebra. Zebra’s major facilities as of December 31, 2004, are listed below: Location Vernon Hills, Illinois, USA Camarillo, California, USA Warwick, Rhode Island, USA Wakeﬁ eld, Rhode Island, USA Greenville, Wisconsin, USA High Wycombe, UK Preston, UK Square Footage Manufacturing, Administrative, Production & Warehousing 111,676 97,921 50,872 24,618 27,000 — 30,450 Research & Sales 113,429 72,156 48,968 8,725 3,000 24,700 8,600 Total Lease Expires June 2014 225,105 170,077 Owned 99,840 33,343 30,000 March 2007 24,700 October 2018 39,050 Owned April 2007 June 2005 Total 342,537 279,578 622,115 Zebra leases various other facilities around the world, which are dedicated to administrative, research and sales functions. The amounts related to these leases, solely or in aggregate, are not material to the consolidated ﬁ nancial statements. During 1999, Zebra consolidated United Kingdom facilities, moving distribution of its Wokingham and High Wycombe facilities to the Preston location, and transferring Wokingham associates to the renovated High Wycombe location. The vacant Wokingham facility totals 27,000 square feet and has a lease that expires in October 2010. Zebra is actively marketing the property, seeking to sublease it through October 2010. We believe that the current rent is approximately equal to the amount we will receive from a sublease. We have accrued for rent during an estimated 18-month marketing period. Zebra announced plans to close its Varades, France facility in early 2004. See Note 19 to our consolidated ﬁ nancial statements, which are part of this report, for further details related to the closing. Zebra France previously leased the Varades building under a series of capital leases. During 2004, we exercised our option to purchase the building under those capital leases and sold the building. The resale value was slightly less than the book value of the building. We also announced plans to consolidate our Warwick, Rhode Island and Wakeﬁ eld, Rhode Island printer manufacturing and repair service business into our Camarillo, California, and Vernon Hills, Illinois locations. Supplies manufacturing and some administrative functions will remain in Rhode Island. We have a series of four additional two-year option periods to continue the use of the Warwick facility. We have evaluated our space requirements in Rhode Island and intend to extend this lease and consolidate the two Rhode Island facilities into the Warwick location during 2005. Since December 31, 2004, we committed to lease three additional properties. In Vernon Hills, Illinois, we committed to lease an additional 34,000 square feet of ofﬁ ce space for three years beginning March 1, 2005. In Heerenveen, Netherlands, we committed to lease approximately 95,000 square feet of ofﬁ ce and warehousing space for 20 years beginning February 15, 2005 with an option to terminate the lease at each ﬁ ve-year anniversary date. In Chula Vista, California, we committed to a lease of approximately 14,000 square feet of manufacturing and warehouse space for two years beginning February 11, 2005. See Note 16 to our consolidated ﬁ nancial statements, which are part of this report, for additional information regarding our leases. Item 3. Legal Proceedings On April 23, 2003, Paxar Americas, Inc. (Paxar Americas) ﬁ led 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 identiﬁ ed Paxar Americas patents, although not each product is accused of infringing each patent. Zebra has ﬁ led an Answer to Paxar Americas’ Complaint, denying Paxar Americas’ allegations of infringement and asserting several afﬁ rmative defenses, including the invalidity of Paxar Americas’ asserted patent claims. Paxar has sought to amend its original complaint to add two additional patents to the lawsuit and to expand the scope of accused products. Zebra has opposed Paxar’s motions in this regard and the court has the issue under advisement. On November 21, 2003, Zebra’s subsidiary, ZIH Corp. (ZIH), ﬁ led a Complaint in the United States District Court for the District of Massachusetts against Paxar Corporation, alleging 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 seek- ing a declaratory judgment that ZIH’s patents-in-suit are not infringed and are invalid and/or unenforceable. Paxar Corporation ﬁ led a motion to transfer ZIH’s Massachusetts suit to Ohio federal court, and the court denied Paxar’s motion. On November 25, 2003, Paxar Americas ﬁ led a Complaint against ZIH in the United States District Court for the Southern District of Ohio, seeking a declaratory 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. In view of the Massachusetts’ District Court’s denial of Paxar Corporation’s motion to transfer to Ohio ZIH’s corresponding patent infringement suit against Paxar Corporation, the parties to Paxar America’s Ohio declaratory judgment action have agreed to transfer this case to Massachusetts. The outcome of litigation is inherently uncertain, particularly in cases such as these where sophisticated factual issues must be assessed and complex technical issues must be decided. As a result, we cannot accurately predict the outcome of these lawsuits. In the event we are unsuccessful in our defense of Paxar Americas’ infringement claims, we could be liable for economic and other damages, which could be material, and we may be forced to incur ongoing licensing expenses or to change how we design, manufacture and market our products. The patents that ZIH has asserted against Paxar Corporation could be found invalid. We have and will continue to incur substantial fees to prosecute and defend these lawsuits. 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 consolidated ﬁ nancial statements as of December 31, 2004. Item 4. Submission of Matters to a Vote of Security Holders Not applicable. PART II Item 5. Market for Registrant’s Common Stock and Related Stockholder Matters Stock Information: Price Range and Common Stock Our Class A Common Stock is traded on the NASDAQ Stock Market under the symbol ZBRA. The following table shows the high and low trade prices for each quarter in 2004 and 2003, as reported by the NASDAQ Stock Market. We adjusted all share prices for a 50% stock dividend that was distributed on August 25, 2004. 2004 First Quarter Second Quarter Third Quarter Fourth Quarter High Low 2003 $48.56 $41.22 45.96 49.90 45.97 58.10 62.40 61.94 First Quarter Second Quarter Third Quarter Fourth Quarter High Low $28.99 $23.91 25.55 32.50 34.20 34.62 37.39 44.80 Source: The NASDAQ Stock Market At February 25, 2005, the last reported price for the Class A Common Stock was $50.07 per share, and there were 389 registered stockholders of record for the Company’s Class A Common Stock. Dividend Policy Since our initial public offering in 1991, we have not declared any cash dividends or distri- butions on our capital stock. Zebra intends to retain its earnings to ﬁ nance future growth and therefore does not anticipate paying any cash dividends in the foreseeable future. 8 Item 6. Selected Consolidated Financial Data Net sales Cost of sales Gross proﬁ t Total operating expenses Operating income Income before income taxes Net income Earnings per share Basic Diluted Weighted average shares outstanding Basic Diluted CONSOLIDATED STATEMENTS OF EARNINGS DATA (In thousands, except per share amounts) Year Ended December 31, 2004 $663,054 319,895 343,159 167,989 (1) 175,170 184,548 $120,643 $ 1.69 $ 1.66 71,556 72,539 2003 $536,397 263,320 273,077 143,859 (1) 129,218 135,992 $ 91,696 $ 1.30 (2) $ 1.28 (2) 70,647 (2) 71,495 (2) 2002 $475,611 244,864 230,747 128,942 (1)(3) 101,805 110,883 (4) $ 71,595 $ 1.03 (2) $ 1.02 (2) 69,678 (2) 70,305 (2) CONSOLIDATED BALANCE SHEET DATA (In thousands) Cash and cash equivalents and investments and marketable securities Working capital Total assets Long-term obligations Stockholders’ equity $557,993 665,062 862,222 4,011 797,654 $447,848 535,816 701,611 2,853 651,915 2004 2003 December 31, 2002 $348,577 427,676 573,088 1,613 534,155 2001 $450,008 240,115 209,893 117,434 (1) 92,459 96,139 $ 61,529 $ 0.89 (2) $ 0.89 (2) 68,923 (2) 69,457 (2) 2001 $249,349 330,510 479,556 408 445,007 2000 $481,569 249,141 232,428 123,758 (1) 108,670 111,911 $ 71,622 $ 1.06 (2) $ 1.05 (2) 67,573 (2) 68,390 (2) 2000 $156,714 256,799 418,896 513 371,288 (1) Includes the following pretax charges related to the closure/consolidation of the Varades, France, the Warwick, Rhode Island and the Wakeﬁ eld, Rhode Island facilities and the integration and in-process research and development costs related to the acquisition of Atlantek, Inc. in 2003, the acquisition of Comtec Information Systems, Inc. in 2000, and the merger with Eltron International, Inc. in 1998: Exit costs for the Varades closure Exit costs for the Warwick consolidation Exit costs for the Wakeﬁ eld closure In-process research and development Integration costs 2004 $ 722 1,269 109 22 46 2003 $1,232 — — 692 9 2002 $ — — — — 73 2001 $ — — — — 1,838 2000 $ — — — 5,953 5,113 (2) Restated for 3-for-2 stock splits in 2003 and 2004 that were paid in the form of 50% stock dividends. (3) Includes $3,300 in operating expenses related to the terminated acquisition of Fargo Electronics, Inc. (4) Includes a pre-tax realized gain of $1,953 related to the sale of 585,000 shares of common stock of Fargo Electronics. 9 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Results of Operations: Fourth Quarter of 2004 versus Fourth Quarter of 2003, Year ended December 31, 2004 versus Year ended December 31, 2003 Sales Sales by product category, percent change, and percent of total sales for the three months and year ended December 31, 2004, and December 31, 2003, were (in thousands, except percentages): Product Category Hardware Supplies Service and software Shipping and handling Cash ﬂ ow hedging activities Total sales Product Category Hardware Supplies Service and software Shipping and handling Cash ﬂ ow hedging activities Total sales Three Months Ended December 31, 2003 2004 Percent Change Percent of Total Sales - 2004 Percent of Total Sales - 2003 $137,529 30,895 6,083 1,444 (1,077) $174,874 $113,263 26,738 6,165 1,184 (150) $147,200 Year Ended December 31, 2004 $518,556 116,849 24,338 4,950 (1,639) $663,054 2003 $409,144 98,519 24,355 4,113 266 $536,397 21.4 15.5 (1.3) 22.0 — 18.8 78.6 17.7 3.5 0.8 (0.6) 100.0 76.9 18.2 4.2 0.8 (0.1) 100.0 Percent Change Percent of Total Sales - 2004 Percent of Total Sales - 2003 26.7 18.6 (0.1) 20.4 — 23.6 78.2 17.6 3.7 0.7 (0.2) 100.0 76.3 18.4 4.5 0.8 — 100.0 Sales to customers by geographic region, percent changes and percent of total sales for the three months and year ended December 31, 2004, and December 31, 2003, were (in thousands, except percentages): Geographic Region Europe, Middle East and Africa Latin America Asia-Paciﬁ c Total International North America Total sales Geographic Region Europe, Middle East and Africa Latin America Asia-Paciﬁ c Total International North America Total sales Three Months Ended December 31, 2003 2004 Percent Change Percent of Total Sales - 2004 Percent of Total Sales - 2003 $ 59,398 10,597 14,534 84,529 90,345 $174,874 $ 47,893 7,978 14,215 70,086 77,114 $147,200 Year Ended December 31, 2004 $213,559 38,119 52,302 303,980 359,074 $663,054 2003 $170,544 29,406 43,904 243,854 292,543 $536,397 24.0 32.8 2.2 20.6 17.2 18.8 34.0 6.1 8.3 48.4 51.6 100.0 32.5 5.4 9.7 47.6 52.4 100.0 Percent Change Percent of Total Sales - 2004 Percent of Total Sales - 2003 25.2 29.6 19.1 24.7 22.7 23.6 32.2 5.7 7.9 45.8 54.2 100.0 31.8 5.5 8.2 45.5 54.5 100.0 We believe that our sales growth for the fourth quarter and the full year of 2004 reﬂ ects the increasing success of sales and marketing programs to improve demand for Zebra products, strengthen distribution channel relationships and increase the awareness of Zebra products and the Zebra brand in targeted markets, within a favorable environment for the adoption of barcoding and specialty printing applications. The growth in Zebra’s business was well balanced across geographies, products, and channels. We experienced notable sales growth in mobile printers, as the mainstream adoption of wireless technology has expanded the uses of mobile printing in applications across 10 an increasing number of vertical markets. In addition, we believe that channel programs implemented in North America supported higher sales in the region with strengthened and expanded channel partner relationships. More Zebra sales representatives in international territories helped increase the number of channel relationships in overseas regions and support sales growth. Gross Proﬁ t Gross proﬁ t information is summarized below (in thousands, except percentages): December 31, 2004 2003 Percent of Percent Total Sales 2004 Change Percent of Total Sales 2003 New printer products (deﬁ ned as printers released within 18 months prior to the end of the applicable ﬁ scal period) as a percent of total printer product sales were as follows: Three months ended Year ended $ 90,895 343,159 $ 74,397 273,077 22.2 25.7 52.0 51.8 50.5 50.9 Three months ended Year ended December 31, 2004 18.9 23.9 2003 21.8 23.3 Our international sales are denominated in multiple currencies, primarily the dollar, pound and euro. This directly causes our reported sales to be subject to ﬂ uctuations based on changes in currency rates. When signiﬁ cant currency rate ﬂ uctuations occur, we review our product pricing and make appropriate changes to maintain our competitive position. We estimate that favorable foreign exchange movements of the euro and the pound versus the dollar had a net positive effect of $4,258,000 on sales during the fourth quarter and $17,626,000 for the full year. We currently hedge a portion of anticipated euro-denominated sales to partially protect Zebra against exchange rate movements. For the fourth quarter, this program resulted in a loss of $1,077,000 and a full-year loss of $1,639,000. See Note 15 to the ﬁ nancial statements for a more detailed discussion of this hedging program. The major contributors to the margin improvement were: • Higher capacity utilization related to the higher sales volume, representing $6,518,000 of the total gross proﬁ t increase for the fourth quarter of 2004 and $34,010,000 for the full year. • Foreign exchange rate movements, which we estimate increased gross proﬁ t by $4,178,000 for the fourth quarter of 2004. For the full year, gross proﬁ t is estimated to have been $16,239,000 higher due to foreign exchange rate movements. • Changes in product mix cost reductions and other items accounted for $5,802,000 of the margin improvement during the fourth quarter and $19,833,000 for the full year. Selling and Marketing Expenses Selling and marketing expenses are summarized below (in thousands, except percentages): December 31, 2004 2003 Percent Change Percent of Total Sales 2004 Percent of Total Sales 2003 Printer unit volumes and average selling price information is summarized below: Three months ended Year ended $22,615 77,062 $19,506 66,635 15.9 15.6 12.9 11.6 13.3 12.4 Total printers shipped Average selling price of printers shipped Total printers shipped Average selling price of printers shipped Three Months Ended December 31, 2004 181,691 $638 2003 Change 145,834 $640 24.6 (0.3) Year Ended December 31, 2004 667,044 $646 2003 Change 540,431 $627 23.4 3.0 We continue to invest heavily in demand-generating activities to build brand equity in our core product lines as well as in the emerging area of radio frequency identiﬁ cation (RFID). During the fourth quarter of 2004, selling and marketing expenses increased due to higher payroll costs of $608,000 from increased stafﬁ ng as well as higher advertising and market development funding of $906,000. For the full year, the payroll costs increased $4,052,000 and advertising and market development funding increased $2,475,000. In addition to increases in the items mentioned above, we increased outside commission, consulting and legal expenses. Much of the additional headcount related to placing more Zebra representatives in high-growth international regions as part of our geographic expansion activities. We also increased staff for better coverage of strategic accounts. For all of 2004, unit volumes increased in nearly all product lines and all regions, with notable strength in mobile printers. For the full year, a favorable product mix toward higher priced products and a richer feature set within product segments, on balance, supported a 3.0% increase in the average selling price of printers shipped. Average unit prices were comparable between the fourth quarter of 2004 and 2003. 11 Research and Development Costs The development of new products and enhancement of existing products are important to Zebra’s business and growth prospects. To maintain and build our product pipeline, we made investments in research and development, summarized below (in thousands, except percentages): Three months ended Year ended December 31, 2004 $ 9,368 37,093 2003 $ 8,722 31,759 Percent of Percent Total Sales 2004 Change Percent of Total Sales 2003 7.4 16.8 5.4 5.6 5.9 5.9 Varades closure Warwick consolidation Wakeﬁ eld closure Total exit costs Three Months Ended December 31, Year Ended December 31, 2004 $(110) 147 109 $ 146 2003 $1,232 — — $1,232 2004 $ 722 1,269 109 $2,100 2003 $1,232 — — $1,232 Exit costs related to these consolidation and closure activities were as follows (in thousands): Quarterly product development expenses ﬂ uctuate widely depending on the status of ongoing projects. We are committed to a long-term strategy of signiﬁ cant investment in product development. For the fourth quarter of 2004, research and development expenses increased because of an increase in payroll costs of $587,000. For the full year, payroll costs increased $3,253,000. Project expenses and consulting expenses also increased as a result of additional expenditures for new products including radio frequency identiﬁ cation (RFID). We expect to invest a larger portion of our research and development expenditures in the future on the development of RFID printer/encoders. General and Administrative Expenses General and administrative expenses are summarized in the table below (in thousands, except percentages): December 31, 2004 2003 Percent of Percent Total Sales 2004 Change Percent of Total Sales 2003 Three months ended Year ended $11,959 49,097 $11,456 41,892 4.4 17.2 6.8 7.4 7.8 7.8 For the fourth quarter of 2004, general and administrative expenses increased primarily as a result of increased legal expenses. For the full year of 2004, general and administrative expenses include $4,111,000 of increased legal expenses related to: • Litigation with Paxar, • Increased intellectual property work, and • International expansion activity. In addition to legal expenses in 2004, we saw an increase in payroll costs and information system expenses. Exit Costs Since the fourth quarter of 2003, we announced several facility consolidation and closure activities. During the fourth quarter of 2003, we announced plans to close our engineering site in Varades, France. 