Zebra Technologies (ZBRA) 10-Q 2005 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 2, 2005
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to                     

Commission File Number:  000-19406

Zebra Technologies Corporation

(Exact name of registrant as specified in its charter)

Delaware	36-2675536
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
333 Corporate Woods Parkway, Vernon Hills, IL 60061
(Address of principal executive offices)           (Zip Code)

Registrant’s telephone number, including area code: (847) 634-6700

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed 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 file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes   ý   No  o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).  Yes ý No o

As of July 29, 2005, there were the following shares outstanding:

Class A Common Stock, $.01 par value 72,150,007

ZEBRA TECHNOLOGIES CORPORATION

QUARTER ENDED JULY 2, 2005

INDEX

PART I - FINANCIAL INFORMATION
	Item 1.		Consolidated Financial Statements
		Consolidated Balance Sheets as of July 2, 2005 (unaudited) and December 31, 2004
		Consolidated Statements of Earnings (unaudited) for the three and six months ended July 2, 2005 and July 3, 2004
		Consolidated Statements of Comprehensive Income (unaudited) for the three and six months ended July 2, 2005 and July 3, 2004
		Consolidated Statements of Cash Flows (unaudited) for the six months ended July 2, 2005 and July 3, 2004
		Notes to Consolidated Financial Statements
	Item 2.			Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3.			Quantitative and Qualitative Disclosures About Market Risk
	Item 4.			Controls and Procedures
PART II - OTHER INFORMATION
	Item 1.			Legal Proceedings
	Item 4.			Submissions of Matters to a Vote of Security Holders
	Item 6.			Exhibits and Reports on Form 8-K
SIGNATURES

2

PART I - - FINANCIAL INFORMATION

Item 1.    Consolidated Financial Statements

ZEBRA TECHNOLOGIES CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Amounts in thousands)

	July 2,		December 31,
	2005		2004
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	10,098	$	17,983
Investments and marketable securities	563,712		540,010
Accounts receivable, net	104,999		96,881
Inventories, net	63,569		59,255
Deferred income taxes	8,747		6,625
Prepaid expenses	5,358		3,884
Total current assets	756,483		724,638
Property and equipment at cost, less accumulated depreciation and amortization	47,564		46,283
Goodwill	69,095		61,793
Other intangibles, net	14,809		6,517
Other assets	30,912		22,991
Total assets	$	918,863	$	862,222
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	21,674	$	24,130
Accrued liabilities	27,501		29,248
Current portion of obligation under capital lease	55		54
Income taxes payable	1,969		6,144
Total current liabilities	51,199		59,576
Obligation under capital lease, less current portion	89		117
Deferred income taxes	3,468		417
Deferred rent	569		564
Other long-term liabilities	4,883		3,894
Total liabilities	60,208		64,568
Stockholders’ equity:
Preferred Stock	¾		¾
Class A Common Stock	721		718
Additional paid-in capital	92,877		84,180
Retained earnings	760,359		706,489
Accumulated other comprehensive income	4,698		6,267
Total stockholders’ equity	858,655		797,654
Total liabilities and stockholders’ equity	$	918,863	$	862,222

See accompanying notes to consolidated financial statements.

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ZEBRA TECHNOLOGIES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS

(Amounts in thousands, except per share data)

(Unaudited)

	Three Months Ended						Six Months Ended
	July 2,			July 3,			July 2,			July 3,
	2005			2004			2005			2004
Net sales	$	176,614		$	162,830		$	347,342		$	317,004
Cost of sales	87,266			78,315			170,629			151,886
Gross profit	89,348			84,515			176,713			165,118
Operating expenses:
Selling and marketing	22,554			18,023			43,621			35,231
Research and development	12,054			9,233			22,721			18,129
General and administrative	16,810			12,562			31,757			25,324
Amortization of intangible assets	387			626			1,034			1,275
Acquired in-process technology	¾			¾			¾			22
Exit costs	141			876			1,658			1,238
Total operating expenses	51,946			41,320			100,791			81,219
Operating income	37,402			43,195			75,922			83,899
Other income (expense):
Investment income	3,072			2,091			6,349			5,163
Interest expense	(27		)	(6		)	(31		)	(32		)
Foreign exchange gain (loss)	812			413			865			(244		)
Other, net	(243		)	(537		)	(545		)	(836		)
Total other income	3,614			1,961			6,638			4,051
Income before income taxes	41,016			45,156			82,560			87,950
Income taxes	14,253			15,728			28,690			30,588
Net income	$	26,763		$	29,428		$	53,870		$	57,362
Basic earnings per share	$	0.37		$	0.41		$	0.75		$	0.80
Diluted earnings per share	$	0.37		$	0.41		$	0.74		$	0.79
Basic weighted average shares outstanding	72,013			71,559			71,939			71,397
Diluted weighted average and equivalent shares outstanding	72,714			72,554			72,706			72,403

See accompanying notes to consolidated financial statements.

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ZEBRA TECHNOLOGIES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Amounts in thousands)

(Unaudited)

	Three Months Ended						Six Months Ended
	July 2,			July 3,			July 2,			July 3,
	2005			2004			2005			2004
Net income	$	26,763		$	29,428		$	53,870		$	57,362
Other comprehensive income (loss):
Foreign currency translation adjustment	(3,555		)	(519		)	(4,641		)	769
Changes in unrealized gains and (losses) on hedging transactions, net of tax	1,792			(117		)	3,045			909
Changes in unrealized gains and (losses) on investments, net of tax	1,052			(1,919		)	27			(1,529		)
Comprehensive income	$	26,052		$	26,873		$	52,301		$	57,511

See accompanying notes to consolidated financial statements.

