-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JOAFyjD+oNXnzwu6dSKMv7FG1MD6cNHS3gL5JdDb+Ser7wI6+cPZDdty/GI+sK4o hoXK7FkfikbZBG3ZlvjrsA== 0000093469-97-000004.txt : 19970401 0000093469-97-000004.hdr.sgml : 19970401 ACCESSION NUMBER: 0000093469-97-000004 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: PITTWAY CORP /DE/ CENTRAL INDEX KEY: 0000093469 STANDARD INDUSTRIAL CLASSIFICATION: COMMUNICATIONS EQUIPMENT, NEC [3669] IRS NUMBER: 135616408 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-04821 FILM NUMBER: 97570566 BUSINESS ADDRESS: STREET 1: 200 S WACKER DR STE 700 CITY: CHICAGO STATE: IL ZIP: 60606-5802 BUSINESS PHONE: 3128311070 MAIL ADDRESS: STREET 1: 200 S WACKER DR STE 700 CITY: CHICAGO STATE: IL ZIP: 60606-5802 FORMER COMPANY: FORMER CONFORMED NAME: STANDARD SHARES INC DATE OF NAME CHANGE: 19900321 FORMER COMPANY: FORMER CONFORMED NAME: STANDARD POWER & LIGHT CORP DATE OF NAME CHANGE: 19660905 10-K 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549-1004 FORM 10-K [x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For The Year Ended December 31, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 1-4821 PITTWAY CORPORATION (Exact Name of Registrant as specified in its Charter) Delaware 13-5616408 (State of Incorporation) (I.R.S. Employer Identification No.) 200 South Wacker Drive, Suite 700, Chicago, Illinois 60606-5802 (Address of Principal Executive Offices) (ZIP Code) 312/831-1070 (Registrant's Telephone Number, Including Area Code) SECURITIES REGISTERED PURSUANT TO SECTION 12 (b) OF THE ACT: Name of Each Exchange Title of Each Class on Which Registered Common Stock, $1.00 par value New York Stock Exchange Class A Stock, $1.00 par value New York Stock Exchange SECURITIES REGISTERED PURSUANT TO SECTION 12 (g) OF THE ACT: NONE 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 and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] State the aggregate market value of the voting stock held by non-affiliates of the Registrant (based on closing sales prices on March 17, 1997): $823,544,000. Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest practicable date (March 17, 1997): Common Stock - 3,938,832 shares outstanding; Class A Stock - 17,042,444 shares outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's 1996 Annual Report to Stockholders are incorporated by reference into Parts I and II of this report. Portions of the Registrant's Proxy Statement for the annual meeting of stockholders to be held on May 8, 1997 are incorporated by reference into Part III of this report. PITTWAY CORPORATION INDEX TO ANNUAL REPORT ON FORM 10-K For The Year Ended December 31, 1996 PART I Page Item 1 Business 3- 9 Item 2 Properties 9-11 Item 3 Legal Proceedings 11-12 Item 4 Submission of Matters to a Vote of Security Holders 12 PART II Item 5 Market For Registrant's Common Equity and Related Stockholder Matters 12 Item 6 Selected Financial Data 12 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 8 Financial Statements and Supplementary Data 13 Item 9 Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 13 PART III Item 10 Directors and Executive Officers of the Registrant 13 Item 11 Executive Compensation 13 Item 12 Security Ownership of Certain Beneficial Owners and Management 13 Item 13 Certain Relationships and Related Transactions 13 PART IV Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K 14 SIGNATURES 15 2 PART I Item 1. Business (a) General Development of Business Pittway Corporation ("Pittway" or "Registrant"), formerly Standard Shares, Inc. ("Standard"), was incorporated under Delaware law in 1925. Pittway and its subsidiaries are referred to herein collectively as the "Company". The Company operates in two reportable industry segments: alarm and other security products, and publishing. Acquisitions and dispositions of businesses by the Company, other than the discontinued operations discussed below, in each of the five years ended December 31, 1996 were not significant to the Company's sales or results of operations. In February 1996, the Company sold 13% of its investment in USSB as part of an initial public offering of USSB common stock. The sale resulted in an after- tax gain of $8.1 million or $.39 per share. Also in February, Cylink Corp- oration made an initial public offering of its common stock. The Company increased its carrying value of this investment to reflect the increase in the Company's equity in Cylink's net book value. An after-tax gain of $14.4 million, or $.69 per share was recorded on the increase in Cylink's equity. See "Real Estate and Other Ventures" in Item 1(c), below. During the first half of 1994, the Company sold its 16.67% ownership in First Alert, Inc., a manufacturer of residential fire protection products, as part of an initial public offering of that company's common stock. The sale