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. During December 2004, we announced plans to close and consolidate our Wakeﬁ eld, Rhode Island facility into our other North American facilities, primarily into the Warwick, Rhode Island facility. These plans are accounted for under SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. Operating Income Operating income is summarized in the following table (in thousands, except percentages): December 31, 2004 2003 Percent of Percent Total Sales 2004 Change Percent of Total Sales 2003 Three months ended Year ended $ 46,160 175,170 $ 32,253 129,218 43.1 35.6 26.4 26.4 21.9 24.1 The increase in operating income is attributable to the following factors: • Accelerated sales growth compared to 2003, • Improved gross margins resulting from better overhead utilization, and • Favorable changes in foreign exchange rates for Zebra’s non-dollar denominated businesses. As a result of these factors, operating income increased by 24.3 percentage points more than the rate of sales growth during the fourth quarter, and 12.0 percentage points more than the rate of sales growth for the full year. Non-operating Income and Expenses Zebra’s non-operating income and expense items are summarized in the following table (in thousands): Three Months Ended December 31, Year Ended December 31, 2004 $2,949 (5) (9) (457) 2003 $4,079 (38) (304) (524) 2004 $10,628 (44) 485 (1,691) 2003 $ 8,553 (154) (552) (1,073) Investment income Interest expense Foreign exchange gains (losses) Other, net Total other income (expense) $2,478 $3,213 $ 9,378 $ 6,774 During the fourth quarter of 2004, Zebra earned $2,949,000 on average cash and marketable securities balances of $540,517,000, which equates to an annualized 2.2% rate of return. For the full year, investment income was $10,628,000, or 2.1%, of average cash and marketable securities balances of $502,921,000. 12 Income Taxes The effective income tax rate for the fourth quarter was 34.3% compared with 31.2% for the same quarter last year. The 2003 rate is lower, because of the resolution of our long- standing dispute with the Illinois Department of Revenue and the related decrease to income tax expense of $1,342,000 during that quarter. For 2004, the effective income tax rate was 34.6% versus 32.6% for 2003 for the reason noted above. Net Income Zebra’s net income is summarized below (in thousands, except per share amounts): Net income Diluted earnings per share Three Months Ended December 31, 2004 $31,963 2003 $24,395 Year Ended December 31, 2004 2003 $120,643 $91,696 $ 0.44 $ 0.34 $ 1.66 $ 1.28 Comparison of Years Ended December 31, 2003 and 2002 Sales Sales by product category, related percent changes and percent of total sales for 2003 and 2002 were as follows: Product Category Hardware Supplies Service and software Shipping and handling Cash ﬂ ow hedging activities Total sales Year Ended December 31, 2003 $409,144 98,519 24,355 4,113 266 $536,397 2002 $360,185 87,981 23,301 4,144 — $475,611 Percent Change Percent of Total Sales - 2003 Percent of Total Sales - 2002 13.6 12.0 4.5 (0.7) — 12.8 76.3 18.4 4.5 0.8 — 100.0 75.7 18.5 4.9 0.9 — 100.0 Sales to customers by geographic region, related percent changes, and percent of total sales for 2003 and 2002 were as follows: Geographic Region Europe, Middle East and Africa Latin America Asia-Paciﬁ c Total International North America Total sales Year Ended December 31, 2003 $170,544 29,406 43,904 243,854 292,543 $536,397 2002 $142,273 28,097 34,953 205,323 270,288 $475,611 Percent Change Percent of Total Sales - 2003 Percent of Total Sales - 2002 19.9 4.7 25.6 18.8 8.2 12.8 31.8 5.5 8.2 45.5 54.5 100.0 29.9 5.9 7.3 43.1 56.9 100.0 Higher sales growth in 2003 was a result of additional geographic expans ion in Asia, Latin America and Europe. In addition, we placed a greater emphasis on high-growth vertical markets and added marketing resources to support emerging radio frequency identiﬁ cation (RFID) opportunities. New printer products accounted for 23.3% of printer sales in 2003, compared with 22.2% in 2002. Our international sales were beneﬁ ted in 2003 by favorable exchange rates. 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 exchange rates that prevailed in 2002. To remain competitive in markets experiencing currency strength against the dollar, we adjusted our pricing resulting in a $12,610,000 reduction in sales. The net sales increase related to exchange rate ﬂ uctuations and offsetting pricing adjustments was $12,173,000 for 2003. 13 Printer unit volumes and average selling price information is summarized below: Total printers shipped Average selling price of printers shipped Year Ended December 31, 2003 540,431 $627 2002 491,111 $614 Percent Change 10.0 2.1 For 2003, the increase in printer volume was due to high sales of desktop and mobile printers as a result of more companies adopting technology for wireless networks. 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 and is offset by higher volumes of the lower priced mobile printers. Gross Proﬁ t Gross proﬁ t information is summarized below (in thousands except percentages) For the Year Ended December 31, 2003 December 31, 2002 Percent Change Gross Proﬁ t $273,077 230,747 18.3 Percent of Total Sales 50.9 48.5 Gross proﬁ t increased due to: • Higher capacity utilization related to the higher sales volume, representing $17,417,000 of the total gross proﬁ t increase for 2003. • Foreign exchange rate movements and related pricing adjustments, which we estimate increased gross proﬁ t by $10,900,000 for 2003 due to foreign exchange movements, net of related pricing adjustments. • Cost reductions, which contributed $9,371,000 to the margin improvement during 2003. Selling and Marketing Expenses Selling and marketing expenses are summarized below (in thousands, except percentages): For the Year Ended December 31, 2003 December 31, 2002 Percent Change Selling and Marketing Expenses Percent of Total Sales $66,635 56,176 18.6 12.4 11.8 The increase in selling and marketing expenses for 2003 resulted from our investments in demand-generating activities with higher advertising, publications and market research, travel, demonstration units and market development fund expenses. Research and Development Costs Research and development costs are summarized below (in thousands, except percentages): For the Year Ended December 31, 2003 December 31, 2002 Percent Change Research and Development Costs Percent of Total Sales $31,759 29,210 8.7 5.9 6.1 General and Administrative Expenses General and administrative expenses are summarized below (in thousands, except percentages): For the Year Ended December 31, 2003 December 31, 2002 Percent Change General and Administrative Expenses Percent of Total Sales $41,892 38,689 8.3 7.8 8.1 For 2003, general and administrative expenses include $596,000 of increased legal expenses related to: • Litigation with Paxar, • Increased intellectual property work, • International activity, and • General contract review. In addition to legal expenses in 2003, we saw an increase in director and ofﬁ cer liability insurance and administrative personnel costs. A portion of these costs resulted from new compliance requirements of the Sarbanes-Oxley Act of 2002 and related regulations. Offsetting these increases was a decline in consulting expenses. Costs Related to Terminated Acquisitions and Merger Costs During 2002, we terminated the acquisition agreement and tender offer in which 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, 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 tender offer. Exit Costs During the fourth quarter of 2003, we announced a plan to close our engineering site in Varades, France. This plan is being accounted for under SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. Included in operating expenses for 2003 are exit costs, consisting of primarily severance, in the amount of $1,232,000. Operating Income Operating income is summarized in the following table (in thousands, except percentages): For 2003, research and development expenses increased primarily due to increases in project expenses, which were higher because of reductions related to third-party funded engineering costs that had occurred in 2002 but did not reoccur in 2003. In addition, payroll and beneﬁ ts were up $1,752,000 over 2002, but consulting expenses were down $945,000. For the Year Ended December 31, 2003 December 31, 2002 Percent Change Operating Income $129,218 101,805 26.9 Percent of Total Sales 24.1 21.4 14 The increase in operating income is attributable to the following factors: • Accelerated sales growth compared to 2002, • Improved gross margins resulting from increased overhead utilization, • Favorable changes in foreign exchange rates for Zebra’s non-dollar denominated business, and • Cost controls that held operating expense growth slightly below the rate of sales growth. As a result of these actions, operating income increased by 14.1 percentage points more than the rate of sales growth during 2002. Non-operating Income and Expenses Zebra’s non-operating income and expense items are summarized in the following table (in thousands): Critical Accounting Policies and Estimates Management prepared the consolidated ﬁ nancial statements of Zebra Technologies Corporation under accounting principles generally accepted in the United States of America. These principles require the use of estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions we used are reasonable, based upon the information available. Our estimates and assumptions affect the reported amounts in our ﬁ nancial statements. The following accounting policies comprise those that we believe are the most critical in understanding and evaluating Zebra’s reported ﬁ nancial results. Revenue Recognition Zebra recognizes sales from product sales at the time of shipment and passage of title, which are generally the same. Other items that affect our revenue recognition include: Investment income Interest expense Foreign exchange gains (losses) Other, net Total other income (expense) Year Ended December 31, 2003 $ 8,553 (154) (552) (1,073) $ 6,774 2002 $10,004 (319) 347 (954) $ 9,078 For 2003, investment income decreased because 2002 results included a $1,953,000 pre- tax realized gain on the sale of 585,000 shares of common stock of Fargo Electronics. Income Taxes The effective income tax rate for 2003 was 32.6% versus 35.4% in 2002. The rate for 2003 is less than the 35% Zebra had previously recorded because of the following nonrecurring tax items during the year: • During the fourth quarter of 2003, we settled our long-standing dispute with the Illinois Department of Revenue and recorded a decrease to income tax expense for $1,342,000 since our reserves for this tax dispute exceeded the amount of the settlement. • 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. Excluding these two tax adjustments, our effective tax rate would have been 35% for 2003. Net Income Zebra’s net income is summarized below (in thousands, except per share amounts): Net income Diluted earnings per share 15 Year Ended December 31, 2002 2003 $91,696 $ 1.28 $71,595 $ 1.02 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 notiﬁ cation received of pending returns. Returns have historically been within expectations and the provisions established, but Zebra cannot guarantee that it will continue to experience return rates consistent with historical patterns. Historically, our product returns have not been signiﬁ cant. However, if a signiﬁ cant issue should arise, it could have a material impact on our ﬁ nancial statements. 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 outstanding volume rebates and establish a reserve for them based on shipment history. Historically, actual volume rebates have been in line with our estimates. Price Protection Some of our customers are offered price protection by Zebra as an incentive to carry inventory of our product. These price protection plans provide that if we lower prices, we will credit them for the price decrease on inventory they hold. We estimate future payments under price protection programs quarterly and establish a reserve, which is charged against revenue. Our customers typically carry limited amounts of inventory, and Zebra infrequently lowers prices on current products. As a result, the amounts paid under theses plans have been minimal. We cannot guarantee that this minimal level will continue. Software Revenue We sell three types of software and record revenue as follows: • Our printers contain embedded ﬁ rmware, which is part of the hardware purchase. We consider the sale of this ﬁ rmware to be incidental to the sale of the printer and do not attribute any revenue to it. • We sell a limited amount of prepackaged, or off-the-shelf, software for the creation of bar code labels using our printers. There is no customization required to use this software, and we have no post-shipment obligations on the software. Revenue is recognized at the time this prepackaged software is shipped. • We sometimes provide custom software as part of a printer installation project. We bill custom software development services separate from the related hardware. Revenue related to custom software is recognized once the custom software development services have been completed and accepted by the customer. Shipping and Handling We charge our customers for shipping and handling services based upon our internal price list for these items. The amounts billed to customers are recorded as revenue when the product ships. Any costs incurred related to these services are included in cost of sales. From time to time, Zebra will enter into sales transactions that include more than one product type. This bundle of products might include printers, current or future supplies, and services. When this type of transaction occurs, we allocate the purchase price to each product type based on the fair value of the individual products. The revenue for each individual product is then recognized when the earning process for that product is complete. Investments and Marketable Securities Investments and marketable securities at December 31, 2004, consisted of U.S. government securities (21.5%), state and municipal bonds (65.0%), corporate bonds (7.8%), and partnership interests (5.7%). We classify our debt and marketable equity securities in one of three categories: trading, available-for-sale or held-to-maturity. Trading securities are bought and held principally for the purpose of selling them in the near term. Held-to-maturity securities are those securities that Zebra has the ability and intent to hold until maturity. All securities not included in trading or held-to-maturity are classiﬁ ed as available-for-sale. Trading and available-for-sale securities are recorded at fair value. Held-to-maturity securities are recorded at amortized cost, adjusted for the amortization or accretion of discounts or premiums. Unrealized holding gains and losses on trading securities are included in earnings. Unrealized holding gains and losses, net of the related tax effect, on available-for-sale securities are excluded from earnings and are reported as a separate component of stockholders’ equity until realized. Accounts Receivable We have standardized credit granting and review policies and procedures for all customer accounts, including: • Credit reviews of all new customer accounts, • Ongoing credit evaluations of current customers, • Credit limits and payment terms based on available credit information, • Adjustments to credit limits based upon payment history and the customer’s current credit worthiness, and as of December 31, 2004, were $1,561,000, or 1.6% of the balance due. We feel this reserve level is appropriate considering the quality of the portfolio as of December 31, 2004. While credit losses have historically been within expectations and the provisions established, we cannot guarantee that our credit loss experience will continue to be consistent with historical experience. Inventories We value our inventories at the lower of the actual cost to purchase or manufacture using the ﬁ rst-in, ﬁ rst-out (FIFO) method, or the current estimated market value. We review inventory quantities on hand and record a provision for excess and obsolete inventory based on forecasts of product demand and production requirements for the subsequent twelve months. A signiﬁ cant increase in the demand for Zebra’s products could result in a short-term increase in the cost of inventory purchases; however, this would be offset by improved overhead utilization resulting from the additional demand. A signiﬁ cant decrease in demand could result in an increase in excess inventory quantities on hand. Our forecasted product demand may prove to be inaccurate, in which case the provision required for excess and obsolete inventory may be understated or overstated. If inventories were determined to be overvalued, we would recognize such costs in cost of goods sold at the time of such determination. We make every effort to ensure the accuracy of our forecasts of product demand; however, any signiﬁ cant unanticipated changes in demand or technological developments could have a signiﬁ cant impact on the value of inventories and reported operating results. Over the last three years, our reserves for excess and obsolete inventories have ranged from 10.4% to 13.1% of gross inventory. As of December 31, 2004, reserves for excess and obsolete inventories were $7,338,000, or 10.9% of gross inventory. We feel this reserve level is appropriate considering the quantities and quality of the inventories as of December 31, 2004. Valuation of Long-Lived and Intangible Assets and Goodwill We test the impairment of goodwill each year or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. We completed our last assessment during June 2004. We evaluate the impairment of other long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered that may trigger an impairment review consist of: • Signiﬁ cant underperformance relative to expected historical or projected future operating results, • Signiﬁ cant changes in the manner of use of the acquired assets or the strategy for the • An active collection effort by regional credit functions, reporting directly to the overall business, corporate ﬁ nancial ofﬁ cers. We reserve for estimated credit losses based upon historical experience and speciﬁ c customer collection issues. Over the last three years, accounts receivable reserves varied from 1.6% to 2.8% of total accounts receivable. Accounts receivable reserves • Signiﬁ cant negative industry or economic trends, • Signiﬁ cant decline in Zebra’s stock price for a sustained period, and • Signiﬁ cant decline in market capitalization relative to net book value. 