Zebra Technologies Corporation — Q2 2017 Form 10-Q
Reporting period: Quarter ended July 1, 2017; comparisons are with the quarter ended July 2, 2016. Six-month figures cover the periods ended on those same dates. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted.
Business context
Zebra provides data-capture products and services, including barcode printers, mobile computers, scanners, RFID and location solutions, software, and support services. It reports Legacy Zebra and Enterprise segments. The October 2016 divestiture of its wireless LAN (WLAN) business affects year-over-year comparisons, particularly for Enterprise.
Financial performance and liquidity
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $896 | $879 | $1,761 | $1,728 |
| Gross profit / margin | $411 / 45.9% | $406 / 46.2% | $812 / 46.1% | $796 / 46.1% |
| Operating income | $58 | $23 | $98 | $33 |
| Net income (loss) | $17 | $(45) | $25 | $(71) |
| Diluted EPS | $0.32 | $(0.88) | $0.48 | $(1.38) |
- Q2 sales rose 1.9%; management reported organic sales growth of 6.4% for the quarter and 6.7% year to date, excluding the prior-year WLAN business and adjusting for currency and specified corporate eliminations.
- Q2 tangible-product sales were $779 million and services and software revenue was $117 million. Operating expenses fell to $353 million from $383 million, mainly as acquisition/integration and restructuring costs declined. Q2 operating income improved despite a slightly lower gross margin.
- For the first six months, operating cash flow was $203 million versus $124 million. Investing cash outflow was $22 million, including $22 million of capital expenditures; financing cash outflow was $238 million, primarily reflecting $240 million of debt repayments. Cash declined $61 million to $95 million.
- At July 1, cash was $95 million, including $82 million held outside the U.S.; current assets were $1,136 million and current liabilities $983 million. Long-term debt carrying value was $2,418 million, comprising $1,050 million of Senior Notes and $1,413 million of Term Loan, net of issuance costs and discounts. The company had $246 million available on its $250 million revolving facility and no revolver borrowings; it reported compliance with debt covenants.
- Q2 Legacy Zebra sales were $313 million and adjusted segment operating income was $63 million; Enterprise sales were $584 million and adjusted segment operating income was $68 million. Segment measures exclude specified purchase-accounting, amortization, acquisition, integration, and restructuring items.
Material changes and management commentary
- Growth was led by higher hardware sales, particularly mobile computing and barcode printing; North America and Latin America contributed to Q2 growth. Services sales were lower, partly due to the WLAN divestiture. Asia-Pacific sales declined.
- Q2 Enterprise organic sales growth was 7.9%; its reported sales rose 1.2%, partly obscured by the WLAN divestiture. Legacy Zebra organic growth was 3.7%. Legacy Zebra gross margin fell year over year, with higher overhead and customer incentives among the cited factors; Enterprise Q2 margin also declined on business mix.
- Management cited progress integrating the Enterprise acquisition, including implementation of a common ERP system and exiting many transition-services agreements. The company completed integration of ERP systems across North America, Latin America, and EMEA during the quarter; disclosure controls were assessed as effective.
- Debt restructuring after quarter-end: on July 26, Zebra amended its credit facilities, including a new $687.5 million term loan and an expanded $500 million revolver. On August 7, it used financing proceeds to redeem $750 million of 7.25% Senior Notes and planned to redeem the remaining $300 million by year-end through lower-cost financing, including a proposed receivables securitization facility. Debt after the August 7 transactions was reported at $2.5 billion. The company expected about $72 million of redemption and transaction fees and $18 million of non-cash accelerated amortization during fiscal 2017; $55 million and $13 million, respectively, had been incurred by August 7.
Outlook, risks, and unusual items
- No numerical full-year 2017 guidance is provided in the supplied filing text. Management said existing capital resources and operating cash generation should cover anticipated capital needs and debt service.
- The new Productivity Plan may include organizational changes, process improvements, and automation. Actions are expected to be substantially complete by the end of fiscal 2018, with the first full year of benefits expected in 2019. Costs and benefits had not yet been finalized. The earlier acquisition-related plan was expected to conclude by December 31, 2017, with $5 million to $7 million of remaining charges.
- Taxes were volatile: the six-month effective tax rate was (47.1)%, including benefits and other effects related to foreign rates, tax credits, intercompany intellectual-property transfer, and share-based compensation. The company noted that interim tax provisions can vary and that tax audits and examinations remain ongoing.
- Derivative positions expose Zebra to currency and interest-rate movements. At July 1, the company reported a net derivative liability of $42 million; it also expected about $7 million of losses on designated interest-rate swaps to be reclassified to earnings over the next four quarters.
- Legal proceedings include the longstanding Waring securities class action involving acquired Symbol Technologies. The company could not reasonably estimate possible losses for that matter, and its D&O insurer disputed reimbursement of defense costs. Zebra said ordinary-course proceedings were not expected to have a material adverse impact, while noting the inherent uncertainty.
- Customer concentration is notable: three distributors accounted for 21.2%, 13.1%, and 13.0% of first-half sales. Three customers represented 22.3%, 12.1%, and 10.6% of accounts receivable at quarter-end.
Important facts for investors to verify
- Whether reported organic growth translates into sustained GAAP sales and margin improvement, given the WLAN divestiture and currency adjustments.
- Execution, total costs, and realized savings from the Productivity Plan and remaining acquisition-related restructuring.
- Completion and total cost of the post-quarter debt refinancing, including redemption of the remaining Senior Notes and any receivables securitization; assess leverage, interest expense, and liquidity afterward.
- Cash conversion and working-capital trends, particularly the inventory increase, and exposure to major distributor customers.
- Developments in tax audits, tax-rate assumptions, and the Waring litigation and insurance dispute.