resulted in an after-tax gain of $11.8 million or $.57 per share. In April 1993, the Company distributed its investment in AptarGroup, Inc. (formerly known as the Seaquist Division packaging group) to stockholders in a tax-free spin-off. AptarGroup, Inc. is a manufacturer of aerosol valves, dispensing pumps and closures which are sold to packagers and marketers in the personal care, fragrance/cosmetics, pharmaceutical, household products and food industries. In October 1992, the Company sold its Barr Company, a contract packager for marketers of aerosol and liquid fill (non-aerosol) personal and household products, to a Canadian packaging company. In July 1992, the Company sold its First Alert/BRK Electronics business to a new company formed by BRK management and an investment firm. These sales resulted in combined after-tax gains of $16.6 million or $.80 per share. (b) Financial Information about Industry Segments Financial information relating to industry segments for each of the three years ended December 31, 1996 is set forth in Note 12 ("Segment Information") to the Consolidated Financial Statements contained in the 1996 Annual Report to Stockholders, pages 43-44, which Note is incorporated herein by reference. (c) Narrative Description of Business The principal operations, products and services rendered by the Company: 3 Alarm and Other Security Products Segment This segment involves the design, manufacture and sale of an extensive line of burglar and commercial fire alarm equipment, closed circuit television, access control and other alarm components and systems as well as the distribution of alarm and other security products manufactured by other companies. By offering a broad line of alarm products needed for security systems, the Company provides a full range of services to independent alarm dealers and installers which range in size from one person operations to the largest national alarm service companies. In every major domestic market area, quick delivery is provided through the Company's computerized regional warehouses and convenience center outlets, authorized distributors and dealers. Various products sold through the alarm system distribution group are purchased from non-affiliated suppliers and manufacturers to offer a broad range of products. Some of the products purchased are resold under the Company's Ademco brand name, others are resold under brand names owned by its suppliers. In the Canadian and overseas markets, alarm and other security products are sold through the Company's distribution centers, authorized distributors and sales agents. The Company also offers AlarmNet to alarm companies in major U.S. markets. AlarmNet is a wireless cellular-like communication network designed to transmit security alarm signals by radio instead of over telephone lines. The Company also offers First Alert Professional, a brand name marketing program to independent burglar alarm dealers. Commercial fire detectors and fire controls are sold through the Company's regional warehouses, electrical and building supply wholesalers and alarm and fire safety distributors. Raw materials essential to the Company's businesses are purchased worldwide in the ordinary course of business from numerous suppliers. The vast majority of these materials are generally available from more than one supplier and no serious shortages or delays have been encountered. Certain raw materials used in producing some of the Company's products can be obtained only from one or two suppliers, the shortage of which could adversely impact production of alarm equipment and commercial fire detectors by the Company. The Company believes that the loss of any other single source of supply would not have a material adverse effect on its overall business. Through its NESCO subsidiary the Company offers a wide variety of services to independent distributors of its fire alarm systems products, including assistance with system design, bonding, technical help, training, marketing and administrative support. Sales and marketing methods common to this industry segment include communications through the circulation of catalogs and merchandising bulletins, direct mail campaigns, and national and local advertising in trade publications. The Company's principal advantages in marketing are its reputation, broad product line, high quality products, extensive integrated distribution network, efficient customer service, competitive prices and brand names. Within the industry there is competition from large and small manufacturers in both the domestic and foreign markets. While competitors will continue to introduce new products similar to those sold by the Company, the Company believes that its research and development efforts and the breadth and quality of its distribution network will permit it to remain competitive. 