16 If we believe that one or more of the above indicators of impairment have occurred, we measure impairment based on projected discounted cash ﬂ ows using a discount rate that incorporates the risk inherent in the cash ﬂ ows. Net intangible assets, long-lived assets and goodwill amounted to $114,593,000 as of December 31, 2004. and defend these lawsuits. 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 consolidated ﬁ nancial statements as of December 31, 2004. Contingencies We record estimated liabilities related to contingencies based on our estimates of the probable outcomes. Quarterly, we assess the potential liability related to pending litigation, tax audits and other contingencies and conﬁ rm or revise estimates and reserves as appropriate. On April 23, 2003, Paxar Americas, Inc. (Paxar Americas) ﬁ led 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 identiﬁ ed Paxar Americas patents, although not each product is accused of infringing each patent. Zebra has ﬁ led an Answer to Paxar Americas’ Complaint, denying Paxar Americas’ allegations of infringement and asserting several afﬁ rmative defenses, including the invalidity of Paxar Americas’ asserted patent claims. Paxar has sought to amend its original complaint to add two additional patents to the lawsuit and to expand the scope of accused products. Zebra has opposed Paxar’s motions in this regard and the court has the issue under advisement. On November 21, 2003, Zebra’s subsidiary, ZIH Corp. (ZIH), ﬁ led a Complaint in the United States District Court for the District of Massachusetts against Paxar Corporation, alleging 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 ﬁ led a motion to transfer ZIH’s Massachusetts suit to Ohio federal court, and the court denied Paxar’s motion. On November 25, 2003, Paxar Americas ﬁ led a Complaint against ZIH in the United States District Court for the Southern District of Ohio, seeking a declaratory 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. In view of the Massachusetts’ District Court’s denial of Paxar Corporation’s motion to transfer to Ohio ZIH’s corresponding patent infringement suit against Paxar Corporation, the parties to Paxar America’s Ohio declaratory judgment action have agreed to transfer this case to Massachusetts. The outcome of litigation is inherently uncertain, particularly in cases such as these where sophisticated factual issues must be assessed and complex technical issues must be decided. As a result, we cannot accurately predict the outcome of these lawsuits. In the event we are unsuccessful in our defense of Paxar Americas’ infringement claims, we could be liable for economic and other damages, which could be material, and we may be forced to incur ongoing licensing expenses or to change how we design, manufacture and market our products. The patents that ZIH has asserted against Paxar Corporation could be found invalid. We have and will continue to incur substantial fees to prosecute Stock-Based Compensation As of December 31, 2004, Zebra had three stock-based compensation plans available for future grants. We account for those plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based compensation cost is reﬂ ected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-based Compensation, to stock-based compensation (in thousands, except per share amounts): Net income, as reported Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects Year Ended December 31, 2003 2004 2002 $120,643 $91,696 $71,595 (5,501) (5,374) (5,102) Pro forma net income $115,142 $86,322 $66,493 Basic earnings per share: As reported Pro forma Diluted earnings per share: As reported Pro forma $1.69 1.61 $1.66 1.59 $1.30 1.22 $1.28 1.21 $1.03 0.95 $1.02 0.95 Expectations During our quarterly conference call on February 9, 2005, we provided net sales and earnings guidance for the ﬁ rst quarter of 2005 as follows (amounts in thousands, except per share data): Net sales Gross proﬁ t margins Operating expenses Earnings per share First Quarter 2005 $175,000 to $178,000 52.0% to 52.5% $46,000 to $46,500 $0.43 to $0.45 The effective tax rate is expected to be 34.75% of income before income taxes. 17 Liquidity and Capital Resources Zebra continued to generate cash well in excess of its operating requirements. As a result, Zebra’s cash and investment balances have continually grown over time. As of December 31, 2004, Zebra had $557,993,000 in cash, cash equivalents, investments and marketable securities, compared with $447,848,000 at December 31, 2003. Factors affecting cash and investment balances during 2004 include (note that changes discussed below include the impact of foreign currency): • Operations provided a net cash increase of $111,256,000 primarily from net income. • Accounts receivable increased $11,491,000 because of higher sales. • Inventories increased $15,456,000. Compared to the same period a year ago, inventory turns decreased to 5.7 from 6.8. • Other assets increased $11,492,000, primarily due to the purchase of life insurance policies on key executives with guaranteed returns, which due to the nature of these investments are classiﬁ ed as long-term. • Accounts payable increased by $6,420,000, in relation to the increase in inventory. • Accrued expenses increased $1,974,000. • Taxes payable increased $3,720,000 due to increased proﬁ ts. • Purchases of property and equipment totaled $16,243,000. • Net purchases of investments and marketable securities totaled $106,428,000. • Stock option exercises and purchases under the stock purchase plan contributed $15,531,000. Zebra’s contractual obligations as of December 31, 2004 were: Contractual Obligations Total Capital lease obligations Operating lease obligations Purchase obligations Total $ 183 36,287 42,946 $79,416 Payments due by period Less than 1 year $ 62 5,116 42,946 $48,124 1-3 years 3-5 years More than 5 years $ 121 8,170 — $8,291 $ — 6,917 — $6,917 $ — 16,084 — $16,084 Purchase obligations are for purchases made in the normal course of business to meet operational requirements, primarily raw materials. Management believes that existing capital resources and funds generated from operations are sufﬁ cient to ﬁ nance anticipated capital requirements. It is our intention to actively pursue opportunities to acquire other businesses. Recently Issued Accounting Pronouncements In March 2004, the FASB issued Emerging Issues Task Force Issue No. 03-1 (EITF 03-1), The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments, which provides new guidance for assessing impairment losses on investments. Additionally, EITF 03-1 includes new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB delayed the accounting provisions of EITF 03-1; however, the disclosure requirements remain effective for annual periods ending after June 15, 2004. We will evaluate the impact of EITF 03-1 once ﬁ nal guidance is issued. See Note 7 to our consolidated ﬁ nancial statements for added disclosures. In November 2004, the FASB issued SFAS No. 151, Inventory Costs – an amendment of ARB No. 43, Chapter 4. SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing”, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated that these costs may be “so abnormal” that they would require treatment as current period charges. This statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal”. This statement also requires that allocation of ﬁ xed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This statement describes our current process; therefore, it will not have any impact on our ﬁ nancial position or results of operations. In December 2004, the FASB issued SFAS No. 123(R) (revised 2004), Share Based Payment, which is a revision of SFAS 123, Accounting for Stock-Based Compensation, and supercedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS No. 123 (R) focuses primarily on accounting for transactions in which an entity obtains employee services through share-based payment transactions. It requires a public entity to measure the cost of employee services received in exchange for the award of equity instruments based on the fair value of the award at the date of grant. The cost will be recognized over the period during which an employee is required to provide services in exchange for the award. The provisions of this statement become effective for Zebra during the third quarter of 2005. We expect the impact on Zebra’s consolidated ﬁ nancial statements to be consistent with the fair value disclosures included in our critical accounting policies and Note 2 to the consolidated ﬁ nancial statements. In December 2004, the FASB issued FSP FAS 109-1, Application of FASB No. 109, Accounting forIincome Taxe, to the Tax Deduction on Qualiﬁ ed Production Activities Provided by the American Jobs Creation Act of 2004. FSP FAS No. 109-1 clariﬁ es SFAS No. 109’s guidance that applies to the new tax deduction for qualiﬁ ed domestic production activities. FSP No. 109-1 became effective upon issuance and we believe that this pronouncement will have an insigniﬁ cant impact on our effective tax rate in 2005. In December 2004, the FASB issued FSP FAS 109-2, Accounting and Disclosure Guidance for the Foreign Repatriation Provision within the American Jobs Creation Act of 2004. FSP FAS 109-2 provides implementation guidance related to the repatriation provision of the American Jobs Creation Act of 2004. We have completed our assessment of earnings of foreign subsidiaries that might be repatriated. At this time we do not expect to repatriate the earnings of our foreign subsidiaries as dividends to take advantage of this tax credit. Risk Factors Investors should carefully consider the risks, uncertainties and other factors described below, as well as other disclosures in Management’s Discussion and Analysis of Financial Condition and Results of Operations, because they could have a material adverse effect on Zebra’s business, ﬁ nancial condition, operating results, and growth prospects. 18 Zebra could encounter difﬁ culties in any acquisition it undertakes, including unanticipated integration problems and business disruption. Acquisitions could also dilute stockholder value and adversely affect operating results. Proposed acquisitions that are not consummated may result in the write-off of certain acquisition costs. Zebra may acquire or make investments in other businesses, technologies, services or products. The process of integrating any acquired business, technology, service or product into operations may result in unforeseen operating difﬁ culties and expenditures. Integration of an acquired company also may consume considerable management time and attention, which could otherwise be available for ongoing development of the business. The expected beneﬁ ts of any acquisition may not be realized. Moreover, Zebra may be unable to identify, negotiate or ﬁ nance future acquisitions successfully. Future acquisitions could result in potentially dilutive issuances of equity securities or the incurrence of debt, contingent liabilities or amortization expenses. To the extent that a proposed acquisition is not consummated, Zebra may be required to write off certain costs associated with the acquisition, which could be signiﬁ cant. Zebra may not be able to continue to develop products to address user needs effectively in an industry characterized by rapid technological change. To be successful, Zebra must adapt to rapidly changing technological and application needs by continually improving its products as well as introducing new products and services to address user demands. Zebra’s industry is characterized by: • Rapidly changing technology • Evolving industry standards • Frequent new product and service introductions • Evolving distribution channels • Changing customer demands Future success will depend on Zebra’s ability to adapt in this rapidly evolving environment. Zebra could incur substantial costs if it has to modify its business to adapt to these changes, and may even be unable to adapt to these changes. Zebra competes in a highly competitive market, which is likely to become more competitive. Competitors may be able to respond more quickly to new or emerging technology and changes in customer requirements. Zebra faces signiﬁ cant competition in developing and selling its systems. Principal competitors have substantial marketing, ﬁ nancial, development and personnel resources. To remain competitive, Zebra believes it must continue to provide: • Technologically advanced systems that satisfy the user demands, • Superior customer service, • High levels of quality and reliability, and • Dependable and efﬁ cient distribution networks. with suppliers or companies that produce complementary products. Any of these factors could reduce Zebra’s earnings. Zebra may incur liabilities as a result of Zebra installed product failures due to design or manufacturing defects. Zebra generally has insurance for such risks and also seeks to limit such risk though product design, manufacturing quality control processes, product testing and contractual limitations. However, due to the large and growing size of Zebra’s installed printer base, a design or manufacturing defect attributable to this large installed printer base could result in product recalls or customer service costs that could have material adverse effects on Zebra’s ﬁ nancial results. 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. Infringement on the proprietary rights of others could put Zebra at a competitive disadvantage, and any related litigation could be time consuming and costly. Third parties may claim that Zebra violated their intellectual property rights. To the extent of a violation of a third party’s patent or other intellectual property right, Zebra may be prevented from operating its business as planned, and may be required to pay damages, to obtain a license, if available, or to use a non-infringing method, if possible, to accomplish its objectives. Any of these claims, with or without merit, could result in costly litigation and divert the attention of key personnel. If such claims are successful, they could result in costly judgments or settlements. Zebra sells a signiﬁ cant portion of its products internationally and purchases important components from foreign suppliers. These circumstances create a number of risks. Zebra sells a signiﬁ cant amount of its products to customers outside the United States. Shipments to international customers are expected to continue to account for a material portion of net sales. Risks associated with sales and purchases outside the United States include: • Fluctuating foreign currency rates could restrict sales, or increase costs of purchasing, in foreign countries. • Foreign governments may impose burdensome tariffs, quotas, taxes, trade barriers or capital ﬂ ow restrictions. • Political and economic instability may reduce demand for our products, or put our foreign assets at risk. • Restrictions on the export or import of technology may reduce or eliminate the ability to sell in or purchase from certain markets. Zebra cannot assure it will be able to compete successfully against current or future competitors. Increased competition in printers or supplies may result in price reductions, lower gross proﬁ t margins and loss of market share, and could require increased spending on research and development, sales and marketing and customer support. Some competitors may make strategic acquisitions or establish cooperative relationships • Potentially limited intellectual property protection in certain countries, such as China, may limit recourse against infringing products or cause Zebra to refrain from selling in certain geographic territories. • Stafﬁ ng and managing international operations may be unusually difﬁ cult. • Zebra may not be able to control international distributors working on its behalf. 