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ZEBRA TECHNOLOGIES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

(Unaudited)

	Six Months Ended
	July 2,			July 3,
	2005			2004
Cash flows from operating activities:
Net income	$	53,870		$	57,362
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	6,399			6,080
Tax benefit from exercise of stock options	2,100			5,516
Acquired in-process technology	¾			22
Deferred income taxes	859			(685		)
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable, net	(12,124		)	(12,496		)
Inventories	(5,342		)	(4,527		)
Other assets	(8,358		)	(3,105		)
Accounts payable	(1,655		)	398
Accrued liabilities	(1,291		)	(2,152		)
Income taxes payable	(3,831		)	1,767
Other operating activities	1,532			(807		)
Net cash provided by operating activities	32,159			47,373
Cash flows from investing activities:
Purchases of property and equipment	(6,607		)	(7,737		)
Acquisition of assets of Retail Systems International, Inc.	(7,655		)	¾
Acquisition of intangible assets	(8,254		)	¾
Purchases of investments and marketable securities	(509,112		)	(709,560		)
Maturities of investments and marketable securities	313,076			475,442
Sales of investments and marketable securities	172,334			178,143
Net cash used in investing activities	(46,218		)	(63,712		)
Cash flows from financing activities:
Proceeds from exercise of stock options and stock purchase plan purchases	6,600			11,432
Payments for obligation under capital lease	(27		)	(8		)
Net cash provided by financing activities	6,573			11,424
Effect of exchange rate changes on cash	(399		)	36
Net decrease in cash and cash equivalents	(7,885		)	(4,879		)
Cash and cash equivalents at beginning of period	17,983			14,266
Cash and cash equivalents at end of period	$	10,098		$	9,387
Supplemental disclosures of cash flow information:
Interest paid	$	31		$	32
Income taxes paid	31,104			23,929

See accompanying notes to consolidated financial statements.

6

ZEBRA TECHNOLOGIES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 – Basis of Presentation

Management prepared these unaudited interim consolidated financial statements for Zebra Technologies Corporation and subsidiaries (Zebra) according to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information required in full-year audited financial statements is omitted, as allowed by SEC rules and regulations. These omissions relate to information and footnote disclosures normally included in the annual financial statements prepared in accordance with accounting principles generally accepted in the United States. You should read our annual financial statements with their notes in our Form 10-K for the year ended December 31, 2004, for these additional disclosures.

The consolidated balance sheet as of December 31, 2004, in this Form 10-Q is taken from the audited consolidated balance sheet in our Form 10-K. These interim financial statements include all adjustments necessary to present fairly Zebra’s consolidated financial position as of July 2, 2005, the consolidated results of operations for the three and six months ended July 2, 2005 and July 3, 2004, and cash flows for the six months ended July 2, 2005 and July 3, 2004. These results, however, are not necessarily indicative of results for the full year.

Note 2—Stock-Based Compensation

As of July 2, 2005, we had three stock-based compensation plans available for future grants. We account for these plans using the intrinsic value method in accordance with the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based compensation cost is reflected in net income, because all options granted under these plans had grant prices equal to the market value of the underlying common stock on the date of grant. The following table shows the effect on net income and earnings per share if we had applied the fair value recognition provisions of Statement of Financial Standards (SFAS) No. 123, Accounting for Stock-based Compensation (in thousands, except per share data):

	Three Months Ended						Six Months Ended
	July 2,			July 3,			July 2,			July 3,
	2005			2004			2005			2004
Net income	$	26,763		$	29,428		$	53,870		$	57,362
Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects	(1,317		)	(1,311		)	(2,605		)	(2,738		)
Pro forma net income	$	25,446		$	28,117		$	51,265		$	54,624
Basic earnings per share:
As reported	$	0.37		$	0.41		$	0.75		$	0.80
Pro forma	0.35			0.39			0.71			0.77
Diluted earnings per share:
As reported	$	0.37		$	0.41		$	0.74		$	0.79
Pro forma	0.35			0.39			0.70			0.75

For pro forma purposes, the fair value of stock options granted prior to January 1, 2005 was determined using the Black-Scholes model. Zebra has changed its fair value option pricing method from the Black-Scholes model to a binomial model for all options granted on or after January 1, 2005. We believe that the binomial model considers characteristics of fair value option pricing that are not recognized under the Black-Scholes model. Similar to the Black-Scholes model, the binomial model takes into account variables such as volatility, dividend yield rate and risk free interest rate. Additionally, the binomial model considers cancellation and historical exercise experience of Zebra to determine the option value. It also takes into account the illiquid nature of employee options during the vesting period and the probability that the option will be exercised prior to the end of its contractual life. For these reasons, we believe that the binomial model provides an estimated fair value that is more representative of actual experience and future expected experience than the value calculated in previous years using the Black-Scholes model.

7

The assumptions used for the 2005 option grants are as follows:

Expected option life	4.83 years
Expected volatility	38.44% per year
Weighted average risk-free interest rate	3.74% per year
- Range of interest rates	2.36% - 4.50%
Dividend yield	0.00% per year

In April 2005, the FASB changed the implementation date for SFAS No. 123(R), Share-Based Payment, which 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. Originally, public companies subject to SEC oversight were required to implement SFAS No. 123(R) as of the beginning of the first interim or annual reporting period beginning after June 15, 2005. As a result of the action by the SEC, the provisions of this statement will now be effective for Zebra during the first quarter of 2006. We expect the impact on Zebra’s consolidated financial statements to be consistent with the fair value disclosures included above.

Note 3 – Inventories

The components of inventories are as follows (in thousands):

	July 2,		December 31,
	2005		2004
Raw materials	$	42,014	$	34,041
Work in process	244		569
Finished goods	21,311		24,645
Total inventories	$	63,569	$	59,255

Note 4 – Business Combinations

Retail Systems International, Inc. On February 11, 2005, Zebra acquired certain assets of Retail Systems International, Inc. (RSI) for $7,655,000. Located in Chula Vista, California, RSI manufactures labels, ribbons, tags and other printed media. The consolidated statements of earnings reflect the results of operations of RSI since the effective date of the purchase. The pro forma impact of this acquisition was not significant.

The following table (in thousands) summarizes the adjusted fair values of the assets acquired at the date of acquisition.

	At February 11, 2005
Inventory	$	238
Property and equipment	469
Intangible assets	1,073
Goodwill	5,875
Total assets acquired	$	7,655

The purchase price was allocated to identifiable tangible assets and intangible assets acquired based on their estimated fair values. The intangible assets of $1,073,000 consist mainly of customer relationships with a useful life of 5 years. The goodwill is not deductible for tax purposes.

Note 5 – Investments and Marketable Securities

We classify the majority of our investments and marketable securities as available-for-sale in accordance with the classifications defined 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 be reflected 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 flow statements, changes in the balances of available-for-sale securities are shown as purchases, sales and maturities of investments and marketable securities.