4 Publishing Segment This segment is a publisher of 33 national business and trade publications. The Company's publications serve both specific industries and broad functional markets which include specialized manufacturing, service industries, technical and professional fields and general management. Most publications are distributed on a monthly basis with several others distributed on a biweekly, annual or biennial frequency. The publications are generally distributed free through controlled circulation. The principal source of revenue is from the sale of advertising space within the magazines. A variety of magazine-related products and services are also offered including: directories, readership lists, specialty publications, custom publishing, trade shows and conferences; research and telemarketing operations; CD-ROMs, on-line computer services, and direct-response card mailer service. Other facets of the business include: the operation of a printing plant for the printing and production of most of the Company's publications and those of other publishers; a national direct mail-marketing organization serving the pharmaceutical, health care and business services markets; and a printer which provides mailing service capabilities to the Company's direct mail-marketing organization and to outside customers. Within the publishing and marketing communications fields, competition exists in the form of other publications and media communication businesses. Reductions in advertising schedules by domestic industrial companies due to economic and other competitive pressures directly impacts the display advertising levels of the Company's publishing segment. The Company competes with one or more other magazines for advertising revenue in each of its magazine titles. The Company's principal sales advantages include relevant editorial content and innovative marketing complemented by specialized multi-magazine supplements. The Company believes that its competitive position also benefits from improvements in productivity and from cost control programs. The Company places great emphasis on providing quality products and services to its customers. Real Estate and Other Ventures The Company is involved in the marketing, sale and development of land near Tampa, Florida for residential and commercial use. Saddlebrook Village, a 2,000 acre parcel of land nearby, is approved for development as a master planned community. Saddlebrook Corporate Center, a nearby 450 acre parcel, originally planned as a business park for mixed use development, was partially converted to a residential community due to the demand for residential housing. Principal competition comes from other residential and commercial developments in Florida. The Company owns 8,606,085 shares (33.6% of the shares outstanding) of Cylink Corporation (Cylink) a leading supplier of network information security products that enable the secure transmission of data over private local area networks and wide area networks and public packet switched networks, such as the Internet. Cylink further offers a line of spread spectrum radio products that are used for wireless voice and data communications. The Company also owns 3,781,375 shares (4.2% of the shares outstanding) of United States Satellite Broadcasting Company Inc. (USSB), a company which provides subscription television programming via high-power direct broadcast satellite to households throughout the Continental U.S. Both of these companies made 5 initial public offerings of their respective stocks in February of 1996. Additionally, the Company has approximately an 8.5% interest in a joint venture that develops wireless signaling equipment for communication between fixed points. The Company has a limited partnership interest in a real estate developer with major commercial and residential high rise properties located primarily in Chicago. See Item 7 of this Form 10-K. The Company also has invested, as a 5% limited partner, in five rental apartment complexes located in Chicago, Indianapolis, San Jose and two near Washington, D.C. which provide certain tax advantages. The Company is an equity participant in leveraged leases of an aircraft and communications satellite transponders. Other Information Patents and Trademarks - While the Company owns or is licensed under a number of patents which are cumulatively important to each of its business units, the loss of any single patent or group of patents would not have a material adverse effect on the Company's overall business. Products manufactured by the Company are sold primarily under its own trademarks and tradenames. Some products purchased and resold by the Company's alarm and security products business are sold under the Company's tradenames while others are sold under tradenames owned by its suppliers. Customers - Neither of