19 Economic factors, which are outside Zebra’s control, could lead to deterioration in the quality of Zebra’s accounts receivables. Zebra sells its products to customers in the United States and several other countries around the world. Sales are typically made on unsecured credit terms, which are generally consistent with the prevailing business practices in a given country. A deterioration of economic or political conditions in a country could impair Zebra’s ability to collect on receivables in the affected country. Zebra depends on the ongoing service of its senior management and ability to attract and retain other key personnel. Future success of Zebra is substantially dependent on the continued service and continuing contributions of senior management and other key personnel. The loss of the service of any executive ofﬁ cer or other key employees could adversely affect business. Zebra has no long-term employment agreements with key personnel and maintains minimal key man life insurance policies on its key employees. Zebra mitigates interest rate risk with an investment policy that requires the use of outside professional investment managers, investment liquidity and broad diversiﬁ cation across investment strategies, and which limits the types of investments that may be made. Moreover, the policy requires due diligence of each investment manager both before employment and on an ongoing basis. The following table sets forth the impact of a one-percentage point movement in interest rates on the value of Zebra’s investment portfolio as of December 31, 2004 (in thousands, except per share data). Interest rate sensitive instruments + 1 percentage point movement - 1 percentage point movement Effect on Pretax Income Effect on Diluted EPS (after tax) $(6,174) $ 6,174 $(0.06) $ 0.06 The ability to attract, retain and motivate highly skilled employees is important to 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 other highly qualiﬁ ed employees in the future. Because these securities are classiﬁ ed as available-for-sale under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, the impact of a one- percentage point movement in interest rates occurs over an extended period of time as investments are sold and the funds are subsequently reinvested. Terrorist attacks or war could lead to further economic instability and adversely affect Zebra’s stock price, operations, and proﬁ tability. The terrorist attacks that occurred in the United States on September 11, 2001 caused major instability in the U.S. and other ﬁ nancial markets. Possible further acts of terrorism and current and future war risks could have a similar impact. The United States continues to take military action against terrorism and is currently engaged in a costly occupation of Iraq. These events may lead to additional armed hostilities or to further acts of terrorism and civil disturbance in the United States or elsewhere, which may further contribute to economic instability. Any such attacks could, among other things, cause further instability in ﬁ nancial markets and could directly, or indirectly through reduced demand, negatively affect Zebra’s facilities and operations or those of its customers or suppliers. Taxing authority challenges may lead to tax payments exceeding current reserves. Zebra operates in multiple tax jurisdictions in the United States and worldwide. Local tax authorities may challenge Zebra’s tax positions from time to time. Adverse outcomes in these situations may exceed Zebra’s reserves for tax payments and may increase Zebra’s effective tax rate. Item 7A. Quantitative and Qualitative Disclosures About Market Risk Interest Rate Risk Zebra is exposed to the impact of changes in interest rates because of our large investment portfolio. As stated in our written investment policy, the investment portfolio is viewed as a strategic resource that will be managed to achieve above market rates of return in exchange for accepting a prudent amount of incremental risk, which includes the risk of interest rate movements. Risk tolerance is constrained by an overriding objective to preserve capital across each quarterly reporting cycle. Foreign Exchange Risk We conduct business in approximately 100 countries throughout the world and, therefore, are exposed to risk based on movements in foreign exchange rates. We generally invoice customers in their local currency and have a resulting foreign currency denominated revenue transaction and accounts receivable. We also purchase certain raw materials and other items in foreign currencies. We manage these risks using derivative ﬁ nancial 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 ﬁ nancial information related to these activities follows (in thousands): Change in gains (losses) from foreign exchange derivatives Gain on net foreign currency assets $(1,246) 1,731 $(3,756) 3,204 Net foreign exchange gain (loss) $ 485 $ (552) $(2,579) 2,926 $ 347 Year Ended December 31, 2003 2004 2002 Notional balance of outstanding contracts: Pound Euro December 31, December 31, 2003 2004 £13,646 €34,000 £8,569 €22,000 20 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 designated these contracts as cash ﬂ ow 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 ﬁ nancial information related to the cash ﬂ ow hedges of future revenues follows (in thousands, except percentages): Net unrealized losses deferred in other comprehensive income: Gross Tax beneﬁ t Net Notional balance of outstanding contracts Hedge effectiveness Net gain (loss) included in revenue for the: Three months ended December 31, 2004 Three months ended December 31, 2003 Year ended December 31, 2004 Year ended December 31, 2003 December 31, December 31, 2003 2004 $(2,231) 781 $(1,450) €30,000 100% $(1,537) 538 $ (999) €30,420 100% 2004 2003 $(1,077) (1,639) $(150) 266 The following table sets forth the impact of a one-percentage point movement in the dollar/pound and dollar/euro rates measured as if Zebra did not engage in the selective hedging practices described above. It is based on the dollar/euro and dollar/pound exchange rates and euro and pound denominated assets and liabilities as of December 31, 2004 (in thousands, except per share data). Foreign exchange Dollar/pound Dollar/euro Effect on Pretax Income Effect on Diluted EPS (after tax) $ 321 $484 $0.00 $0.00 Equity Price Risk From time to time, Zebra has taken direct equity positions in companies. These investments relate to potential acquisitions and other strategic business opportunities. To the extent that it has a direct investment in the equity securities of another company, Zebra is exposed to the risks associated with such investments. Zebra currently employs four investment managers, two of which manage portfolios of investment funds (i.e., fund of funds). These investment funds use a variety of investment strategies, some of which involve the use of equity securities. Each investment manager’s portfolio is designed to be market neutral, although an individual fund within a portfolio may be exposed to market risk. By policy, management limits the amount of Zebra’s investments in alternative investment strategies to a maximum of 15% of the total investment portfolio, with no single investment exceeding $15,000,000. Zebra utilizes a Value-at-Risk (VaR) model to determine the maximum potential one-day loss in the fair value of its interest rate, foreign exchange and equity price sensitive instruments. The following table sets forth the impact of a one-percentage point change in the value of all equity positions held by Zebra’s investment managers (in thousands, per share data). Equity price sensitive instruments + 1 percentage point movement - 1 percentage point movement Effect on Pretax Income Effect on Diluted EPS (after tax) $ 400 $(400) $ 0.00 $(0.00) Item 8. Financial Statements and Supplementary Data The ﬁ nancial statements and schedule of the Company are annexed to this Report as pages F-1 through F-22. An index to such materials appears on page F-1. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures Not applicable. Item 9A. Controls and Procedures Evaluation of Disclosure Controls and Procedures We conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as deﬁ ned in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this Form 10-K. The controls evaluation was conducted under the supervision of our Disclosure Committee, and with the participation of management, including our Chief Executive Ofﬁ cer and Chief Financial Ofﬁ cer. Based on that evaluation, our Chief Executive Ofﬁ ce and Chief Financial Ofﬁ cer, have concluded that our disclosure controls and procedures were effective to provide reasonable assurance that (i) the information required to be disclosed by us in this Annual Report on Form 10-K was recorded, processed, summarized and reported within the time periods speciﬁ ed in the SEC’s rules and forms, and (ii) information required to be disclosed by us in our reports that we ﬁ le or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal ﬁ nancial ofﬁ cers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. 21 Management’s Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over ﬁ nancial reporting as deﬁ ned in Rules 13a-15(f) and 15d-15(f) under the Exchange Act to provide reasonable assurance regarding the reliability of our ﬁ nancial reporting and the preparation of the ﬁ nancial statements for external purposes in accordance with generally accepted accounting principles. Our management assessed the effectiveness of our internal control over ﬁ nancial reporting as of December 31, 2004. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control- Integrated Framework. Based on this assessment and those criteria, our management believes that, as of December 31, 2004, our internal control over ﬁ nancial reporting is effective. Our independent registered public accounting ﬁ rm, KPMG LLP, has issued an attestation report on management’s assessment of Zebra’s internal control over ﬁ nancial reporting. That report is included on page 23 of this Report on Form 10-K. Changes in Internal Control over Financial Reporting During 2004, we made numerous changes to our controls and procedures as part of our ongoing monitoring of our controls. However, none of these changes has materially affected, or are reasonably likely to materially affect, our internal control over ﬁ nancial reporting. Inherent Limitations on the Effectiveness of Controls Our management, including our Chief Executive Ofﬁ cer and Chief Financial Ofﬁ cer, does not expect that our disclosure controls and procedures or our internal controls will prevent or detect all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reﬂ ect the fact that there are resource constraints, and the beneﬁ ts of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within Zebra have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. 22 Commission (COSO). Also, in our opinion, the Company maintained, in all material respects, effective internal control over ﬁ nancial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Zebra Technologies Corporation and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of earnings, comprehensive income, stockholders’ equity, and cash ﬂ ows for each of the years in the three-year period ended December 31, 2004, and our report dated March 2, 2005 expressed an unqualiﬁ ed opinion on those consolidated ﬁ nancial statements. /s/KPMG LLP Chicago, Illinois March 2, 2005 Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders of Zebra Technologies Corporation: We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Zebra Technologies Corporation (the Company) maintained effective internal control over ﬁ nancial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over ﬁ nancial reporting and for its assessment of the effectiveness of internal control over ﬁ nancial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over ﬁ nancial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over ﬁ nancial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over ﬁ nancial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over ﬁ nancial reporting is a process designed to provide reasonable assurance regarding the reliability of ﬁ nancial reporting and the preparation of ﬁ nancial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over ﬁ nancial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reﬂ ect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of ﬁ nancial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the ﬁ nancial statements. Because of its inherent limitation, internal control over ﬁ nancial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management’s assessment that the Company maintained effective internal control over ﬁ nancial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway 23 PART III SIGNATURES Item 10. Directors and Executive Ofﬁ cers of the Registrant We have adopted a Code of Ethics that applies to Zebra’s Chief Executive Ofﬁ cer, Chief Financial Ofﬁ cer and the Vice President and Controller. The Code of Ethics is posted on the investor page of Zebra’s Internet Web site, www.zebra.com, and is available for download. All other information in response to this item is incorporated by reference from the Proxy Statement sections entitled “Election of Directors” and “Executive Ofﬁ cers.” Item 11. Executive Compensation The information in response to this item is incorporated by reference from the Proxy Statement section entitled “Executive Compensation and Certain Transactions.” Item 12. Security Ownership of Certain Beneﬁ cial Owners and Management and Related Stockholder Matters The information in response to this item is incorporated by reference from the Proxy Statement section entitled “Security Ownership of Management and Certain Beneﬁ cial Owners” and “Equity Compensation Plan Information.” Item 13. Certain Relationships and Related Transactions The information in response to this item is incorporated by reference from the Proxy Statement section entitled “Executive Compensation and Certain Transactions.” Item 14. Principal Accounting Fees and Services The information in response to this item is incorporated by reference from the Proxy Statement section entitled “Fees of Independent Auditors.” PART IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K The ﬁ nancial statements and schedule ﬁ led as part of this report are listed in the accompanying Index to Financial Statements and Schedule. The exhibits ﬁ led as a part of this report are listed in the accompanying Index to Exhibits. Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 28th day of February 2005. ZEBRA TECHNOLOGIES CORPORATION By: /s/Edward L. Kaplan Edward L. Kaplan Chairman and Chief Executive Ofﬁ cer Pursuant to the requirements of the Securities and Exchange Act of 1934, the Report has been signed below by the following persons in the capacities and on the dates indicated. Signature Title Date /s/Edward L. Kaplan Edward L. Kaplan Chief Executive Ofﬁ cer and Chairman of the Board of Directors (Principal Executive Ofﬁ cer) /s/Gerhard Cless Gerhard Cless Executive Vice President and Director February 28, 2005 February 28, 2005 /s/Charles R. Whitchurch Charles R. Whitchurch Chief Financial Ofﬁ cer and Treasurer (Principal Financial and Accounting Ofﬁ cer) February 28, 2005 /s/Christopher G. Knowles Director Christopher G. Knowles /s/Ross W. Manire Ross W. Manire /s/Robert J. Potter Robert J. Potter /s/Michael A. Smith Michael A. Smith Director Director Director February 28, 2005 February 28, 2005 February 28, 2005 February 28, 2005 24 Index to Exhibits (1) Certiﬁ cate of Incorporation of the Registrant. 10.16 (2) Amendment No. 1 to the 2002 Non-Employee Director Stock Option Plan. + 10.17 (2) 2002 Non-Employee Director Stock Option Plan Non-Qualiﬁ ed Stock Option Agreement. + (2) Certiﬁ cate of Amendment to Certiﬁ cate of Incorporation of the Registrant. 10.18 (15) 2005 Executive Deferred Compensation Plan. + (3) Certiﬁ cate of Amendment to Certiﬁ cate of Incorporation of the Registrant. (4) Bylaws of the Registrant. (5) Amendment to Bylaws of the Registrant. (2) Amendment to Bylaws of the Registrant. (3) Amendment to Bylaws of the Registrant. (3) Amendment to Bylaws of the Registrant. (6) Amendment to Bylaws of the Registrant. (4) Specimen stock certiﬁ cate representing Class A Common Stock. (6) (7) (8) Rights Agreement between the Registrant and Mellon Investor Services, as Rights Agent. 1997 Stock Option Plan. + First Amendment to the 1997 Stock Option Plan. + (8) Second Amendment to the 1997 Stock Option Plan. + (9) Third Amendment to the 1997 Stock Option Plan. + 10.19 10.20 21.0 23.1 31.1 31.2 32.1 32.2 Employment Agreement dated July 17, 1997 and Interofﬁ ce Memorandum dated January 27, 1997 between the Registrant and Charles R. Whitchurch. + Employment Agreement between the Registrant and Veraje Anjargolian, dated April 1, 1997. + Subsidiaries of the Registrant. Consent of KPMG LLP, independent auditors. Certiﬁ cation pursuant to Rule 13a-14(a)/15d-14(a). Certiﬁ cation pursuant to Rule 13a-14(a)/15d-14(a). Certiﬁ cation Pursuant to 18 U.S.C Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Certiﬁ cation Pursuant to 18 U.S.C Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9 4.0 4.1 10.1 10.2 10.3 10.4 10.5 (10) Amendment No. Four to the 1997 Stock Option Plan. + 10.6 10.7 (8) (4) Form of Stock Option Agreement. + Form of Indemniﬁ cation Agreement between the Registrant and each of its directors. 10.8 (4) Lease between the Registrant and Unique Building Corporation for the Registrant’s facility in Vernon Hills, Illinois, as amended. 10.9 (7) Directors’ 1997 Stock Option Plan.+ 10.10 (11) 10.11 (12) 10.12 (13) 10.13 (13) 10.14 (14) Amendment to the lease between the Registrant and Unique Building Corporation for the Registrant’s facility in Vernon Hills, Illinois, dated April 1, 1993. Amendment to the lease between the Registrant and Unique Building Corporation for the Registrant’s facility in Vernon Hills, Illinois, dated December 1, 1994. Amendment to the lease between the Registrant and Unique Building Corporation for the Registrant’s facility in Vernon Hills, Illinois, dated June 1, 1996. Amendment to the lease between the Registrant and Unique Building Corporation for the Registrant’s facility in Vernon Hills, Illinois, dated June 2, 1996. Amendment to the lease between the Registrant and Unique Building Corporation for the Registrant’s facility in Vernon Hills, Illinois, dated as of July 1, 1999. 