8

Changes in unrealized gains and losses on investment securities are included in these financial statements as follows (in thousands):

	Three Months Ended					Six Months Ended
	July 2,		July 3,			July 2,		July 3,
	2005		2004			2005		2004
Changes in unrealized gains and (losses) on available-for-sale securities, net of tax, recorded in accumulated other comprehensive income	$	1,052	$	(1,919	)	$	27	$	(1,529	)

All investments and marketable securities are considered available-for-sale securities; therefore, there are no unrealized gains or losses on trading securities recorded in investment income.

Note 6–Stockholders’ Equity

Share count and par value data related to stockholders’ equity are as follows:

	July 2,		December 31,
	2005		2004
Preferred Stock
Par value per share	$	0.01	$	0.01
Shares authorized	10,000,000		10,000,000
Shares outstanding	¾		¾
Common Stock - Class A
Par value per share	$	0.01	$	0.01
Shares authorized	150,000,000		150,000,000
Shares issued	72,098,005		71,819,806
Shares outstanding	72,098,005		71,819,806

Note 7–Other Comprehensive Income (Loss)

Stockholders’ equity includes certain items classified as other comprehensive income, including:

•Foreign currency translation adjustment relates to our non-U.S. subsidiary companies that have designated a functional currency other than the U.S. dollar. We are required to translate the subsidiary functional currency financial statements to dollars using a combination of historical, month-end, and average foreign exchange rates. This combination of rates creates the foreign currency translation adjustment component of other comprehensive income.

•Unrealized 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 flow hedges, and we have deferred income statement recognition of gains and losses until the hedged transaction occurs. See Note 10 for more details.

•Unrealized gains (losses) on investments classified as available-for-sale are deferred from income statement recognition until the gains or losses are realized. See Note 5 for more details.

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The components of other comprehensive income (loss) included in the Consolidated Statements of Comprehensive Income are as follows (in thousands):

	Three Months Ended						Six Months Ended
	July 2,			July 3,			July 2,			July 3,
	2005			2004			2005			2004
Foreign currency translation adjustments	$	(3,555	)	$	(519	)	$	(4,641	)	$	769
Changes in unrealized gains and (losses) on foreign currency hedging activities:
Gross	$	2,869		$	(180	)	$	4,789		$	1,398
Income tax (benefit)	1,077			(63		)	1,744			489
Net	$	1,792		$	(117	)	$	3,045		$	909
Changes in unrealized gains and (losses) on investments classified as available-for-sale:
Gross	$	1,687		$	(2,952	)	$	57		$	(2,352	)
Income tax (benefit)	635			(1,033		)	30			(823		)
Net	$	1,052		$	(1,919	)	$	27		$	(1,529	)

The components of other comprehensive income (loss) included in the Consolidated Balance Sheets are as follows (in thousands):

	As of
	July 2,		December 31,
	2005		2004
Foreign currency translation adjustments	$	2,871	$	7,512
Unrealized gains and (losses) on foreign currency hedging activities:
Gross	$	2,558	$	(2,231	)
Income tax (benefit)	963		(781		)
Net	$	1,595	$	(1,450	)
Unrealized gains on investments classified as available-for-sale:
Gross	$	372	$	315
Income tax	140		110
Net	$	232	$	205

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Note 8–Earnings Per Share

Earnings per share were computed as follows (in thousands, except per share amounts):

	Three Months Ended				Six Months Ended
	July 2,		July 3,		July 2,		July 3,
	2005		2004		2005		2004
Basic earnings per share:
Net income	$	26,763	$	29,428	$	53,870	$	57,362
Weighted average common shares outstanding	72,013		71,559		71,939		71,397
Per share amount	$	0.37	$	0.41	$	0.75	$	0.80
Diluted earnings per share:
Net income	$	26,763	$	29,428	$	53,870	$	57,362
Weighted average common shares outstanding	72,013		71,559		71,939		71,397
Add: Effect of dilutive securities – stock options	701		995		767		1,006
Diluted weighted average and equivalent shares outstanding	72,714		72,554		72,706		72,403
Per share amount	$	0.37	$	0.41	$	0.74	$	0.79

Potentially dilutive securities that were excluded from the earnings per share calculation consist of stock options with an exercise price greater than the average market price of the Class A common stock. These options were as follows:

	Three Months Ended		Six Months Ended
	July 2,	July 3,	July 2,	July 3,
	2005	2004	2005	2004
Potentially dilutive shares	821,000	1,200	325,000	1,200

Note 9—Goodwill and Other Intangible Asset Data

Intangible asset data are as follows (in thousands):

	July 2, 2005					December 31, 2004
	Gross Carrying Amount		Accumulated Amortization			Gross Carrying Amount		Accumulated Amortization
Amortized intangible assets
Current technology	$	20,511	$	(8,569	)	$	12,258	$	(7,746	)
Customer relationships	3,406		(539		)	2,333		(328		)
Total	$	23,917	$	(9,108	)	$	14,591	$	(8,074	)
Unamortized intangible assets
Goodwill	$	69,095				$	61,793
Aggregate amortization expense
For the year ended December 31, 2004						$	2,569
For the three months ended July 2, 2005	$	387
For the six months ended July 2, 2005	1,034
Estimated amortization expense
For the year ended December 31, 2005	2,464
For the year ended December 31, 2006	2,751
For the year ended December 31, 2007	2,700
For the year ended December 31, 2008	2,702
For the year ended December 31, 2009	2,578
For the year ended December 31, 2010	1,705
For the year ended December 31, 2011	943

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During the first quarter of 2005, we made a final contingent payment related to the Atlantek acquisition for $1,287,000, which was added to goodwill.  In addition, we purchased certain assets of a label converting facility in Chula Vista, CA, with an adjusted allocation of net goodwill of $5,875,000 as described in Note 4.

During the first half of 2005, we acquired intangible assets in the amount of $9,327,000 for customer relationships and licenses to use certain technology. Our preliminary estimate is that these intangible assets will have a commercial life of 5 to 6 years.

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 2005. At that time, no adjustment to goodwill was necessary due to impairment.

We evaluate the impairment of other long-lived assets including identifiable intangible 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:

•Significant underperformance relative to historical or projected future operating results

•Significant changes in the manner of use of the acquired assets or the strategy for the overall business

•Significant negative industry or economic trends

•Significant decline in Zebra’s stock price for a sustained period

•Significant decline in market capitalization relative to net book value

If we believe that one or more of the above indicators of impairment have occurred, we measure impairment based on a projected discounted cash flow methodology using a discount rate that incorporates the risk inherent in the cash flows.