the Company's industry segments is dependent upon a single customer or a few customers. The loss of any one or more of these customers would not have a material adverse effect on the Company's results of operations. Research and Development - The Company is engaged in programs to develop and improve products as well as develop new and improved manufacturing methods. Expenditures for Company sponsored research and development activities in the alarm and other security products segment were $18.1 million in 1996, $16.6 million in 1995 and $11.8 million in 1994. These costs, which are expensed in the Company's consolidated income statement, were associated with a number of products in varying stages of development, none of which represents a significant item of cost or is projected to be a significant addition to the Company's line of products. Product Liability - Due to the nature of the fire and security alarm business, the Company has been, and continues to be, subjected to numerous claims and lawsuits alleging defects in its products. This exposure has been lessened by the sale of First Alert/BRK Electronics. It is likely, due to the present litigious atmosphere in the United States, that additional claims and lawsuits will be filed in future years. The Company believes that it maintains sufficient insurance to cover this exposure. 6 Environmental Matters - The Company anticipates that compliance with various laws and regulations relating to protection of the environment will not have a material effect on its capital expenditures, earnings or competitive position. Employees - At December 31, 1996, there were approximately 6,800 persons employed by the Company, including 5,200 employed in the United States. Approximately 1,200 of the employees working in the United States were represented by labor unions. The Company considers its relations with its employees and the unions representing its employees to be good. Risks and Uncertainties - In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company wishes to caution readers that the following important factors, among others, in some cases have affected, and in the future could affect, the Company's actual results and could cause its actual results in 1997 and beyond to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. Risks associated with acquisition strategy - The Company's strategy includes the acquisition of businesses that complement or augment the Company's existing products and services. Promising acquisitions are difficult to identify and complete for a number of reasons, including competition among prospective buyers and the need for regulatory approvals, including antitrust approvals. Any acquisitions completed by the Company may be made at substantial premiums over the fair value of the net assets of the acquired companies. There can be no assurance that the Company will be able to complete future acquisitions or that the Company will be able to successfully integrate any acquired businesses. In order to finance such acquisitions, it may be necessary for the Company to raise additional funds through public or private financings. Any equity or debt financing, if available at all, may be on terms which are not favorable to the Company and, in the case of equity financing, may result in dilution to the Company's stockholders. Competition - The Company encounters and expects to continue to encounter significant competition in the sale of its products and services. The Company's competitors include a number of large multinational corporations, some of which may be able to adapt more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the promotion and sale of their products than the Company. Competition could increase if new companies enter the market or if existing competitors expand their product lines or intensify efforts within existing product lines. There can be no assurance that the Company's current products, products under development, or ability to develop new technologies will be sufficient to enable it to compete effectively. Risks associated with international operations - International sales account for 14% of the Company's 1996 consolidated revenues and the Company intends to continue to expand its presence in international markets. International revenues are subject to a number of risks, including the following: agreements may be difficult to enforce and receivables difficult to collect through a foreign country's legal system; foreign customers may have longer payment 7 cycles; foreign countries may impose additional withholding taxes or otherwise tax the Company's foreign income, impose tariffs, or adopt other restrictions on foreign trade; fluctuations in exchange rates may affect product demand and adversely affect the profitability in U.S. dollars of products and services provided by the