10.15 (2) 2002 Non-Employee Director Stock Option Plan. + 25 (1) (2) (3) (4) (5) (6) (7) (8) Previously ﬁ led with the Securities and Exchange Commission as an Exhibit to the Company’s Registration Statement on Form S-3, File No. 333- 33315, and incorporated herein by reference. Previously ﬁ led with the Securities and Exchange Commission as an Exhibit to the Company’s Form 10-Q for the quarterly period ended June 29, 2002, and incorporated herein by reference. Previously ﬁ led with the Securities and Exchange Commission as an Exhibit to the Company’s Form 10-Q for the quarterly period ended June 28, 2003. Previously ﬁ led with the Securities and Exchange Commission as an Exhibit to the Company’s Registration Statement on Form S-1, as amended, File No. 33-41576, and incorporated herein by reference. Previously ﬁ led with the Securities and Exchange Commission as an Exhibit to the Company’s Annual Report on Form 10-K for the ﬁ scal year ended December 31, 1992, and incorporated herein by reference. Previously ﬁ led with the Securities and Exchange Commission as an Exhibit to the Company’s Form 10-Q for the quarterly period ended March 30, 2002, and incorporated herein by reference. Previously ﬁ led with the Securities and Exchange Commission as an Exhibit to the Company’s Annual Report on Form 10-K for the ﬁ scal year ended December 31, 1997, and incorporated herein by reference. Previously ﬁ led with the Securities and Exchange Commission as an Exhibit to the Company’s Registration Statement on Form S-8, File No. 333-63009, and incorporated herein by reference. (9) (10) (11) (12) (13) (14) (15) Previously ﬁ led with the Securities and Exchange Commission as an Exhibit to the Company’s Registration Statement on Form S-8, File No. 333- 84512, and incorporated herein by reference. Previously ﬁ led with the Securities and Exchange Commission as an Exhibit to the Company’s Form 10-Q for the quarterly period ended September 28, 2002, and incorporated herein by reference. Previously ﬁ led with the Securities and Exchange Commission as an Exhibit to the Company’s Annual Report on Form 10-K for the ﬁ scal year ended December 31, 1993, and incorporated herein by reference. Previously ﬁ led with the Securities and Exchange Commission as an Exhibit to the Company’s Annual Report on Form 10-K for the ﬁ scal year ended December 31, 1994, and incorporated herein by reference. Previously ﬁ led with the Securities and Exchange Commission as an Exhibit to the Company’s Annual Report on Form 10-K for the ﬁ scal year ended December 31, 1996, and incorporated herein by reference. Previously ﬁ led with the Securities and Exchange Commission as an Exhibit to the Company’s Form 10-Q for the quarterly period ended April 1, 2000, and incorporated herein by reference. Previously ﬁ led with the Securities and Exchange Commission as an Exhibit to the Company’s Current Report on Form 8-K ﬁ led on February 9, 2005, and incorporated herein by reference. + Management contract or compensatory plan or arrangement required to be ﬁ led as an exhibit to this Annual Report on Form 10-K. 26 ZEBRA TECHNOLOGIES CORPORATION AND SUBSIDIARIES Report of Independent Registered Public Accounting Firm INDEX TO FINANCIAL STATEMENTS AND SCHEDULE The Board of Directors and Stockholders of Zebra Technologies Corporation: Financial Statements Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets as of December 31, 2004 and 2003 Consolidated Statements of Earnings for the years ended December 31, 2004, 2003, and 2002 Consolidated Statements of Comprehensive Income for the years ended December 31, 2004, 2003, and 2002 Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2004, 2003, and 2002 Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003, and 2002 Notes to Consolidated Financial Statements Financial Statement Schedule Page F-1 F-2 F-3 F-4 F-5 F-6 F-7 The following ﬁ nancial statement schedule is included herein: Schedule II - Valuation and Qualifying Accounts F-22 All other ﬁ nancial statement schedules are omitted because they are not applicable or the required information is shown in the consolidated ﬁ nancial statements or notes thereto. We have audited the accompanying consolidated balance sheets of Zebra Technologies Corporation and subsidiaries (the Company) as of December 31, 2004 and 2003, and the related consolidated statements of earnings, comprehensive income, stockholders’ equity, and cash ﬂ ows for each of the years in the three-year period ended December 31, 2004. In connection with our audits of the consolidated ﬁ nancial statements, we also have audited the consolidated ﬁ nancial statement schedule of valuation and qualifying accounts. These consolidated ﬁ nancial statements and the consolidated ﬁ nancial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated ﬁ nancial statements and the consolidated ﬁ nancial statement schedule based on our audits. We conducted our audits in accordance with auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the ﬁ nancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the ﬁ nancial statements. An audit also includes assessing the accounting principles used and signiﬁ cant estimates made by management, as well as evaluating the overall ﬁ nancial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated ﬁ nancial statements referred to above present fairly, in all material respects, the ﬁ nancial position of the Company as of December 31, 2004 and 2003, and the results of their operations and their cash ﬂ ows for each of the years in the three-year period ended December 31, 2004, in conformity with U. S. generally accepted accounting principles. Also, in our opinion, the related consolidated ﬁ nancial statement schedule, when considered in relation to the basic consolidated ﬁ nancial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over ﬁ nancial reporting as of December 31, 2004, based on the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 2, 2005 expressed an unqualiﬁ ed opinion on management’s assessment of, and the effective operation of, internal control over ﬁ nancial reporting. /s/KPMG LLP Chicago, Illinois March 2, 2005 F-1 ZEBRA TECHNOLOGIES CORPORATION CONSOLIDATED BALANCE SHEETS (Amounts in thousands, except share and per share data) ASSETS Current assets: Cash and cash equivalents Investments and marketable securities Accounts receivable, net of allowances of $1,561 in 2004 and $1,388 in 2003 Inventories, net Deferred income taxes Prepaid expenses Total current assets Property and equipment at cost, net of accumulated depreciation and amortization Goodwill Other intangibles, net 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 Additional paid-in capital Retained earnings Accumulated other comprehensive income Total stockholders’ equity Total liabilities and stockholders’ equity See accompanying notes to consolidated ﬁ nancial statements. December 31, 2004 December 31, 2003 $ 17,983 540,010 96,881 59,255 6,625 3,884 724,638 46,283 61,793 6,517 22,991 $862,222 $ 24,130 29,248 54 6,144 59,576 117 417 564 3,894 64,568 — 718 84,180 706,489 6,267 797,654 $ 14,266 433,582 81,867 42,781 4,507 4,415 581,418 39,286 61,150 9,031 10,726 $701,611 $ 16,238 26,938 153 2,273 45,602 452 723 518 2,401 49,696 — 711 61,929 585,846 3,429 651,915 $862,222 $701,611 F-2 ZEBRA TECHNOLOGIES CORPORATION CONSOLIDATED STATEMENTS OF EARNINGS (Amounts in thousands, except per share data) Net sales Cost of sales Gross proﬁ t 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 Basic weighted average shares outstanding Diluted weighted average and equivalent shares outstanding See accompanying notes to consolidated ﬁ nancial statements. F-3 2004 $663,054 319,895 343,159 77,062 37,093 49,097 2,569 22 2,100 — 46 167,989 175,170 10,628 (44) 485 (1,691) 9,378 184,548 63,905 Year Ended December 31, 2003 $536,397 263,320 273,077 66,635 31,759 41,892 1,640 692 1,232 — 9 143,859 129,218 8,553 (154) (552) (1,073) 6,774 135,992 44,296 2002 $475,611 244,864 230,747 56,176 29,210 38,689 1,494 — — 3,300 73 128,942 101,805 10,004 (319) 347 (954) 9,078 110,883 39,288 $120,643 $ 91,696 $ 71,595 $ 1.69 $ 1.66 71,556 72,539 $ 1.30 $ 1.28 70,647 71,495 $ 1.03 $ 1.02 69,678 70,305 ZEBRA TECHNOLOGIES CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Amounts in thousands) Net income Other comprehensive income (loss): Foreign currency translation adjustment Changes in unrealized gain/loss on hedging transactions, net of income taxes Changes in unrealized holding gains/loss on investments, net of income taxes Comprehensive income See accompanying notes to consolidated ﬁ nancial statements. 2004 $120,643 3,402 (451) (113) $123,481 Year Ended December 31, 2003 $91,696 4,110 (999) 346 $95,153 2002 $71,595 2,968 — (1,603) $72,960 F-4 ZEBRA TECHNOLOGIES CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (Dollars in thousands) Balance at December 31, 2001 $586 $124 $58,617 $422,555 $(35,482) $(1,393) $445,007 Class A Common Stock Class B Common Stock Additional Paid-in Capital Retained Earnings Accumulated Other Treasury Comprehensive Stock Income (Loss) Total Conversion of 3,693,876 shares of Class B Common Stock to 3,693,876 shares of Class A Common Stock Reissuance of 575,976 treasury shares upon exercise of stock options and purchases under stock purchase plan Tax beneﬁ t 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 8,743,612 shares of Class B Common Stock to 8,743,612 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 beneﬁ t 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 Issuance of 725,274 common shares upon exercise of stock options and purchases under stock purchase plan Payment for fractional shares in 3-for-2 stock split Tax beneﬁ t 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, 2004 See accompanying notes to consolidated ﬁ nancial statements. F-5 37 — — — — — 623 87 — 1 — — — — — — 711 7 — — — — — — $718 (37) — — — — — — — — — — 87 (5,616) 3,082 — — — 56,083 (87) — — — — — — — — — — — — — — — — — — (1,630) 2,631 (142) 4,987 — — — — 61,929 15,524 (238) 6,965 — — — — $84,180 — — 71,595 — — 494,150 — — — — — 91,696 — — — 585,846 — — — 120,643 — — — $706,489 18,722 — — — — (16,760) — 16,760 — — — — — — — — — — — — — — — — — — — (1,603) 2,968 13,106 3,082 71,595 (1,603) 2,968 (28) 534,155 — — — — — — 346 (999) 4,110 3,429 — — — — (113) (451) 3,402 — 15,130 2,632 (142) 4,987 91,696 346 (999) 4,110 651,915 15,531 (238) 6,965 120,643 (113) (451) 3,402 $ 6,267 $797,654 ZEBRA TECHNOLOGIES CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in thousands) Cash ﬂ ows from operating activities: Net income Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization Tax beneﬁ t 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 ﬂ ows from investing activities: Purchases of property and equipment Acquisition of Atlantek, Inc., net of cash acquired Purchases of investments and marketable securities Maturities of investments and marketable securities Sales of investments and marketable securities Net cash used in investing activities Cash ﬂ ows from ﬁ nancing activities: Proceeds from exercise of stock options and stock purchase plan purchases Payments for obligation under capital lease Other ﬁ nancing activities Net cash provided by ﬁ nancing 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 ﬂ ow information: Interest paid Income taxes paid Supplemental disclosures of non-cash transactions: Conversion of Class B Common Stock to Class A Common Stock Assets under capital lease obligation See accompanying notes to consolidated ﬁ nancial statements. 2004 Year Ended December 31, 2003 2002 $ 120,643 $ 91,696 $ 71,595 12,255 6,965 22 — — (2,358) (11,491) (15,456) (11,492) 6,420 1,974 3,720 54 — 111,256 (16,243) — (1,287,388) 861,249 319,711 (122,671) 15,531 (434) (238) 14,859 273 3,717 14,266 11,580 4,987 692 — — (697) (5,141) (1,659) 350 (3,156) 6,909 (962) (2,196) — 102,403 (8,407) (13,680) (1,055,125) 894,165 57,537 (125,510) 17,762 (200) (142) 17,420 1,535 (4,152) 18,418 $ 17,983 $ 14,266 $ 44 56,055 $ 154 38,779 — — 87 — 12,259 3,082 — 1,360 193 (616) (1,629) 2,922 3,969 (939) 2,607 (896) 1,241 (111,997) (16,849) (8,481) — — — 3,499 (4,982) 13,106 (117) — 12,989 932 (7,910) 26,328 $ 18,418 $ 319 33,840 37 333 F-6 ZEBRA TECHNOLOGIES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 Description of Business Zebra Technologies Corporation and its wholly-owned subsidiaries (Zebra) design, manufacture, sell and support a broad range of direct thermal and thermal transfer label printers, radio frequency identiﬁ cation printer/encoders, dye sublimation card printers, digital photo printers and related accessories and support software. These products are used principally in automatic identiﬁ cation (auto ID), data collection and personal identiﬁ cation applications and are distributed world-wide through a network of resellers, distributors and end users representing a wide cross-section of industrial, service and government organizations. Note 2 Summary of Signiﬁ cant Accounting Policies Principles of Consolidation. These consolidated ﬁ nancial statements were prepared on a consolidated basis to include the accounts of Zebra and its wholly owned subsidiaries. All signiﬁ cant intercompany accounts, transactions and unrealized proﬁ t were eliminated in consolidation. Use of Estimates. These consolidated ﬁ nancial statements were prepared using estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated ﬁ nancial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents. Cash consists primarily of deposits with banks. In addition, Zebra considers highly liquid short-term investments with original maturities of less than seven days to be cash equivalents. Investments and Marketable Securities. Investments and marketable securities at December 31, 2004, consisted of U.S. government securities, state and municipal bonds, partnership interests and equity securities, which are held indirectly in diversiﬁ ed funds actively managed by investment professionals. Zebra classiﬁ es its debt and marketable equity securities in one of three categories: trading, available-for-sale or held-to-maturity. Trading securities are bought and held principally for the purpose of selling them in the near term. Held-to-maturity securities are those securities that Zebra has the ability and intent to hold until maturity. All securities not included in trading or held-to-maturity are classiﬁ ed as available-for-sale. Trading and available-for-sale securities are recorded at fair value. Held-to-maturity securities are recorded at amortized cost, adjusted for the amortization or accretion of discounts or premiums. Unrealized holding gains and losses on trading securities are included in earnings. Unrealized holding gains and losses, net of the related tax effect, on available-for-sale securities are excluded from earnings and are reported as a separate component of stockholders’ equity until realized. Inventories. Inventories are stated at the lower of cost or market, and cost is determined by the ﬁ rst-in, ﬁ rst-out (FIFO) method. Property and Equipment. Property and equipment is stated at cost. Depreciation 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 30 years for buildings and range from 3 to 10 years for other property. Property and equipment held under capital leases is amortized using the straight-line method over the shorter of the lease term or estimated useful life of the asset. Income Taxes. Zebra accounts for income taxes under the asset and liability method. Accordingly, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the ﬁ nancial statement carrying amounts of existing assets and liabilities and their respective tax 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 differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Intangible Assets. Goodwill represents the unamortized excess of the cost of acquiring a business over the fair values of the net assets received at the date of acquisition. Goodwill is no longer being amortized as required by SFAS No. 142, Goodwill and Other Intangible Assets. We test the impairment of goodwill each year or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. We completed our last assessment during June 2004. We evaluate the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered that might trigger an impairment review consist of: • Signiﬁ cant underperformance relative to expected historical or projected future operating results • Signiﬁ cant changes in the manner of use of the acquired assets or the strategy for the overall business • Signiﬁ cant negative industry or economic trends • Signiﬁ cant decline in Zebra’s stock price for a sustained period • Signiﬁ cant 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 ﬂ ow using a discount rate that incorporates the risk inherent in the cash ﬂ ows. Other intangible assets consist primarily of current technology and customer relationships. These assets are recorded at cost and amortized on a straight-line basis over 5 to 8 years. Accumulated amortization for these other intangible assets was $8,074,000 and $5,505,000 at December 31, 2004 and 2003, respectively. F-7 Revenue Recognition. Revenue includes sales of hardware, supplies, software and services (including repair services, extended service contracts, and professional services). Product revenue is recognized when product has been shipped, risk of loss has passed to the purchaser, and Zebra has fulﬁ lled all of its obligations. We provide for an estimate of product returns based on historical experience. Revenue related to extended warranty and service contracts is recorded as deferred income and recognized over the life of the contract. Professional services revenue is recorded when performed. From time to time, Zebra will enter into sales transactions that include more than one product type. This bundle of products might include printers, current or future supplies, and services. When this type of transaction occurs, we allocate the purchase price to each product type based on the fair value of the individual products. The revenue for each individual product is then recognized when the earning process for that product is complete. Zebra records payments to resellers of its product as reductions to revenue unless these payments meet the requirements for operating expense treatment under EITF 01-09 Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products). See the market development funds accounting policy for further details. received by Zebra. These payments are treated as marketing costs consistent with the requirements of EITF 01-9, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products). Any payments to resellers that do not meet these requirements are recorded as reductions to revenue. Warranty. Zebra provides warranty coverage of up to one year on printers against defects in material and workmanship. A provision for warranty expense is recorded at the time of shipment and adjusted quarterly based on historical warranty experience. The following is a summary of Zebra’s accrued warranty obligation during the years ended December 31, 2004 and 2003. Accrued warranty – beginning balance Add: warranty expense Deduct: warranty payments Accrued warranty – ending balance 2004 $ 1,351 3,209 2,869 $ 1,691 2003 $ 1,090 3,095 2,834 $ 1,351 2002 $ 1,021 2,564 2,495 $ 1,090 Fair Value of Financial instruments. Zebra estimates the fair value of its