Note 10—Derivative Instruments

In the normal course of business, portions of Zebra’s operations are subject to fluctuations in currency values. We manage these risks using derivative financial instruments.

Hedging of Net Assets

We use forward contracts and options to manage exposure related to our pound and euro denominated net assets and designate these contracts and options as fair value hedges. We record gains and losses on these contracts and options in income each quarter along with the transaction gains and losses related to our net euro asset position, which would ordinarily offset each other to a large extent. Summary financial information related to these activities follows (in thousands):

	Three Months Ended					Six Months Ended
	July 2,		July 3,			July 2,			July 3,
	2005		2004			2005			2004
Gains and (losses) from foreign exchange derivatives	$	533	$	(183	)	$	1,602		$	345
Gains and (losses) on net foreign currency assets	279		596			(737		)	(589		)
Net foreign exchange gain (loss)	$	812	$	413		$	865		$	(244	)

	As of
	July 2, 2005		December 31, 2004
Notional balance of outstanding contracts:
Pound	£	17,199	£	13,646
Euro	€	32,000	€	34,000

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Hedging of Anticipated Sales

We manage the exchange rate risk of anticipated euro denominated sales using forward contracts and option collars. We designate these contracts as cash flow hedges. Gains and losses on these contracts are deferred in other comprehensive income until the contracts are settled and the hedged sales are realized, at which time the deferred gains or losses will be reported as an increase or decrease to sales. Summary financial information related to the cash flow hedges of future revenues follows (in thousands, except percentages):

	As of
	July 2, 2005				December 31, 2004
Net unrealized gains and (losses) deferred in other comprehensive income:
Gross	$	2,558			$	(2,231		)
Income tax (benefit)	963				(781			)
Net	$	1,595			$	(1,450		)
Notional balance of outstanding contracts	€		28,700		€		30,000
Hedge effectiveness	100			%	100			%
	2005				2004
Net gains and (losses) included in revenue for the:
Three months ended July 2, 2005	$	(398		)
Three months ended July 3, 2004					$	12
Six months ended July 2, 2005	$	(671		)
Six months ended July 3, 2004					$	(631		)

Note 11—Costs associated with Exit or Disposal Activities

During the first 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 identified on a separate line of our income statement, as part of operating expenses. Our consolidation plan is intended to reduce costs and improve manufacturing efficiency.

Our Varades facility conducted the product development for our line of card printers and included 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 July 2, 2005, we incurred the following exit costs (in thousands):

Type of Cost	Total costs incurred to date
Severance, stay bonuses, and other employee-related expenses	$	1,713
Asset disposal costs	64
Other exit costs	308
Total	$	2,085

We expect to incur no further significant costs for this project.

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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 substantially complete by the end of 2004. 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. The following table shows the exit costs incurred and remaining costs expected as of July 2, 2005 (in thousands).

Type of Cost	Costs incurred to date		Additional costs expected		Total costs expected to be incurred
Severance, stay bonuses, and other employee-related expenses	$	766	$	—	$	766
Other exit costs	474		100		574
Total	$	1,240	$	100	$	1,340

During December 2004, we announced plans to close and consolidate our Wakefield, Rhode Island facility into our other North American facilities. This transition is expected to be complete by the end of 2005. The following table shows the exit costs incurred and remaining costs expected as of July 2, 2005 (in thousands).

Type of Cost	Costs incurred to date		Additional costs expected		Total costs expected to be incurred
Severance, stay bonuses, and other employee-related expenses	$	132	$	—	$	132
Other exit costs	8		309		317
Total	$	140	$	309	$	449

Zebra has a leased warehouse facility in Wokingham, United Kingdom that currently is not utilized. The lease runs through October 2010, with annual rent of £192,500. The facility previously had been subleased at a profit through December 2003 when the subtenant left the facility. In 2004, we began efforts to market the building for sublease through the balance of the lease period. At that time, we recorded a reserve of approximately $670,000 for the estimated loss on rent based on the market conditions at that time. During the first quarter of 2005, we reviewed the current real estate market data related to this property and concluded that the prospects of subleasing the facility prior to lease expiration are remote, and Zebra will receive no economic benefit for the remaining lease payments. Therefore, during the first quarter of 2005, we recorded in exit costs additional reserves of approximately $1,524,000 for Zebra’s estimated liability under this lease.

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Liabilities and expenses related to exit activities for the three and six months ended July 2, 2005 were as follows (in thousands):

	Varades Closure		Warwick Consolidation			Wakefield Closure			Wokingham Lease			Total
Accrued liabilities related to exit activities at December 31, 2004	$	155	$	439		$	90		$	550		$	1,234
Expenses incurred for the three months ended April 2, 2005	18		(15		)	(10		)	1,524			1,517
Expenses incurred for the three months ended July 2, 2005	113		(13		)	41			¾			141
Total expenses incurred for the six months ended July 2, 2005	131		(28		)	31			1,524			1,658
Less: Amounts paid for the six months ended July 2, 2005	261		379			34			154			828
Exchange rate impact	¾		¾			¾			(133		)	(133		)
Accrued liabilities related to exit activities at July 2, 2005	$	25	$	32		$	87		$	1,787		$	1,931

The negative expenses related to adjustment of reserves due to changes in the estimates of additional expected costs.

Note 12—Contingencies

On April 24, 2003, Paxar Americas, Inc. (Paxar Americas) filed a patent infringement lawsuit in the United States District Court for the Southern District of Ohio against Zebra and certain of its subsidiaries. Paxar Americas’ Complaint alleges that certain of Zebra’s products infringe on one or more of eight identified Paxar Americas patents, although not every product is accused of infringing each patent. Zebra filed an Answer to Paxar Americas’ Complaint, denying Paxar Americas’ allegations of infringement and asserting several affirmative defenses, including the invalidity of Paxar Americas’ asserted patent claims. Paxar Americas moved to amend its Complaint to add two patents and a trademark-based claim and the Court granted the motion. Paxar Americas filed its Amended Complaint on March 31, 2005, dropping one of the eight originally asserted patents and adding two newly asserted patents. Paxar Americas also filed a motion to withdraw another of the originally asserted patents from the Amended Complaint. Zebra filed its Answer denying all infringement and asserting affirmative defenses including the invalidity of Paxar Americas’ asserted patent claims. On July 15, 2004, the Court heard argument from the parties regarding the proper construction of the claims of the patents-in-suit and the parties submitted post-argument briefs. On April 20, 2005, at the Court’s request, the parties identified disputed claim terms regarding the newly asserted patents and provided their respective positions regarding those terms to the Court. Fact discovery closed on June 10, 2005; expert discovery in this case is ongoing. The case currently is scheduled for trial in October 2005.