Company in foreign markets where payment for the Company's products and services is made in the local currency; U.S. export licenses may be difficult to obtain; and the protection of intellectual property in foreign countries may be more difficult to enforce. There can be no assurance that any of these factors will not have a material adverse impact on the Company's business and results of operations. Rapid and significant technological change and new products - The markets for the Company's products are characterized by rapid and significant technological change, evolving industry standards and frequent new product introductions and enhancements. Many of the Company's products and products under development are technologically innovative, and require significant planning, design, development and testing, at the technological, product and manufacturing process levels. These activities can require significant commitments of capital, personnel and other resources by the Company. In addition, products that are competitive in the Company's markets are frequently characterized by rapid and significant technological change due to industry standards that may change and by the introduction of new products and technologies that render existing products and technologies uncompetitive or obsolete. There can be no assurance that any of the products currently being developed by the Company, or those to be developed in the future, will be technologically feasible or accepted by the marketplace, that any such development will be completed in any particular time frame, or that the Company's products or proprietary technologies will not become uncompetitive or obsolete. Possible adverse effect from changes in governmental regulations - The Company competes in several markets which involve compliance by its customers with Federal, state, local and foreign regulations. The Company develops, configures and markets its products to meet customer needs created by such regulations. These regulations may be amended in response to new scientific evidence or political or economic considerations. Any significant change in regulations could adversely affect demand for the Company's products in regulated markets. Risks associated with dependence on capital spending policies - The level of capital spending by users of the Company's products can have a significant effect on the Company's revenues. Such spending is based on a wide variety of factors, including the resources available to make purchases, the spending priorities among various types of equipment, public policy, and the effects of different economic cycles. Any decrease in such spending could have a material adverse effect on the Company's business and results of operations. Dependence on patents and proprietary rights - The Company seeks to obtain patents and protect trade secrets for significant new technologies, products and processes because of the length of time and expense associated with bringing new products through the development process and to the marketplace. The Company's success depends in part on its ability to develop patentable products and obtain and enforce patent protection for its products both in the U.S. and in other countries. The Company owns numerous U.S. and foreign patents, and intends to file additional applications for patents as appropriate to cover its products. No assurance can be given that patents 8 will issue from any pending or future patent applications owned by or licensed to the Company or that the claims allowed under any issued patents will be sufficiently broad to protect the Company's technology. In addition, no assurance can be given that any issued patents owned by or licensed to the Company will not be challenged, invalidated or circumvented, or that the rights granted thereunder will provide competitive advantages to the Company. The Company could incur substantial costs in defending itself in suits brought against it or in suits in which the Company may assert its patent rights against others. If the outcome of any such litigation is unfavorable to the Company, the Company's business and results of operations could be materially adversely affected. The Company relies on trade secrets and proprietary know-how which it seeks to protect, in part, by confidentiality agreements with its collaborators, employees and consultants. There can be no assurance that these agreements will not be breached, that the Company would have adequate remedies for any breach or that the Company's trade secrets will not otherwise become known or be independently developed by competitors. (d) Financial Information About Foreign and Domestic Operations and Export Sales Financial information concerning foreign and domestic operations and export sales is set forth in Note 12 ("Segment Information") to the Consolidated