ﬁ nancial instruments as follows: Revenue includes all customer billings for shipping and handling charges. The related costs of shipping and handling revenue are recorded as cost of goods sold. Instrument Method for determining fair value Research and Development Costs. Research and development costs are expensed as incurred. These costs include: • Salaries, beneﬁ ts, and other R&D personnel related costs • Consulting and other outside services used in the R&D process • Engineering supplies • Engineering related information systems costs • Allocation of building and related costs From time to time, Zebra will provide engineering and development services to third parties on a contract basis. Zebra does not guarantee the outcome of this research and does not retain any obligation to repay third-party funding received for these contract services. Since these services are not part of our standard product offering, we treat payments received under these arrangements as reductions to research and development costs. Advertising. Advertising costs are expensed as incurred. Advertising expenses for the years ended December 31, 2004, 2003 and 2002 totaled $5,117,000, $3,721,000 and $3,965,000, respectively. Market Development Funds. Zebra makes market development funds available to its resellers to support demand generation activity by the resellers. These funds require the reseller to provide speciﬁ c services or beneﬁ ts to Zebra and substantiate the fair value of such. Zebra reimburses resellers for agreed activities up to the fair value of the beneﬁ t Cash, cash equivalents, accounts receivable, accounts payable and accrued liabilities Investments and marketable securities Foreign currency forward contracts Foreign currency option contracts Cost, which approximates fair value due to the short-term nature of these instruments Market quotes from independent pricing services 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 In accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, we recognize derivative instruments and hedging activities as either assets or liabilities on the balance sheet and measure them at fair value. Gains and losses resulting from changes in fair value are accounted for depending on the use of the derivative and whether it is designated and qualiﬁ es for hedge accounting. See Note 15 for additional information on our derivatives and hedging activities. F-8 Stock-based Compensation. At December 31, 2004, Zebra has three stock-based compensation plans, which are described more fully in Note 3. Zebra accounts for those plans using the intrinsic method in accordance with the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based compensation cost is reﬂ ected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if Zebra had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-based Compensation, to stock-based compensation. Net income, as reported 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 Year Ended December 31, 2004 2003 $120,643 $91,696 2002 $71,595 (5,501) (5,374) (5,102) $ 115,142 $86,322 $66,493 $ 1.69 1.61 $ 1.66 1.59 $ 1.30 1.22 $ 1.28 1.21 $ 1.03 0.95 $ 1.02 0.95 Deferred Compensation Plan. Zebra has a deferred compensation plan that permits 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 into hypothetical investments. Zebra tracks the performance of these hypothetical investments in order to determine the value of each participant’s deferral. Zebra accrues the deferred compensation liability in other long-term liabilities as the amount that is actually owed to the participants. Our deferred compensation liability was $3,894,000 as of December 31, 2004, and $2,401,000 as of December 31, 2003. Zebra actually invests the funds in company owned life insurance policies, in which Zebra is the beneﬁ ciary, to fund the ultimate payment of the deferred compensation. These polices are valued at the cash surrender value and are included other assets. Foreign Currency Translations. 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 year. The resulting translation gains or losses are recorded in stockholders’ equity as a cumulative translation adjustment, which is a component of accumulated other comprehensive income. Capitalized Software. Zebra’s investment in software development consists primarily of enhancements to its existing E-commerce web-based application, which will include the automation of current business activities. Speciﬁ cally, the activities include the processing of customer orders; the acknowledgement of customer orders and delivery; and the ﬁ nancial invoicing for all of Zebra’s products and will aid in enabling Zebra to create new business efﬁ ciencies. Costs associated with the planning and design phases of web-based development, including coding and testing activities necessary to establish technological feasibility 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 and are amortized over their estimated useful lives. Acquisition Costs. Zebra periodically has expenditures related to potential acquisitions. These expenditures are recorded as prepaid expenses until such time as Zebra either completes 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, the costs are expensed during the period in which it is abandoned. During 2002, operating expenses included $3,300,000 of costs related to such an abandonment. Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of. Zebra accounts for long-lived assets in accordance with the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The statement requires that long-lived assets and certain identiﬁ able intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the sum of the undiscounted cash ﬂ ows expected to result from the use and the 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 amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Recently Issued Accounting Pronouncements. In March 2004, the FASB issued Emerging Issues Task Force Issue No. 03-1 (EITF 03-1), The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments, which provides new guidance for assessing impairment losses on investments. Additionally, EITF 03-1 includes new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB delayed the accounting provisions of EITF 03-1; however, the disclosure requirements remain effective for annual periods ending after June 15, 2004. We will evaluate the impact of EITF 03-1 once ﬁ nal guidance is issued. See Note 7 for added disclosures. In November 2004, the FASB issued SFAS No. 151, Inventory Costs – an amendment of ARB No. 43, Chapter 4. SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing”, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43, F-9 Chapter 4, previously stated that these costs may be “so abnormal” that they would require treatment as current period charges. This statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal”. This statement also requires that allocation of ﬁ xed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This statement describes our current process; therefore, it will not have any impact on our ﬁ nancial position or results of operations. In December 2004, the FASB issued SFAS No. 123(R) (revised 2004), Share Based Payment, which is a revision of SFAS 123, Accounting for Stock-Based Compensation, and supercedes APB Opinion No. 25, Accounting for Stock Issued to Employees and its related implementation guidance. SFAS No. 123 (R) focuses primarily on accounting for transactions in which an entity obtains employee services through share-based payment transactions. It requires a public entity to measure the cost of employee services received in exchange for the award of equity instruments based on the fair value of the award at the date of grant. The cost will be recognized over the period during which an employee is required to provide services in exchange for the award. The provisions of this statement become effective for Zebra during the third quarter of 2005. We expect the impact on Zebra’s consolidated ﬁ nancial statements to be consistent with the fair value disclosures included in our critical accounting policies and Note 2 to the consolidated ﬁ nancial statements. In December 2004, the FASB issued FSP FAS 109-1, Application of FASB No. 109, Accounting forIincome Taxe, to the Tax Deduction on Qualiﬁ ed Production Activities Provided by the American Jobs Creation Act of 2004. FSP FAS No. 109-1 clariﬁ es SFAS No. 109’s guidance that applies to the new tax deduction for qualiﬁ ed domestic production activities. FSP No. 109-1 became effective upon issuance and we believe that this pronouncement will have an insigniﬁ cant impact on our effective tax rate in 2005. In December 2004, the FASB issues FSP FAS 109-2, Accounting and Disclosure Guidance for the Foreign Repatriation Provision within the American Jobs Creation Act of 2004. FSP FAS 109-2 provides implementation guidance related to the repatriation provision of the American Jobs Creation Act of 2004. We have completed our assessment of earning of foreign subsidiaries that might be repatriated. At this time we do not expect to repatriate the earnings of our foreign subsidiaries as dividends to take advantage of this tax credit. Reclassiﬁ cations. Certain amounts in the prior years’ ﬁ nancial statements have been reclassiﬁ ed to conform to the current year’s presentation. Note 3 Stock Based Compensation As of December 31, 2004, Zebra has three active stock option and stock purchase plans, which are described below. The Board of Directors adopted the 1997 Stock Option Plan, effective February 11, 1997, and 9,562,500 shares of Class A Common Stock were reserved for issuance under the plan. The 1997 Stock Option Plan is a ﬂ exible plan that provides the committee that administers the Plan broad discretion to fashion the terms of the awards to provide eligible participants with stock-based incentives, including: (i) nonqualiﬁ ed and incentive stock options for the purchase of Zebra’s Class A Common Stock and (ii) dividend equivalents. The persons eligible to participate in the 1997 Stock Option Plan are directors, ofﬁ cers, and employees of Zebra or any subsidiary of Zebra who, in the opinion of the committee administering the plan, are in a position to make contributions to the growth, management, protection and success of Zebra or its subsidiaries. As of December 31, 2004, 2,735,718 shares were available under the plan. The options granted under the 1997 Stock Option Plan have an exercise price equal to the closing market price of Zebra’s stock on the date of grant. The options generally vest over two- to ﬁ ve-year periods and have a legal life of ten years from the date of grant. The Compensation Committee of the Board of Directors administers the plan. Zebra’s Board of Directors adopted the 1997 Director Plan, effective February 11, 1997. The 1997 Director Plan provides for the issuance of options to purchase up to 173,250 shares of Class A Common Stock, which shares are reserved and available for purchase upon the exercise of options granted under the 1997 Director Plan. Only directors who are not employees or ofﬁ cers of Zebra are eligible to participate in the 1997 Director Plan. Under the 1997 Director Plan, each non-employee director was granted, on the effective date of the plan, an option to purchase 33,750 shares of Class A Common Stock, and each non-employee director subsequently elected to the Board will be granted an option to purchase shares of Class A Common Stock on the date of his or her election. Options granted under the 1997 Director Plan provide for the purchase of Class A Common Stock at a price equal to the fair market value on the date of grant. If there are not sufﬁ cient shares remaining and available to all non-employee directors eligible for an automatic grant at the time at which an automatic grant would otherwise be made, then each eligible non- employee director shall receive an option to purchase a pro rata number of shares. Unless otherwise provided in an option agreement, options granted under the 1997 Director Plan shall become exercisable in ﬁ ve equal increments beginning on the date of the grant and on each of the ﬁ rst four anniversaries thereof. All options expire on the earlier of (a) ten years following the grant date or (b) the second anniversary of the termination of the non-employee director’s directorship for any reason other than due to death or disability (as deﬁ ned in the 1997 Director Plan). A total of 118,125 shares were issued under this plan, which was terminated February 1, 2002. At December 31, 2004, 11,250 options issued under the 1997 Director Plan remained outstanding and unexercised. The Board of Directors and stockholders adopted the 2001 Stock Purchase Plan and reserved 1,125,000 shares of Class A Common Stock for issuance under the plan. Under this plan, employees who work a minimum of 20 hours per week may elect to withhold up to 10% of their cash compensation through regular payroll deductions to purchase shares of Class A Common Stock from Zebra over a period not 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, 2004, 298,763 shares have been purchased under the plan. Zebra’s Board of Directors adopted the 2002 Director Plan, effective February 1, 2002. The 2002 Director Plan provides for the issuance of options to purchase up to 360,000 shares of Class A Common Stock, which shares are reserved and available for purchase F-10 upon the exercise of options granted under the 2002 Director Plan. Only directors who are not employees or ofﬁ cers of Zebra are eligible to participate in the 2002 Director Plan. Under the 2002 Director Plan, each non-employee director was granted, on the effective date of the plan, an option to purchase 45,000 shares of Class A Common Stock, and each non-employee director subsequently elected to the Board will be granted an option to purchase shares of Class A Common Stock on the date of his or her election or appointment. Options granted under the 2002 Director Plan provide for the purchase of Class A Common Stock at a price equal to the fair market value on the date of grant. If there are not sufﬁ cient shares remaining and available to all non-employee directors eligible for an automatic grant at the time at which an automatic grant would otherwise be made, then each eligible non-employee director shall receive an option to purchase a pro rata number of shares. As of December 31, 2004, 187,932 shares were available under the plan. Unless otherwise provided in an option agreement, options granted under the 2002 Director Plan shall become exercisable in ﬁ ve equal increments beginning on the date of the grant and on each of the ﬁ rst four anniversaries thereof. All options expire on the earlier of (a) ten years following the grant date, (b) the ﬁ rst anniversary of the termination date of the non-employee director’s directorship for any reason other than those listed in clause (c) below, or (c) the termination of the non-employee director’s directorship by Zebra’s stockholders for cause, or resignation for cause, in each case as deﬁ ned in the option agreement. For purposes of calculating the compensation cost consistent with SFAS No. 123, the fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The following table shows the weighted-average assumptions used for stock option grants as well as the fair value of the options granted based on those assumptions: Expected dividend yield Volatility Risk free interest rate Expected weighted-average life Fair value of options granted Weighted-average grant date fair value of options granted 2004 2003 2002 0% 50% 3.25% Six years $8,178,000 0% 53% 3.29% Six years $11,490,000 0% 53% 4.55% Six years $19,676,000 $24.56 $14.00 $12.17 The fair value of the employees’ purchase rights issued under 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 2004 $49.76 $42.29 0% 32% 1.19% 2003 $29.44 $25.02 0% 27% 1.06% 2002 $22.73 $19.32 0% 40% 2.17% Stock option activity for the years ended December 31, 2004, 2003, and 2002 was as follows: Fixed Options Outstanding at beginning of year Granted Exercised Canceled Outstanding at end of year Options exercisable at end of year 2004 Weighted-Average Exercise Price $21.61 47.37 18.64 24.91 $25.37 $19.77 Shares 3,159,243 333,001 (660,466) (237,796) 2,593,982 712,088 2003 Weighted-Average Exercise Price $19.34 27.02 17.20 21.92 $21.61 $17.64 Shares 3,729,805 867,865 (893,698) (544,729) 3,159,243 693,855 2002 Weighted-Average Exercise Price $ 17.05 21.79 14.26 21.41 $19.34 $15.49 Shares 3,176,715 1,617,192 (769,478) (294,624) 3,729,805 861,203 The following table summarizes information about ﬁ xed stock options outstanding at December 31, 2004: Range of Exercise Prices $ 10.74-$18.17 $ 19.33-$21.62 $ 21.62-$25.23 $ 25.23-$39.27 $ 39.27-$53.92 F-11 Number of Shares 534,899 828,925 547,938 367,669 315,551 2,593,982 Options Outstanding Weighted-Average Remaining Contractual Life Weighted-Average Exercise Price Number of Shares Weighted-Average Exercise Price Options Exercisable 4.95 years 7.00 years 8.08 years 6.26 years 9.14 years $15.30 21.57 25.16 30.07 47.38 338,099 159,970 42,654 171,365 — 712,088 $13.66 21.57 25.15 28.80 — 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 Wakeﬁ eld, Rhode Island, Atlantek had been a privately held company. Atlantek designs and manufactures thermal digital printers. The consolidated statements of earnings reﬂ ect the results of operations of Atlantek since the effective date of the acquisition. The pro forma impact of this acquisition was not signiﬁ cant. The following table (in thousands) summarizes the adjusted fair values of the assets acquired and liabilities assumed at the date of acquisition. At November 17, 2003 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 $ 3,887 670 7,884 6,619 19,060 (2,369) (2,825) (186) (5,380) $ 13,680 The purchase price was allocated to identiﬁ able tangible assets and intangible assets acquired and liabilities assumed based on their estimated fair values. Of the $7,884,000 of acquired intangible assets, $714,000 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 Accounted for by the Purchase Method. The write-off of in-process technology is stated separately in the operating expense section of the consolidated statements of earnings. The remaining $7,170,000 of acquired intangible assets consists of current technology of $4,837,000 with useful lives from 5 to 6 years and customer relationships of $2,333,000 with a useful life of 8 years. The goodwill is not deductible for tax purposes. The transaction called for two payments in addition to the original payment, which are contingent upon revenue related to speciﬁ c products for the ﬁ rst two years after the acquisition. These payments were not assured beyond a reasonable doubt at the time of the acquisition. During the fourth quarter of 2004, the ﬁ rst of these payments was made for $632,000 and added to goodwill. One additional and ﬁ nal payment may be made in the fourth quarter of 2005 and would be added to goodwill at that time. Acquisition Termination Costs and Sale of Investment. In the ﬁ rst 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 purchase preferred stock) of Fargo Electronics, Inc. for $7.25 per share in cash. In connection with the termination, Zebra recorded $3,300,000 in expenses for capitalized acquisition costs and other acquisition costs that would otherwise have been capitalized. 