On November 21, 2003, Zebra’s wholly-owned subsidiary, ZIH Corp. (ZIH), filed 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 filed a motion to transfer ZIH’s Massachusetts suit to the United States District Court for the Southern District of Ohio. ZIH opposed Paxar Corporation’s motion to transfer, and the Court denied the motion. On November 25, 2003, Paxar Americas filed a Complaint against ZIH in the United States District Court for the Southern District of Ohio, seeking a 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. The Court granted the parties’ motion to stay this action pending the District Court of Massachusetts’ ruling on Paxar Corporation’s motion to transfer. In view of the Massachusetts District Court’s denial of Paxar Corporation’s motion to transfer ZIH’s Massachusetts suit to Ohio, the

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parties to Paxar Corporation’s Ohio declaratory judgment suit jointly filed a motion to transfer this action to the District Court of Massachusetts and the District Court of Ohio approved that motion. On June13, 2005, Paxar filed an amended answer to the Massachusetts complaint with counterclaims seeking a declaratory judgment that ZIH’s patents-in-suit are not infringed and are invalid and/or unenforceable. On July 7, 2005, the parties stipulated to dismissal of the Massachusetts complaint with prejudice and dismissal of Paxar’s counterclaims and its Ohio declaratory judgment action without prejudice. On July 11, 2005, the Massachusetts district court granted the stipulated order and dismissed the case.

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. 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 financial statements as of July 2, 2005.

Note 13—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.

Warranty Reserve (in thousands)	Six Months Ended July 2, 2005			Six Months Ended July 3, 2004
Balance at beginning of period	$	1,691		$	1,351
Warranty expense during the period	3,184			1,804
Warranty payments made during the period	(2,077		)	(1,627		)
Balance at end of the period	$	2,798		$	1,528

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Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations: Second Quarter of 2005 versus second Quarter of 2004

Sales

Sales by product category, percent change, and percent of total sales for the three and six months ended July 2, 2005, and July 3, 2004, were (in thousands, except percentages):

	Three Months Ended
	July 2,			July 3,		Percent	Percent of		Percent of
Product Category	2005			2004		Change	Total Sales - 2005		Total Sales - 2004
Hardware	$	135,915		$	127,167	6.9	77.0		78.1
Supplies	33,071			28,273		17.0	18.7		17.4
Service and software	6,648			6,283		5.8	3.8		3.9
Shipping and handling	1,378			1,095		25.8	0.7		0.6
Cash flow hedging activities	(398		)	12		NM	(0.2	)	¾
Total sales	$	176,614		$	162,830	8.5	100.0		100.0

	Six Months Ended
	July 2,			July 3,			Percent		Percent of		Percent of
Product Category	2005			2004			Change		Total Sales - 2005		Total Sales - 2004
Hardware	$	269,386		$	245,645		9.7		77.6		77.5
Supplies	63,019			56,947			10.7		18.1		18.0
Service and software	12,728			12,824			(0.7	)	3.7		4.0
Shipping and handling	2,880			2,219			29.8		0.8		0.7
Cash flow hedging activities	(671		)	(631		)	NM		(0.2	)	(0.2	)
Total sales	$	347,342		$	317,004		9.6		100.0		100.0

Sales to customers by geographic region, percent changes and percent of total sales for the three months ended July 2, 2005, and July 3, 2004, were (in thousands, except percentages):

	Three Months Ended
	July 2,		July 3,		Percent	Percent of	Percent of
Geographic Region	2005		2004		Change	Total Sales - 2005	Total Sales - 2004
Europe, Middle East and Africa	$	58,271	$	53,156	9.6	33.0	32.6
Latin America	12,897		9,452		36.4	7.3	5.8
Asia-Pacific	15,665		12,039		30.1	8.9	7.4
Total International	86,833		74,647		16.3	49.2	45.8
North America	89,781		88,183		1.8	50.8	54.2
Total sales	$	176,614	$	162,830	8.5	100.0	100.0

	Six Months Ended
	July 2,		July 3,		Percent	Percent of	Percent of
Geographic Region	2005		2004		Change	Total Sales - 2005	Total Sales - 2004
Europe, Middle East and Africa	$	118,851	$	105,608	12.5	34.2	33.3
Latin America	23,023		17,891		28.7	6.6	5.6
Asia-Pacific	28,124		24,189		16.3	8.1	7.6
Total International	169,998		147,688		15.1	48.9	46.5
North America	177,344		169,316		4.7	51.1	53.5
Total sales	$	347,342	$	317,004	9.6	100.0	100.0

Quarterly sales growth was moderated by a sales slowdown in mobile printer products, compared with large shipments to major retail customers last year. These sales were largely concentrated in North America and the Europe, Middle East and Africa (EMEA) region, our two largest geographic territories. Sales growth in North America and EMEA contrasted with the growth in Latin America and Asia Pacific, which have benefited from the placement of more Zebra sales representatives, sales engineers and other support personnel in those territories.

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New printer products (defined as printers released within 18 months prior to the end of the applicable fiscal period) accounted for 3.7% of printer sales in the second quarter of 2005 and 27.5% of printer sales in the second quarter of 2004. Year to-date new printer products accounted for 11.9% in 2005, compared with 28.1% for the corresponding period in 2004. The decline in sales of new printer products is the result of technical problems that have delayed the introduction of various new products. We expect several new printer products to begin shipping in the second half of the year.

Our international sales are denominated in multiple currencies, primarily the dollar, pound and euro, which cause our reported sales to be subject to fluctuations in currency rates. We estimate that unfavorable foreign exchange movements of the euro and the pound versus the dollar had a net negative effect of $343,000 on sales during the second quarter compared to the second quarter of 2004.

