Zebra Technologies Corporation — Q3 2016 Form 10-Q
Reporting period: Quarter ended October 1, 2016; comparisons are with the quarter ended October 3, 2015. Amounts are in millions of dollars except per-share data. Zebra designs and sells data-capture and related hardware, software, and services through its Legacy Zebra and Enterprise segments.
Financial performance
| Metric | Q3 2016 | Q3 2015 | First 9 months 2016 | First 9 months 2015 |
|---|---|---|---|---|
| Net sales | $904 | $916 | $2,632 | $2,699 |
| Gross profit | $414 | $414 | $1,210 | $1,216 |
| Gross margin | 45.8% | 45.2% | 46.0% | 45.1% |
| Operating income (loss) | $(24) | $25 | $9 | $31 |
| Net loss | $(83) | $(29) | $(154) | $(131) |
| Diluted loss per share | $(1.61) | $(0.57) | $(2.99) | $(2.56) |
| Operating cash flow | — | — | $245 | $116 |
Quarterly sales declined 1.3%; nine-month sales declined 2.5%. Hardware sales were the main source of weakness, while supplies and quarterly services and software sales increased slightly. Q3 operating expenses rose to $438 from $389, principally because of a $62 non-cash goodwill and intangible impairment tied to the WLAN divestiture. Excluding that charge, management said quarterly operating income would have increased $13 year over year; on the same basis, nine-month operating income would have increased $40.
For the first nine months, operating cash flow was $245; capital expenditures were $49, or approximately $196 of operating cash flow less capital expenditures. Cash declined $29 to $163. Long-term debt was $2,788, compared with $3,012 at December 31, 2015; cash and cash equivalents were $163. The company had no revolver borrowings and $246 available under its $250 revolving facility, after letters of credit. It made $235 of optional term-loan principal payments during the nine months and another $42 payment on November 4, after quarter-end. The term loan rate was 4.09% at quarter-end; interest expense was $145 for the nine-month period.
Material changes and business developments
- Legacy Zebra Q3 sales fell 4.1% to $301 and segment operating income fell 25.4% to $50. Barcode printers and location solutions were weaker; a one-time concession to Chinese printer distributors reduced segment gross margin by about one percentage point.
- Enterprise Q3 sales were flat at $605, while segment operating income rose 39.1% to $89, reflecting better gross margin and lower operating expenses. Enterprise nine-month sales fell 1.5%, but segment operating income increased 24.2% to $200.
- On September 13, Zebra agreed to sell its WLAN business to Extreme Networks for $55 in cash, subject to working-capital and other adjustments. Zebra recorded a $62 impairment charge. The assets and liabilities were classified as held for sale, but the business remained in continuing operations. The sale closed October 28; final closing-balance-sheet work was expected by the first quarter of 2017. WLAN contributed $76 of revenue and $37 of gross profit in the first nine months.
- The June 2016 term-loan amendment lowered the LIBOR spread from 400 to 325 basis points. The company recorded a $2.7 debt-extinguishment-related charge and paid $4.9 to creditors, recorded as a debt discount.
Outlook, risks, and unusual matters
Management stated that existing capital resources and funds generated from operations should be sufficient for anticipated capital needs and debt service. The company expected 2016 exit and restructuring charges of $20–$30; $17 had been recorded through October 1. The filing refers to a full-year 2016 financial outlook but the provided filing text does not give clear numerical guidance.
Management cited continued acquisition integration and progress winding down Motorola Solutions transition services. Key risks include significant debt and variable-rate exposure, foreign-exchange and international-market fluctuations, customer and supplier concentration, and the uncertain business effects of the U.K.’s EU-withdrawal process. Three distributors each represented at least 10% of nine-month sales; the largest represented 20.3%. Three customers each exceeded 10% of accounts receivable at quarter-end.
Internal controls over financial reporting were deemed ineffective because of a material weakness in the income-tax provision process, related to the complexity of the post-acquisition legal-entity structure and forecasting and review controls. Zebra described remediation actions, including improved procedures and additional accounting and tax personnel, but had not yet concluded remediation was effective. The filing also notes that financial statements for 2015 and Q1 and Q2 2016 were restated on November 14, 2016, in part due to this weakness. A long-running securities class action involving acquired Symbol Technologies remains unresolved; the company said it could not reasonably estimate possible losses.
Most important facts for investors to verify
- Progress and testing results for remediation of the tax-control material weakness, and the scope and effects of the referenced restatements.
- Final WLAN sale proceeds and closing adjustments, and whether the divestiture changes reported results or liquidity beyond the disclosed impairment.
- Debt repayment pace, cash generation, interest-rate exposure, and covenant compliance; Zebra reported compliance at October 1, 2016.
- Whether hardware demand, Legacy Zebra margins, distributor concentration, and regional trends improve or weaken in subsequent periods.
- Developments in the Symbol litigation and the potential business effects of Brexit-related currency, trade, and customer uncertainty.