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. Note 5 Stockholders’ Equity Share count and par value data related to stockholders’ equity are as follows: Preferred Stock Par value per share Shares authorized Shares outstanding Common Stock—Class A Par value per share Shares authorized Shares issued Shares outstanding December 31, 2004 December 31, 2003 $0.01 10,000,000 — $0.01 78,358,189 71,819,806 71,819,806 $0.01 10,000,000 — $0.01 78,358,189 71,098,953 71,098,953 On July 15, 2004, the Board of Directors authorized a ﬁ fty percent (50%) stock dividend on each issued share of Class A common stock payable before the close of business on August 25, 2004, to holders of all such shares at the close of business on July 29, 2004. All share counts and per-share amounts have been restated to reﬂ ect this stock dividend. During 2004, Zebra sold put options indexed in our own stock that would, if exercised, require us to repurchase 100 shares for each option exercised at a speciﬁ ed strike price. As of December 31, 2004, 800 options were outstanding and have an expiration of February 2005. Of the outstanding options, 400 options have a strike price of $45 per share, and 400 options have a strike price of $50 per share. If all of the options were to be exercised, Zebra would be required to repurchase 80,000 shares of Class A Common Stock at a total price of $3,800,000. 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 held by the acquiring person, entitles the registered holder to purchase one ten-thousandth of a share of Series A Junior Participating Preferred Stock, par value $0.01 per share, at a price of $300 per one ten-thousandth of Class A Preferred 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 commences a tender offer that would result in the person or group becoming an owner of 15% or more of the outstanding common stock. The Rights will expire on March 14, 2012 unless that date has been extended by the Board of Directors or unless the Rights are redeemed or terminated earlier. A committee of Zebra’s independent directors will review the Rights Plan at least every three years and decide whether it should continue or be revoked. Zebra generally may amend the Rights Plan or redeem the Rights at $0.001 per Right at any time prior to the time a person or group has acquired at least 15% of the outstanding common stock. F-12 Note 6 Earnings Per Share For the years ended December 31, 2004, 2003, and 2002, earnings per share were computed as follows (in thousands, except per-share amounts): Basic earnings per share: Net income Weighted average common shares outstanding Per share amount Diluted earnings per share: Net income Weighted average common shares outstanding Add: Effect of dilutive securities – stock options Year Ended December 31, 2004 2003 2002 $120,643 $91,696 $71,595 71,556 $1.69 70,647 $1.30 69,678 $1.03 $120,643 $91,696 $71,595 71,556 70,647 69,678 983 848 627 Diluted weighted average and equivalent shares outstanding Per share amount 72,539 $ 1.66 71,495 $ 1.28 70,305 $ 1.02 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 13,800 in 2004, 79,068 in 2003, and 438,469 in 2002. Note 7 Investments and Marketable Securities We classify the majority of our investments and marketable securities as available- for-sale in accordance with the classiﬁ cations deﬁ ned 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 securities are reﬂ ected in the accumulated other comprehensive income caption of stockholders’ equity in the balance sheet, until we dispose of the securities. Once these securities are disposed of, either by sale or maturity, the accumulated changes in market value are transferred to investment income. On the cash ﬂ ow statements, changes in the balances of available-for-sale securities are shown as purchases, sales and maturities of investments and marketable securities under investing activities. Amortized Gross Unrealized Cost Holding Gains Holding Losses Gross Unrealized Fair Value Available-for-sale: U.S. government and agency securities State and municipal bonds Corporate bonds Partnership interests Trading securities: Other $ 111,492 351,141 42,757 28,652 534,042 5,653 $539,695 $ 42 785 2 2,075 2,904 — $2,904 $(1,320) $110,214 351,089 42,327 30,727 (837) (432) — (2,589) 534,357 — 5,653 $(2,589) $540,010 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): Amortized Gross Unrealized Cost Holding Gains Holding Losses Gross Unrealized Fair Value Available-for-sale: U.S. government and agency securities State and municipal bonds Equity securities Corporate bonds Partnership interests Trading securities: Other $187,988 197,575 3,325 19,900 18,652 427,440 5,653 $433,093 $ 207 464 — 100 639 1,410 — $1,410 $(696) $ 187,499 197,814 3,325 20,000 19,291 (225) — — — (921) 427,929 — 5,653 $(921) $433,582 Unrealized gains and losses on investment securities are included in these ﬁ nancial statements as follows (in thousands): Year Ended December 31, 2004 2003 2002 Changes in unrealized gains and losses on available-for-sale securities, net of tax, recorded in accumulated other Changes in market value of trading securities are recorded in investment income as they occur, and the related cash ﬂ ow statement includes changes in the balances of trading securities as operating cash ﬂ ows. comprehensive income $(113) $346 $(1,603) Unrealized gains on trading securities recorded in investment income $ — $ — $(1,360) The amortized cost, gross unrealized holding gains, gross unrealized holding losses and aggregate fair value of investment securities at December 31, 2004, were as follows (in thousands): F-13 The following table shows the number, aggregate market value and unrealized losses (in thousands) of investments with market values that were less than amortized cost as of December 31, 2004. These lower market values are caused by short-term ﬂ uctuations in interest rates and are not a reﬂ ection of the credit worthiness of the issuer. Market values are expected to recover to the amortized cost prior to maturity. Government securities State and municipal bonds Corporate bonds Total Government securities State and municipal bonds Corporate bonds Total Unrealized Loss < 12 months Number of Investments Aggregate Market Value Unrealized Losses 16 104 10 130 $ 54,313 173,501 37,596 $265,410 $ (505) (676) (432) $(1,613) Unrealized Loss > 12 months Number of Investments Aggregate Market Value Unrealized Lossses 16 112 — 128 $46,839 12,242 — $59,081 $(815) (161) — $(976) As of December 31, 2003, the number, aggregate market value and unrealized losses (in thousands) of investments with market values that were less than amortized cost were: Government securities State and municipal bonds Total Unrealized Loss < 12 months Number of Investments Aggregate Market Value Unrealized Losses 13 14 27 $ 85,706 22,861 $108,567 $(677) (97) $(774) The contractual maturities of debt securities at December 31, 2004, were as follows (in thousands): Due within one year Due after one year through ﬁ ve years Due after ﬁ ve years Fair Value $136,268 269,450 117,333 $523,051 Using the speciﬁ c identiﬁ cation method, the proceeds and realized gains on the sales of available-for-sale securities were as follows (in thousands): Proceeds Realized gains Realized losses Net realized gains included in other comprehensive income as of the end of the prior year 2004 $319,711 1,289 (900) 2003 $57,537 2,371 (2,121) 2002 $3,499 1,953 (193) 384 213 1,760 Note 8 Related-Party Transactions Unique Building Corporation (Unique), an entity controlled by certain ofﬁ cers and stockholders of Zebra, leases a facility to Zebra under a lease described in Note 16. Management believes that the lease payments are substantially consistent with amounts that could have been negotiated with third parties on an arm’s-length basis and represent market conditions at the time of the negotiations. Lease payments related to the lease, and recorded as a component of all functional areas, were included in the consolidated ﬁ nancial statements as follows (in thousands): Unrealized Loss > 12 months Number of Investments Aggregate Market Value Unrealized Lossses 2004 2003 2002 Unique Operating Lease $2,284 2,198 2,085 Government securities State and municipal bonds Total 18 9 27 $ 5,755 9,923 $15,678 $ (19) (128) $(147) Future minimum lease payments related to the lease as of December 31, 2004, are as follows (in thousands): Unique Operating Lease 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 diversiﬁ ed 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. 2005 2006 2007 2008 2009 Thereafter Total minimum lease payments $ 2,336 2,336 2,336 2,380 2,573 12,389 $24,350 F-14 Note 9 Inventories The components of inventories, net of allowances, are as follows (in thousands): Note 11 Income Taxes The geographical sources of income before income taxes were as follows (in thousands): Raw material Work in process Finished goods Total inventories December 31, 2004 $34,041 569 24,645 $59,255 2003 $29,127 645 13,009 $42,781 United States Outside United States Total Year Ended December 31, 2003 2004 2002 $164,784 19,764 $184,548 $132,056 3,936 $135,992 $101,454 9,429 $110,883 Note 10 Property and Equipment Property and equipment, which includes assets under capital leases, is comprised of the following (in thousands): Buildings Land Machinery, equipment and tooling Furniture and ofﬁ ce equipment Computers and software Automobiles Leasehold improvements Projects in progress Less accumulated depreciation and amortization December 31, 2004 2003 $ 12,510 1,910 48,241 6,525 42,690 73 7,658 5,608 125,215 (78,932) $ 11,911 1,910 45,156 6,415 37,486 128 4,878 2,473 110,357 (71,071) Net property and equipment $ 46,283 $ 39,286 Other items related to property and equipment are as follows: Assets under capital lease Less: related accumulated depreciation Unamortized computer software costs December 31, 2004 $ 333 144 $7,771 2003 $ 333 78 $6,054 Amortization of capitalized software $2,125 $2,132 $2,042 Year Ended December 31, 2003 2004 2002 Zebra does not provide for deferred income taxes on undistributed earnings of foreign subsidiaries, which totaled approximately $34,000,000 at December 31, 2004 and $22,500,000 at December 31, 2003. Should such earnings be remitted to Zebra, foreign tax credits would be available to substantially offset the U.S. income taxes due upon repatriation. The provision for income taxes consists of the following (in thousands): Current: Federal State Foreign Deferred: Federal State Foreign Total Year Ended December 31, 2003 2004 2002 $53,810 5,874 6,023 (1,568) (118) (116) $38,954 3,723 2,561 $30,660 5,247 3,254 (261) (35) (646) 296 40 (209) $63,905 $44,296 $39,288 The provision for income taxes differs from the amount computed by applying the U.S. statutory Federal income tax rate of 35% to income before income taxes. The reconciliation of statutory and effective income taxes is presented below (in thousands): Year Ended December 31, 2003 2004 2002 Provision computed at statutory rate State income tax (net of Federal tax beneﬁ t) Federal tax beneﬁ t of state tax settlement Tax-exempt interest income Tax beneﬁ t of exempt foreign trade income Research and experimental credit Other Provision for income taxes $64,592 3,595 — (1,767) (1,750) (350) (415) $63,905 $ 47,597 2,952 (2,450) (1,674) (1,488) (1,959) 1,318 $44,296 $38,809 3,634 — (2,422) (1,575) — 842 $39,288 F-15 Deferred income taxes reﬂ ect the impact of temporary differences between the amounts of assets and liabilities for ﬁ nancial 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. Note 12 Goodwill and Other Intangible Asset Data During the ﬁ rst quarter of 2002, we implemented SFAS No. 142, Goodwill and Other Intangible Assets, which replaces the requirements to amortize intangible assets with indeﬁ nite lives and goodwill with a requirement for an annual impairment test. SFAS No. 142 also set requirements for identiﬁ able intangible assets. Tax effects of temporary differences that give rise to deferred tax assets and liabilities are as follows (in thousands): Intangible asset data are as follows (in thousands): 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 partnership interests Unrealized loss on securities and hedges Total deferred tax assets Deferred tax liabilities: Unrealized gain on securities Acquisition related items Depreciation and amortization Total deferred tax liabilities Net deferred tax assets December 31, 2004 2003 $ 212 65 902 1,466 3,652 224 2,520 — 2,537 1,245 12,823 — (649) (5,966) (6,615) $ 205 88 643 1,099 2,848 235 898 1,886 2,019 658 10,579 (11) — (6,784) (6,795) $ 6,208 $ 3,784 Amortized intangible assets Current technology Customer relationships Total Unamortized intangible assets Goodwill December 31, 2004 December 31, 2003 Gross Gross Carrying Accumulated Carrying Accumulated Amount Amortization Amount Amortization $12,258 2,333 $14,591 $(7,746) $12,033 2,503 (328) $(8,074) $14,536 $(5,466) (39) $(5,505) $61,793 $61,150 Aggregate amortization expense For the year ended December 31, 2003 For the year ended December 31, 2004 Estimated amortization expense 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 $ 2,569 $ 1,613 1,180 1,103 1,099 975 292 255 $ 1,640 During the fourth quarter of 2004, a contingent payment related to the Atlantek acquisition was made for $632,000 and added to goodwill. See Note 4 for further details. Note 13 Other Assets Other assets consists of the following (in thousands): Life insurance policies related to the deferred compensation plan (See Note 18) Life insurance policies on key executives Long-term equity securities Deposits Other long-term assets Total December 31, 2004 2003 $ 3,401 10,367 100 344 8,779 $22,991 $ 2,116 — 271 1,140 7,199 $10,726 Zebra invested $10,027,000 in life insurance policies on 48 key executives during 2004, which currently has a cash surrender value of $10,367,000 and a guaranteed rate of return of 8% through July 28, 2005. F-16 Note 14 401(k) Savings and Proﬁ t 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. Qualiﬁ ed 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 earnings 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. Hedging of Anticipated Sales During 2003, we began managing the exchange rate risk of anticipated euro denominated sales using forward contracts and designate these contracts as cash ﬂ ow hedges. Unrealized 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 ﬁ nancial information related to the cash ﬂ ow hedges of future revenues follows (in thousands, except percentages): Net unrealized losses deferred in accumulated other comprehensive income: Gross Tax beneﬁ t Net Notional balance of outstanding contracts Hedge effectiveness Net gain (loss) included in revenue for the: Three months ended December 31, 2004 Three months ended December 31, 2003 Year ended December 31, 2004 Year ended December 31, 2003 We recorded no gain or loss for 2002. December 31, December 31, 2003 2004 $ (2,231) 781 $ (1,450) €30,000 100% $ (1,537) 538 $ (999) €30,420 100% 2004 2003 $ (1,077) (1,639) $ (150) 266 The above year-to-date gains and losses are the net pretax gains and losses released from other comprehensive income into earnings during 2004 and 2003. We expect to release pretax losses in the amount of $2,231,000 from other comprehensive income into earnings during 2005 along with gains and losses on similar contracts entered into early in 2005. Currently, the initial duration of our forecasted sales hedge contracts is six months. Effectiveness testing is performed on each contract monthly. We have not experienced any gains or losses due to ineffectiveness. If we were to experience such gains or losses, we would record them as a foreign exchange gain or loss. If we were to cancel or net settle a hedge designated as a cash ﬂ ow hedge prior to the scheduled settlement date, we would recognize the gain or loss on that settlement immediately as a foreign exchange gain or loss. Zebra has a discretionary proﬁ t-sharing plan for qualiﬁ ed employees, to which it contributes a percentage of eligible payroll each year. Participants are not permitted to make contributions under the proﬁ t-sharing plan. Company contributions to these plans, which were charged to operations, approximated the following (in thousands): 401(k) Proﬁ t sharing Total Year Ended December 31, 2003 2004 2002 $ 1,742 2,329 $4,071 $1,572 1,544 $ 3,116 $1,452 1,146 $2,598 Percentage of eligible payroll contributed for proﬁ t-sharing plan 3.1% 2.4% 1.9% Note 15 Derivative Instruments In the normal course of business, portions of Zebra’s operations are subject to ﬂ uctuations in currency values. We manage these risks using derivative ﬁ nancial 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 ﬁ nancial information related to these activities follows (in thousands): Year Ended December 31, 2003 2004 2002 Change in gains (losses) from foreign exchange derivatives Gain on net foreign currency assets $(1,246) 1,731 $(3,756) 3,204 Net foreign exchange gain (loss) $ 485 $ (552) $(2,579) 2,926 $ 347 Notional balance of outstanding contracts: Pound Euro F-17 December 31, December 31, 2003 2004 £13,646 €34,000 £ 8,569 €22,000 Note 16 Commitments and Contingencies Leases. In September 1989, Zebra entered into a lease agreement for its Vernon Hills facility and certain machinery, equipment, furniture and ﬁ xtures with Unique Building Corporation, a related party. The facility portion of the lease is the only remaining portion in existence as of December 31, 2004, and is treated as an operating 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 modiﬁ cation 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). Minimum future obligations under non-cancelable operating leases and future minimum capital lease payments as of December 31, 2004 are as follows (in thousands): 2005 2006 2007 2008 2009 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 Capital Leases Operating Leases $ 5,116 4,512 3,658 3,360 3,557 16,084 $36,287 $ 62 121 — — — — 183 (12) 171 (54) $117 Rent expense for operating leases charged to operations was as follows (in thousands): Rent expense Year Ended December 31, 2003 2004 2002 $6,404 $5,591 $5,699 In addition to the related party lease noted above, the operating lease information includes a variety of other properties around the world. These properties are used as manufacturing facilities, distribution centers and sales ofﬁ ces. Lease terms range from six months to 25 years with breaking periods speciﬁ ed in the lease agreements. Since December 31, 2004, Zebra signed three additional operating lease agreements, which are not included in the schedule above. In Vernon Hills, Illinois, we leased an additional 34,000 square feet of ofﬁ ce space for 3 years beginning March 1, 2005 with annual payments of $612,000. In Heervenveen, the Netherlands, we leased approximately 95,000 square feet of ofﬁ ce and warehouse space for 20 years beginning February 15, 2005 with an option to terminate the lease at each ﬁ ve-year anniversary date. The annual payments on this lease will be €350,000, or approximately $440,000. In Chula Vista, California, we leased approximately 14,000 square feet of manufacturing and warehouse space for two years beginning February 11, 2005 with annual payments of $135,000. 