We currently hedge a portion of anticipated euro-denominated sales to protect Zebra against exchange rate movements. For the second quarter, this program resulted in a loss of $398,000 and a year-to-date loss of $671,000. See Note 10 to the financial statements for a more detailed discussion of this hedging program.

Printer unit volumes and average selling price information is summarized below:

	Three Months Ended						Six Months Ended
	July 2,		July 3,		Percent		July 2,		July 3,		Percent
	2005		2004		Change		2005		2004		Change
Total printers shipped	179,538		164,926		8.9		350,047		315,583		10.9
Average selling price of printers shipped	$	644	$	648	(0.6	)	$	647	$	644	0.5

Gross Profit

Gross profit information is summarized below (in thousands, except percentages):

	Three Months Ended					Six Months Ended
	July 2,		July 3,		Percent	July 2,		July 3,		Percent
	2005		2004		Change	2005		2004		Change
Gross Profit	$	89,348	$	84,515	5.7	$	176,713	$	165,118	7.0
Gross Margin	50.6		51.9			50.9		52.1

Gross profit margin decreased by 1.3 percentage points over last year. This decrease in margin is attributable to:

•Unfavorable foreign exchange movements,

•Higher distribution and freight expenses, and

•Less efficient overhead absorption.

Selling and Marketing Expenses

Selling and marketing expenses are summarized below (in thousands, except percentages):

	Three Months Ended					Six Months Ended
	July 2,		July 3,		Percent	July 2,		July 3,		Percent
	2005		2004		Change	2005		2004		Change
Selling and marketing expenses	$	22,554	$	18,023	25.1	$	43,621	$	35,231	23.8
Percent of sales	12.8		11.1			12.6		11.1

Higher selling and marketing expenses reflect ongoing investments in demand-generating activities to build brand equity in our core product lines as well as in the emerging area of radio frequency identification (RFID). During the second quarter of 2005, selling and marketing expenses increased due to higher payroll costs of $1,969,000 from increased staffing as well as higher business development expenses of $1,212,000, outside commissions of $391,000, information expenses of $346,000 and travel expenses of $316,000. The increased staffing was primarily focused on increasing our presence in targeted geographic territories to support growth in those regions, building sales and marketing teams to deliver vertical market applications, and strengthening strategic alliances with complementary companies. For the first six months of 2005, market development funding also increased.

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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					Six Months Ended
	July 2,		July 3,		Percent	July 2,		July 3,		Percent
	2005		2004		Change	2005		2004		Change
Research and development costs	$	12,054	$	9,233	30.6	$	22,721	$	18,129	25.3
Percent of sales	6.8		5.7			6.5		5.7

Quarterly product development expenses fluctuate widely depending on the status of on-going projects. We are committed to a long-term strategy of significant investment in product development. For the second quarter of 2005, project expenses increased by $1,731,000, and professional services increased $542,000 in relation to the second quarter of 2004. For the first six months of 2005, payroll costs also increased. Included in the project expense increase are write-offs of tooling and other materials related to product development in the amount of $1,047,000 for the second quarter of 2005 and $2,118,000 for the year to-date.

General and Administrative Expenses

General and administrative expenses are summarized in the table below (in thousands, except percentages):

	Three Months Ended					Six Months Ended
	July 2,		July 3,		Percent	July 2,		July 3,		Percent
	2005		2004		Change	2005		2004		Change
General and administrative expenses	$	16,810	$	12,562	33.8	$	31,757	$	25,324	25.4
Percent of sales	9.5		7.7			9.1		8.0

For the second quarter of 2005, recruiting expenses increased $499,000 and legal expenses increased $2,372,000. The increase in legal expenses is related to work on intellectual property matters, including litigation with Paxar as described in Note 12. We expect higher legal expenses to continue for subsequent quarters based on the legal activity we are currently experiencing. For the year to-date, audit fees also increased compared to 2004 due to Sarbanes-Oxley implementation.

Operating Income

Operating income is summarized in the following table (in thousands, except percentages):

	Three Months Ended						Six Months Ended
	July 2,		July 3,		Percent		July 2,		July 3,		Percent
	2005		2004		Change		2005		2004		Change
Operating income	$	37,402	$	43,195	(13.4	)	$	75,922	$	83,899	(9.5	)
Percent of sales	21.2		26.5				21.9		26.5

Non-operating Income and Expenses

Zebra’s non-operating income and expense items are summarized in the following table (in thousands):

	Three Months Ended						Six Months Ended
	July 2,			July 3,			July 2,			July 3,
	2005			2004			2005			2004
Investment income	$	3,072		$	2,091		$	6,349		$	5,163
Interest expense	(27		)	(6		)	(31		)	(32		)
Foreign exchange gain (losses)	812			413			865			(244		)
Other, net	(243		)	(537		)	(545		)	(836		)
Total other income	$	3,614		$	1,961		$	6,638		$	4,051
Rate of Return Analysis:
Average cash and marketable securities balances	$	573,509		$	493,264		$	565,902		$	473,396
Annualized rate of return	2.1		%	1.7		%	2.2		%	2.2		%

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Income Taxes

The effective income tax rate for the second quarter and the year to-date of 2005 were 34.7%, compared to 34.8% for the same time periods last year.

Net Income

Zebra’s net income is summarized below (in thousands, except per share amounts):

	Three Months Ended				Six Months Ended
	July 2,		July 3,		July 2,		July 3,
	2005		2004		2005		2004
Net income	$	26,763	$	29,428	$	53,870	$	57,362
Diluted earnings per share	$	0.37	$	0.41	$	0.74	$	0.79

Liquidity and Capital Resources

During the first six months, Zebra continued to generate cash in excess of its operating requirements. As a result, Zebra’s cash and investment balances have continually grown over time. As of July 2, 2005, Zebra had $573,810,000 in cash, cash equivalents, investments and marketable securities, compared with $557,993,000 at December 31, 2004. Factors affecting cash and investment balances during the first six months of 2005 include (note that changes discussed below include the impact of foreign currency):

•Operations provided cash in the amount of $32,159,000, primarily from net income.

•Accounts receivable increased $12,124,000 year-to-date because of higher sales. Days sales outstanding increased to 54 days in the second quarter of 2005 compared to 51 days at the end of 2004.

•Inventories increased $5,342,000. Inventory turns were down to 5.5 from 5.7 at the end of 2004.

•Taxes payable decreased $3,831,000 because of the timing of tax payments.

