Zebra Technologies Corporation — Q3 2014 Form 10-Q
Reporting period: Quarter ended September 27, 2014; results are unaudited. Unless noted, dollar amounts below are in millions. The quarter’s results reflect Zebra before its acquisition of Motorola Solutions’ Enterprise business, which closed on October 27, 2014.
Financial performance
| Metric | Q3 2014 | Q3 2013 | First 9 months 2014 | First 9 months 2013 |
|---|---|---|---|---|
| Net sales | $303.3 | $263.5 | $880.0 | $753.6 |
| Gross profit / margin | $151.5 / 50.0% | $128.6 / 48.8% | $441.6 / 50.2% | $362.6 / 48.1% |
| Operating income / margin | $27.0 / 8.9% | $46.8 / 17.7% | $113.4 / 12.9% | $111.2 / 14.7% |
| Net income | $14.9 | $38.6 | $84.1 | $92.7 |
| Diluted EPS | $0.29 | $0.76 | $1.64 | $1.81 |
| Operating cash flow | Not provided for the quarter | $129.7 | $137.0 |
Q3 sales grew 15.1%, with growth in all regions; services and software revenue rose 51.6%, partly reflecting organic growth and the Hart Systems acquisition. Gross margin improved on lower product and freight costs and better fixed-cost absorption. Profitability fell despite sales growth, principally because Q3 acquisition and integration costs were $35.3 million, versus $0.3 million a year earlier. Nine-month acquisition and integration costs were $60.6 million.
For the first nine months, capital spending on property and equipment was $20.0 million. Net cash decreased $2.6 million to $60.2 million. At September 27, cash and investments totaled $541.9 million, including $481.7 million of investments and marketable securities. Current assets were $921.1 million and current liabilities $158.2 million (current ratio approximately 5.8). The balance sheet reported no acquisition debt at quarter-end. Foreign subsidiaries held $330.9 million of cash and investments; the company generally does not intend to repatriate these funds because of potential U.S. tax.
Changes, acquisition and outlook
Year-to-date sales increased 16.8%; gross margin expanded 2.1 percentage points, while operating margin declined 1.8 points and net income fell 9.3%. Other expense shifted from income of $2.4 million in the prior-year period to expense of $4.1 million, including a $2.3 million impairment of a minority investment and losses on acquisition-related interest-rate swaps. Inventory rose to $139.6 million from $121.0 million at year-end.
After quarter-end, Zebra completed the $3.45 billion acquisition of Motorola Solutions’ Enterprise business. It issued $1.05 billion of 7.25% senior notes due 2022 and drew a $2.2 billion term loan bearing variable interest at LIBOR (subject to a 0.75% floor) plus 4.0%; a $250 million revolving facility remained undrawn. The company had used forward swaps to hedge part of the planned variable-rate exposure. Management stated an expectation of approximately $150 million in annual cost savings, fully achieved by 2017; this is an expectation, not a guarantee.
There is no specific revenue or earnings guidance in the filing. Management expected a $5.9 million UK tax-law-related charge to reverse in Q4 following the acquisition financing, and expected to record an additional $2.6 million tax benefit related to interest expense. Q3’s reported effective tax rate was 39.8%; management said it would have been 21.8% excluding the UK tax-law change and acquisition expenses.
Risks, contingencies and unusual items
- Acquisition integration, retention of key employees, customer termination rights, unanticipated liabilities, and achieving expected synergies are significant risks. Purchase-price allocation and acquisition pro forma results were not available in this filing.
- Post-acquisition debt materially increases financial risk. The filing identifies interest and principal servicing, refinancing, variable interest rates, restrictive covenants, and potential covenant defaults as risks. A secured net leverage covenant applies in specified circumstances.
- Three distributors each accounted for at least 10% of sales in Q3 (17.1%, 12.8%, and 11.8%), creating customer/channel concentration.
- Other risks include foreign exchange and market exposure, reliance on overseas suppliers and manufacturing, product acceptance and competition, and litigation. Management did not expect ordinary-course legal proceedings to have a material adverse effect, while noting outcomes are uncertain.
- Zebra decided to dispose of a failed-auction auction-rate security and recorded a $0.6 million impairment. The filing also reports ongoing restructuring activity; nine-month 2014 charges were $0.4 million.
Most important facts for investors to verify
- Post-acquisition debt balances, interest expense, covenant headroom, and cash available for debt service.
- Integration progress, actual cost savings versus the $150 million annual target, and customer and employee retention.
- Final acquisition purchase-price allocation, acquired business results, and any additional integration or restructuring costs.
- Whether the expected Q4 tax reversal and interest-related tax benefit were realized.
- Sales trends and exposure to the three major distributor customers and foreign-currency movements.