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, 2004 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) ﬁ led 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 identiﬁ ed Paxar Americas patents, although not each product is accused of infringing each patent. Zebra has ﬁ led an Answer to Paxar Americas’ Complaint, denying Paxar Americas’ allegations of infringement and asserting several afﬁ rmative defenses, including the invalidity of Paxar Americas’ asserted patent claims. Paxar has sought to amend its original complaint to add two additional patents to the lawsuit and to expand the scope of accused products. Zebra has opposed Paxar’s motions in this regard and the court has the issue under advisement. On November 21, 2003, Zebra’s subsidiary, ZIH Corp. (ZIH), ﬁ led a Complaint in the United States District Court for the District of Massachusetts against Paxar Corporation, alleging 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 ﬁ led a motion to transfer ZIH’s Massachusetts suit to Ohio federal court, and the court denied Paxar’s motion. On November 25, 2003, Paxar Americas ﬁ led a Complaint against ZIH in the United States District Court for the Southern District of Ohio, seeking a declaratory 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. In view of the Massachusetts’ District Court’s denial of Paxar Corporation’s motion to transfer to Ohio ZIH’s corresponding patent infringement suit against Paxar Corporation, the parties to Paxar America’s Ohio declaratory judgment action have agreed to transfer this case to Massachusetts. The outcome of litigation is inherently uncertain, particularly in cases such as these where sophisticated factual issues must be assessed and complex technical issues must be decided. As a result, we cannot accurately predict the outcome of these lawsuits. In the event we are unsuccessful in our defense of Paxar Americas’ infringement claims, we could be liable for economic and other damages, which could be material, and we may be forced to incur ongoing licensing expenses or to change how we design, manufacture and market our products. The patents that ZIH has asserted against Paxar Corporation could be found invalid. We have and will continue to incur substantial fees to prosecute and defend these lawsuits. 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 consolidated ﬁ nancial statements as of December 31, 2004. F-18 Note 17 Segment Data and Export Sales Zebra is organized with two internal business units, bar code and card printers. These business units have similar economic characteristics, products and services, production processes, types of customers, distribution methods, and regulatory environments. Additionally, there are signiﬁ cant shared services supporting both business units. Because of these similarities, we have aggregated our internal business units and have treated them as one reportable segment as permitted by SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. Gain (loss) on cash surrender value of life insurance policies included in investment income Year Ended December 31, 2003 2004 2002 $94 $60 $(16) Information regarding Zebra’s operations by geographic area is contained in the following table. These amounts (in thousands) are reported in the geographic area of the destination of the ﬁ nal sale. Deferred compensation liability included in other long-term liability Cash surrender value included in other assets December 31, December 31, 2003 2004 $3,894 $3,401 $2,401 $2,116 Europe, North Middle East & Africa America Latin America Asia Total $359,074 108,725 $213,559 5,669 $38,119 3 $52,302 196 $663,054 114,593 During February 2005, we adopted the 2005 Executive Deferred Compensation Plan, a new nonqualiﬁ ed deferred compensation plan. The plan is virtually the same as the plan noted above except that it now complies with the requirements of the new Section 409A of the Internal Revenue Code, enacted under the American Jobs Creation Act of 2004. Section 409A imposes a number of requirements on nonqualiﬁ ed deferred compensation plans, primarily relating to the timing of elections and distributions and is effective for deferrals made after December 31, 2004. 2004 Net sales Long-lived assets 2003 Net sales Long-lived assets 2002 Net sales Long-lived assets $292,543 102,962 $170,544 6,415 $29,406 3 $43,904 87 $536,397 109,467 $270,288 90,873 $142,273 6,502 $28,097 — $34,953 98 $475,611 97,473 We manage our business based on these regions rather than by individual countries. Net sales by major product category are as follows (in thousands): 2004 2003 2002 Hardware Supplies $518,556 409,144 360,185 $116,849 98,519 87,981 Service and Software $24,338 24,355 23,301 Shipping and Handling $4,950 4,113 4,144 Cash Flow Hedging Activities $(1,639) 266 — Total $663,054 536,397 475,611 Note 18 Deferred Compensation Plan Beginning January 1, 2002, Zebra offered a deferred compensation plan that permits 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 gain/loss from the changes to the deferred compensation liability, which is charged to compensation expense. To fund this plan, Zebra purchases corporate-owned whole-life insurance contracts on the related employees, of which Zebra is the beneﬁ ciary. The following table shows the income, asset and liability amounts related to this plan (in thousands): F-19 Note 19 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 is accounted for under SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. All exit costs associated with this activity are identiﬁ ed on a separate line of our income statement, as part of operating expenses. Our consolidation plan is intended to reduce costs and improve manufacturing efﬁ ciency. Currently, our Varades facility conducts the product development for our line of card printers and includes the European service center for these printers. We transferred the product development activities to Camarillo, California, where we have manufactured these printers since 2001. We transferred the European card printer service operation to our Preston, United Kingdom, facility where the Europe, Middle East and African distribution of these printers already occurs. To date, we have closed substantially all of this facility with only minor administrative functions remaining. As of December 31, 2004, we incurred the following exit costs (in thousands): Type of Cost Total Costs Incurred Severance, stay bonuses, and other employee-related expenses Asset disposal costs Other exit costs Total $1,605 64 285 $1,954 We expect to incur no further costs for this project. During January 2004, we announced plans to consolidate our Warwick, Rhode Island, printer manufacturing and repair service into our Camarillo, California and Vernon Hills, Illinois locations. This transition was 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. As of December 31, 2004, we expect the following exit costs (in thousands): Type of Cost Severance, stay bonuses, and other employee-related expenses Other exit costs Total Costs Incurred to Date Additional Costs Expected Total Costs Expected to be Incurred $ 838 431 $1,269 $ — 210 $210 $ 838 641 $1,479 During December 2004, we announced plans to close and consolidate our Wakeﬁ eld, Rhode Island facility into our other North American facilities primarily into the Warwick, Rhode Island facility. This transition is expected to take 6 months to complete. As of December 31, 2004, we expect the following exit costs (in thousands): Type of Cost Severance, stay bonuses, and other employee-related expenses Other exit costs Total Costs Incurred to Date Additional Costs Expected Total Costs Expected to be Incurred $109 — $109 $ 54 317 $371 $163 317 $480 Liabilities and expenses related to exit activities for the year ended December 31, 2004 were as follows (in thousands): Accrued liabilities related to exit activities at December 31, 2003 Total expenses incurred for the year ended December 31, 2004 Less: Amounts paid for the year ended December 31, 2004 Accrued liabilities related to exit activities at December 31, 2004 Varades Closure Warwick Wakeﬁ eld Closure Consolidation Total $ 990 $ — $ — $ 990 722 1,557 1,269 109 2,100 830 19 2,406 $ 155 $ 439 $ 90 $ 684 Note 20 Other Comprehensive Income (Loss) Stockholders’ equity contains certain items classiﬁ ed as other comprehensive income, including: • Foreign currency translation adjustments related to our non-U.S. subsidiary companies that have designated a functional currency other than the dollar. We are required to translate the subsidiary functional currency ﬁ nancial 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. • Unrealized holding gains (losses) on foreign currency hedging activities relate to derivative instruments used to hedge the currency exchange rates for forecasted euro sales. These hedges are designated as cash ﬂ ow hedges, and we have deferred income statement recognition of gains and losses until the hedged transaction occurs. See Note 15 for more details. • Unrealized gains (losses) on investments classiﬁ ed as available-for-sale are deferred from income statement recognition. See Note 7 for more details. The components of other comprehensive income included in the Consolidated Statements of Comprehensive Income are as follows (in thousands): Year Ended December 31, 2003 2004 2002 Foreign currency translation adjustments $3,402 $ 4,110 $ 2,968 Changes in unrealized gains/(losses) on hedging transactions: Gross Income tax beneﬁ t Net Changes in unrealized holding gains/ (losses) on investments classiﬁ ed as available-for-sale: Gross Income tax (beneﬁ t) Net $ (694) (243) $ (451) $ (174) (61) $ (113) $(1,537) (538) $ (999) $ 531 185 $ 346 — — — $(2,466) (863) $(1,603) F-20 The components of accumulated other comprehensive income (loss) included in the Consolidated Balance Sheets are as follows (in thousands): Note 21 Quarterly Results of Operations (unaudited) (Amounts in thousands, except per share data) Foreign currency translation adjustments $ 7,512 $ 4,110 As of December 31, December 31, 2003 2004 Unrealized losses on foreign currency hedging activities: Gross Income tax beneﬁ t Net Unrealized gains on investments classiﬁ ed as available-for-sale: Gross Income tax Net $(2,231) (781) $(1,450) $(1,537) (538) $ (999) $ 315 110 $ 205 $ 489 171 $ 318 2004 Net sales Cost of sales Gross proﬁ t First Quarter $154,174 73,571 Second Quarter $162,830 78,315 Third Quarter $171,176 84,030 Fourth Quarter (2) $174,874 83,979 80,603 84,515 87,146 90,895 Selling and marketing Research and engineering General and administrative Amortization of intangibles Acquired in-process technology Exit costs Merger costs Total operating expenses Operating income 17,207 8,896 12,746 649 22 363 23 39,906 40,697 Investment income (expense) Interest expense Foreign exchange gain (loss) Other, net 3,073 (26) (656) (293) 18,023 9,233 12,527 626 — 876 13 41,298 43,217 2,091 (6) 413 (560) 19,217 9,596 11,865 647 — 715 10 42,050 45,096 2,515 (7) 737 (381) Total other income (expense) 2,098 1,938 2,864 22,615 9,368 11,959 647 — 146 — 44,735 46,160 2,949 (5) (9) (457) 2,478 Income before taxes Income taxes Net income 42,795 14,861 45,155 15,728 47,960 16,641 48,638 16,675 $ 27,934 $ 29,427 $ 31,319 $ 31,963 Basic earnings per share Diluted earnings per share $ 0.39 (1) $ 0.39 (1) $ 0.41(1) $ 0.41(1) $ 0.44 $ 0.43 $ 0.45 $ 0.44 F-21 2003 Net sales Cost of sales Gross proﬁ t First Quarter (2) Second Quarter (2) Third Fourth Quarter (2) Quarter (2) $124,685 60,336 $129,863 63,305 $134,649 66,876 $147,200 72,803 64,349 66,558 67,773 74,397 Selling and marketing Research and engineering General and administrative Amortization of intangibles Acquired in-process technology Exit costs Merger costs Total operating expenses Operating income Investment income (expense) Interest expense Foreign exchange gain (loss) Other, net 14,504 7,579 10,251 371 — — — 32,705 31,644 2,439 (38) (143) 6 16,754 7,560 10,248 371 — — — 34,933 31,625 3,017 (14) (87) (292) 15,871 7,898 9,937 371 — — — 34,077 33,696 (982) (64) (18) (263) Total other income (expense) 2,264 2,624 (1,327) 19,506 8,722 11,456 527 692 1,232 9 42,144 32,253 4,079 (38) (304) (524) 3,213 Note 22 Major Customers ScanSource, Inc., is our most signiﬁ cant customer and our net sales to them as a percent of total net sales were as follows: ScanSource Year Ended December 31, 2003 2004 14.1 13.8 2002 13.6 No other customer accounted for 10% or more of total net sales during these years. ZEBRA TECHNOLOGIES CORPORATION Schedule II Valuation and Qualifying Accounts (Amounts in thousands) Income before taxes Income taxes Net income 33,908 11,868 34,249 11,987 32,369 9,370 35,466 11,071 Description $ 22,040 $ 22,262 $ 22,999 $ 24,395 Valuation account for accounts receivable: Balanceat Charged to Costs and Beginning Expenses Deductions of Period Balance at End of Period Basic earnings per share Diluted earnings per share $ 0.31(1) $ 0.31(1) $ 0.32(1) $ 0.31(1) $ 0.32(1) $ 0.34(1) $ 0.32(1) $ 0.34(1) Year ended December 31, 2004 Year ended December 31, 2003 Year ended December 31, 2002 $1,388 $1,236 $1,975 $ 368 $ 557 $ 909 $ 195 $ 405 $1,648 $1,561 $1,388 $1,236 (1) Restated for a 3-for-2 stock split in August 2004 paid in the form of a 50% stock dividend. (2) Includes the following pretax charges related to the closure/consolidation of the Varades, France, the Warwick, Rhode Island and the Wakeﬁ eld, Rhode Island facilities and the integration and in- process research and development costs related to the acquisition of Atlantek, Inc.: Valuation accounts for inventories: Year ended December 31, 2004 Year ended December 31, 2003 Year ended December 31, 2002 $6,238 $5,075 $5,916 $5,653 $4,337 $1,664 $3,854 $3,174 $2,505 $8,037 $6,238 $5,075 Q4 2003 Q1 2004 Q2 2004 Q3 2004 Q4 2004 See accompanying report of independent registered public accounting ﬁ rm. Exit costs for the Varades closure Exit costs for the Warwick consolidation Exit costs for the Wakeﬁ eld closure In-process research and development Integration costs $1,232 $224 $390 $218 $(110) — — 692 9 139 — 22 23 486 — — 13 497 — — 10 147 109 — — F-22 STOCKHOLDER INFORMATION Corporate Headquarters Zebra Technologies Corporation 333 Corporate Woods Parkway Vernon Hills, Illinois 60061-3109 U.S.A. Phone: +1 847 634 6700 Fax: +1 847 913 8766 Annual Meeting Zebra’s Annual Meeting of Stockholders will be on May 17, 2005, 10:30 A.M. (Central Time), at the Hilton Northbrook, 2855 North Milwaukee Avenue, Northbrook, Illinois. Independent Auditors Ernst & Young LLP Chicago, Illinois Transfer Agent and Registrar Mellon Investor Services LLC Overpeck Center 85 Challenger Road Ridgeﬁ eld, New Jersey 07660-2108 Phone: 877 870 2368 http://melloninvestor.com/isd 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 ﬁ led 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 accessing the Company’s Web site at www.zebra.com Equal Employment Opportunities/Afﬁ rmative Action It is the policy of Zebra Technologies Corporation to provide equal opportunities and afﬁ rmative action in all areas of its employment practices without regard to race, religion, national origin, sex, age, ancestry, citizenship, disability, veteran status, marital status, sexual orientation or any other reason prohibited by law. Board of Directors Officers Edward L. Kaplan Chairman and Chief Executive Officer Zebra Technologies Corporation Edward L. Kaplan Chairman and Chief Executive Officer Gerhard Cless Executive Vice President 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. Gerhard Cless Executive Vice President Veraje Anjargolian Vice President, General Manager Card Printer Solutions Noel Elfant Vice President, General Counsel and Corporate Secretary Hugh K. Gagnier Senior Vice President, Operations Specialty Printing Solutions Philip Gerskovich Senior Vice President, Corporate Development Todd R. Naughton Vice President, Controller Michael H. Terzich Senior Vice President, Office of the CEO (1) Member of Audit Committee (2) Member of Compensation Committee (3) Member of Nominating Committee Charles R. Whitchurch Chief Financial Officer and Treasurer Zebra Technologies Corporation International Headquarters 333 Corporate Woods Parkway | Vernon Hills, IL | 60061-3109 USA +1 847 634 6700 | www.zebra.com

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