•Purchases of property and equipment totaled $6,607,000.

•Acquisition of assets of Retail Systems International, Inc. totaled $7,655,000.

•Acquisition of intangible assets totaled $8,254,000.

•Net purchases of investments and marketable securities totaled $23,702,000.

•Stock option exercises and purchases under the stock purchase plan contributed $6,600,000.

Management believes that existing capital resources and funds generated from operations are sufficient to finance anticipated capital requirements. It is our intention to actively pursue opportunities to acquire other businesses.

Critical Accounting Policies and Estimates

Management prepared the consolidated financial statements of Zebra Technologies Corporation under accounting principles generally accepted in the United States of America. These principles require the use of estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions we use are reasonable, based upon the information available.

Our estimates and assumptions affect the reported amounts in our financial statements. The following accounting policies comprise those that we believe are the most critical in understanding and evaluating Zebra’s reported financial results.

Revenue Recognition

Zebra recognizes product sales at the time of shipment and passage of title, which are generally the same. Other items that affect our revenue recognition include:

Customer returns

Customers have the right to return products that do not function properly within a limited time after delivery. We monitor and track product returns and record a provision for the estimated future returns based on historical experience and any notification received of pending returns. Returns have historically been within expectations and the provisions established, but Zebra cannot guarantee that it will continue to experience return rates consistent with historical patterns. Historically, our product returns have not been significant. However, if a significant issue should arise, it could have a material impact on our financial 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

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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 consequence, 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 firmware, which is part of the hardware purchase. We consider the sale of this firmware to be incidental to the sale of the printer and do not attribute any revenue to it.

•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.

Investments and Marketable Securities

Investments and marketable securities at July 2, 2005 consisted of U.S. government securities (15.3%), state and municipal bonds (71.7%), corporate bonds (5.7%) and partnership interests (7.3%). We classify our marketable equity and debt 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 classified 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. As of July 2, 2005, all of Zebra’s investments and marketable securities are classified as available-for-sale.

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

•An active collection effort by regional credit functions, reporting directly to the corporate financial officers.

We reserve for estimated credit losses based upon historical experience and specific customer collection issues. Over the last three years, accounts receivable reserves varied from 1.5% to 2.8% of total accounts receivable. Accounts receivable reserves as of July 2, 2005, were $1,600,000, or 1.5% of the balance due. We feel this reserve level is appropriate considering the quality of the portfolio as of July 2, 2005. 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.

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Inventories

We value our inventories at the lower of the actual cost to purchase or manufacture using the first-in, first-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.

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 July 2, 2005, reserves for excess and obsolete inventories were $9,421,000, or 12.8% of gross inventory. We feel this reserve level is appropriate considering the quantities and quality of the inventories as of July 2, 2005.

Valuation of Long-Lived and Intangible Assets and Goodwill.

We test the impairment of identifiable intangibles and 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 2005. At that time, no adjustment to goodwill was necessary due to impairment.

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:

•Significant underperformance relative to expected historical or projected future operating results,

•Significant changes in the manner of use of the acquired assets or the strategy for the overall business,

•Significant negative industry or economic trends,

•Significant decline in Zebra’s stock price for a sustained period, and

•Significant decline in market capitalization relative to net book value.

If we believe that one or more of the above indicators of impairment have occurred, we measure impairment based on projected discounted cash flows using a discount rate that incorporates the risk inherent in the cash flows. Net intangible assets, long-lived assets and goodwill amounted to $131,468,000 as of July 2, 2005.

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 confirm or revise estimates and reserves as appropriate.

On April 24, 2003, Paxar Americas, Inc. (Paxar Americas) filed a patent infringement lawsuit in the United States District Court for the Southern District of Ohio against Zebra and certain of its subsidiaries. Paxar Americas’ Complaint alleges that certain of Zebra’s products infringe on one or more of eight identified Paxar Americas patents, although not every product is accused of infringing each patent. Zebra filed an Answer to Paxar Americas’ Complaint, denying Paxar Americas’ allegations of infringement and asserting several affirmative defenses, including the invalidity of Paxar Americas’ asserted patent claims. Paxar Americas moved to amend its Complaint to add two patents and a trademark-based claim and the Court granted the motion. Paxar Americas filed its Amended Complaint on March 31, 2005, dropping one of the eight originally asserted patents and adding two newly asserted patents. Paxar Americas also filed a motion to withdraw another of the originally asserted patents from the Amended Complaint. Zebra filed its Answer denying all infringement and asserting affirmative defenses including the invalidity of Paxar Americas’ asserted patent claims. On July 15, 2004, the Court heard argument from the parties regarding the proper construction of the claims of the patents-in-suit and the parties submitted post-argument briefs. On April 20, 2005, at the Court’s request, the parties identified disputed claim terms regarding the newly asserted patents and provided their respective positions regarding those terms to the Court. Fact discovery closed on June 10, 2005; expert discovery in this case is ongoing. The case currently is scheduled for trial in October 2005.

On November 21, 2003, Zebra’s wholly-owned subsidiary, ZIH Corp. (ZIH), filed 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 filed a motion to transfer ZIH’s Massachusetts suit to the United States District Court for the Southern District of Ohio. ZIH opposed Paxar Corporation’s motion to transfer, and the Court denied the motion. On November 25, 2003, Paxar Americas filed a Complaint against ZIH in the United States District Court for the Southern District of Ohio, seeking a declaratory judgment that the patents asserted by ZIH in its Massachusetts

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Complaint are not infringed and are invalid and unenforceable. On December 17, 2003, Paxar Americas amended its complaint to add Zebra Technologies Corporation as a defendant. The Court granted the parties’ motion to stay this action pending the District Court of Massachusetts’ ruling on Paxar Corporation’s motion to transfer. In view of the Massachusetts District Court’s denial of Paxar Corporation’s motion to transfer ZIH’s Massachusetts suit to Ohio, the parties to Paxar Corporation’s Ohio declaratory judgment suit jointly filed a motion to transfer this action to the District Court of Massachusetts and the District Court of Ohio approved that motion. On June13, 2005, Paxar filed an amended answer to the Massachusetts complaint with counterclaims seeking a declaratory judgment that ZIH’s patents-in-suit are not infringed and are invalid and/or unenforceable. On July 7, 2005, the parties stipulated to dismissal of the Massachusetts complaint with prejudice and dismissal of Paxar’s counterclaims and its Ohio declaratory judgment action without prejudice. On July 11, 2005, the Massachusetts district court granted the stipulated order and dismissed the case.

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. 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 financial statements as of July 2, 2005.

New Accounting Pronouncement

In April 2005, the FASB changed the implementation date for SFAS No. 123(R), Share-Based Payment, which 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. Originally, public companies subject to SEC oversight were required to implement SFAS No. 123(R) as of the beginning of the first interim or annual reporting period beginning after June 15, 2005. As a result of the action by the SEC, the provisions of this statement will now be effective for Zebra during the first quarter of 2006. We expect the impact on Zebra’s consolidated financial statements to be consistent with the fair value disclosures included in our critical accounting policies and Note 2 to the consolidated financial statements.

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections — a Replacement of APB Opinion No. 20 and FASB Statement No. 3, which changes the requirements for the accounting and reporting of a change in accounting principle. The Statement applies to all voluntary changes in accounting principle and to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. This Statement requires retrospective application to prior periods’ financial statements of change in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. Zebra is required to adopt this statement during the first quarter of 2006. We do not expect the adoption of this statement to have a material impact on our financial condition or results of operations.

Significant Customer

ScanSource, Inc. is our most significant customer and our sales to them accounted for the following percentages of total net sales:

	July 2, 2005		July 3, 2004
For the three months ended	15.2	%	14.0	%
For the six months ended	15.5	%	13.6	%

No other customer accounted for 10% or more of total net sales during these time periods.

Significant Suppliers

Zebra sources some of our component parts from sole suppliers. A disruption in the supply of such component parts could have a material adverse effect on our operations and financial results.

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Expectations

As stated on our quarterly conference call on July 27, 2005, we estimate net sales, gross profit margins, operating expenses, and earnings for the third quarter of 2005 as follows (in thousands, except per share amounts and percentages):

	Third Quarter 2005
Net sales	$170,000 to $180,000
Gross profit margins	50.0% to 50.5%
Operating expenses	$49,000 to $51,000
Diluted earnings per share	$0.35 to $0.39

The effective tax rate is expected to be 34.75% of income before income taxes for the third quarter of 2005.

Safe Harbor

Forward-looking statements contained in this filing, including without limitation the information contained in “Expectations” directly above, 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 reflected 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 Zebra’s financial results. Profits will be affected by Zebra’s ability to control manufacturing and operating costs. Because of Zebra’s large investment portfolio, interest rate and financial market conditions will also have an impact on results. Foreign exchange rates will have an effect on financial results, because of the large percentage of Zebra’s international sales. When used in this document and documents referenced herein, 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. Readers of this document are referred to prior filings with the Securities and Exchange Commission, including the Risk Factors portion of Management’s Discussion and Analysis of Financial Condition and Results of Operation in Zebra’s Form 10-K for the year ended December 31, 2004, for a further discussion of issues that could affect Zebra’s future results. 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 report.

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Item 3.Quantitative and Qualitative Disclosures About Market Risk

There were no material changes, except as discussed below, in Zebra’s market risk during the quarter ended July 2, 2005. For additional information on market risk, refer to the “Quantitative and Qualitative Disclosures About Market Risk” section of our Form 10-K for the year ended December 31, 2004.

In the normal course of business, portions of Zebra’s operations are subject to fluctuations in currency values. We manage these risks using derivative financial instruments.

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Item 4.    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 defined 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-Q. The controls evaluation was conducted under the supervision of our Disclosure Committee, and with the participation of management, including our Chief Executive Officer and Chief Financial Officer. Based on that evaluation, our Chief Executive Office and Chief Financial Officer, 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 report on Form 10-Q was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) information required to be disclosed by us in our reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in our internal controls over financial reporting during the quarter ended July 2, 1005 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

Inherent Limitations on the Effectiveness of Controls

Our management, including our Chief Executive Office and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent 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 reflect the fact that there are resource constraints, and the benefits 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 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.

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PART II - OTHER INFORMATION

Item 1.    Legal Proceedings

In connection with the litigation between Paxar Americas, Inc. and Zebra and certain of its subsidiaries, Paxar Americas filed its Amended Complaint on March 31, 2005, dropping one of the eight originally asserted patents and adding two newly asserted patents. Paxar Americas also filed a motion to withdraw another of the originally asserted patents from the Amended Complaint. Zebra filed its Answer denying all infringement and asserting affirmative defenses including the invalidity of Paxar Americas’ asserted patent claims. On July 15, 2004, the Court heard argument from the parties regarding the proper construction of the claims of the patents-in-suit and the parties submitted post-argument briefs. On April 20, 2005, at the Court’s request, the parties identified disputed claim terms regarding the newly asserted patents and provided their respective positions regarding those terms to the Court. Fact discovery closed on June 10, 2005; expert discovery in this case is ongoing. The case currently is scheduled for trial in October 2005. See “Note 12 — Contingencies” in the Notes to our Consolidated Financial Statements included in this Report on Form 10-Q for further information regarding this lawsuit and related proceedings.

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. 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 financial statements as of July 2, 2005.

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Item 4.    Submissions of Matters to a Vote of Security Holders

(a)The Company held its Annual Meeting of Stockholders on May 17, 2005.

(b)The Company’s stockholders voted on the following proposals:

1.To elect two directors to the Company’s Board of Directors to hold office for a three-year term.

Directors	For	Authority Withheld
Edward L. Kaplan	66,116,580	1,168,783
Christopher G. Knowles	64,342,638	2,942,725

2.To ratify the selection by the Audit Committee of the Board of Directors of Ernst & Young LLP as the independent auditors of the Company’s financial statements for the year ending December 31, 2005.

For	Against	Abstain
66,729,296	499,134	56,933

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Item 6.    Exhibits and Reports on Form 8-K

31.1	Rule 13a-14(a)/15d-14(a) Certification
31.2	Rule 13a-14(a)/15d-14(a) Certification
32.1	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

Pursuant to the requirements 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.

		ZEBRA TECHNOLOGIES CORPORATION
Date:	August 2, 2005		By:	/s/Edward L. Kaplan
				Edward L. Kaplan
				Chief Executive Officer
Date:	August 2, 2005		By:	/s/Charles R. Whitchurch
				Charles R. Whitchurch
				Chief Financial Officer

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