Financial Statements contained in the 1996 Annual Report to Stockholders, pages 43-44, which Note is incorporated herein by reference. Item 2. Properties The Company's principal properties and their general characteristics are as follows: Principal Lease Approximate Location Use Expiration Square Feet Alarm and Other Security Products Segment- Syosset, New York (1) N/A 340,000 Syosset, New York (3) 1997 14,000 Syosset, New York (1) 1997 6,000 Syosset, New York (1) 2000 33,000 Syosset, New York (1) 2014 10,000 Torrance, California (1) 1998 48,000 Miami, Florida (2) 2000 14,000 El Paso, Texas (2) 2001 19,000 El Paso, Texas (2) 2002 74,000 Louisville, Kentucky (3) 1997 4,000 Louisville, Kentucky (3) 1998 4,000 Raleigh, North Carolina (1) 1998 8,000 Northford, Connecticut (1) N/A 240,000 St. Charles, Illinois (1) 2003 158,000 St. Charles, Illinois (1) 2004 50,000 West Chicago, Illinois (1) 1998 21,000 Norcross, Georgia (3) 1998 6,000 Melbourne, Australia (2) 1998 5,000 Sydney, Australia (2) 1998 25,000 Alleur, Belgium (2) 1997 5,000 Toronto, Canada (2) 1998 7,000 9 Principal Lease Approximate Location Use Expiration Square Feet Alarm and Other Security Products Segment- (continued) Concord, Ontario, Canada (2) 1997 7,000 Brighton, England (1) 1997 24,000 Lichfield Staffs, England (4) 2014 20,000 Burgess Hill, England (4) N/A 60,000 East Kilbride, Scotland (1) N/A 15,000 Hilden, Germany (2) 1999 8,000 Purmerend, The Netherlands (2) N/A 25,000 Tsuen Wan, NT, Hong Kong (2) 1999 5,000 Milan, Italy (1) N/A 14,000 Milan, Italy (2) 2001 8,000 Trieste, Italy (1) N/A 40,000 Juarez, Mexico (4) 1997 71,000 Juarez, Mexico (4) 2004 83,000 Juarez, Mexico (4) 2007 148,000 Madrid, Spain (2) 2000 8,000 Barcelona, Spain (2) 2005 6,000 Distribution Centers Hub Locations: Atlanta, Georgia (2) 2005 29,000 Boston, Massachusetts (2) 1999 14,000 Los Angeles, California (2) 1999 30,000 Chicago, Illinois (2) 2005 40,000 Clearwater, Florida (2) 2004 27,000 Memphis, Tennessee (2) 2006 15,000 Richmond, Virginia (2) 2004 14,000 Louisville, Kentucky (2) 2007 190,000 Phoenix, Arizona (2) 2004 15,000 Dallas, Texas (2) 1997 21,000 Denver, Colorado (2) 1999 11,000 Detroit, Michigan (2) 2000 15,000 Pine Brook, New Jersey (2) 1998 37,000 Seattle, Washington (2) 2006 25,000 Toronto, Canada (2) 2007 26,000 Montreal, Canada (2) 2000 9,000 Publishing Segment- Cleveland, Ohio (3) 2000 179,000 Cleveland, Ohio (2) 2001 28,000 Berea, Ohio (5) N/A 100,000 New York, New York (3) 2000 10,000 Dunedin, Florida (3) 2000 13,000 Safety Harbor, Florida (1) 1997 19,000 Tampa, Florida (2) 1999 19,000 Tampa, Florida (5) 2000 15,000 Hasbrouck Heights, New Jersey (3) 2006 22,000 General Corporate- Chicago, Illinois (3) 2001 12,000 Other properties in the alarm and other security products segment include 85 full-line convenience centers in addition to those hub locations listed above which function as retail-like sales distribution outlets to serve the North 10 American market. These 85 centers are under leases expiring through 2006 and range in size from 1,200 to 12,300 square feet. Other properties in the publishing segment include 14 sales and/or editorial offices under leases expiring through 2007 located in major cities throughout the United States. The Company believes the above facilities are adequate for its present needs. (1) Offices, Manufacturing and Warehousing (2) Warehousing (3) General Offices (4) Manufacturing (5) Printing N/A Not applicable - facilities are owned by the Company Item 3. Legal Proceedings On May 10, 1989, the Circuit Court of the Sixth Judicial Circuit in and for Pasco County, Florida, entered a judgment against Saddlebrook Resorts, Inc. ("Saddlebrook"), a former subsidiary of the Company, in a lawsuit which arose out of the development of Saddlebrook's resort and a portion of the adjoining residential properties owned and developed by the Company. The lawsuit (James H. Porter and Martha Porter, Trustees, et al. vs. Saddlebrook Resorts, Inc. and The County of Pasco, Florida; Case No. CA83-1860), alleges damage to plaintiffs' adjoining property caused by surface water effects from improvements to the properties. Damages of approximately $8 million were awarded to the plaintiffs and an injunction was entered requiring, among other things, that Saddlebrook work with local regulatory authorities to take corrective actions. Saddlebrook made two motions for a new trial, based on separate grounds. One such motion was granted on December 18, 1990. Such grant was appealed by the plaintiffs. The other such motion was denied on February 28, 1991. Saddlebrook appealed such denial. The appeals were consolidated, fully briefed and heard in February 1992. Saddlebrook received a favorable ruling on March 18, 1992, dismissing the judgment and remanding the case to the Circuit Court for a new trial. An agreed order has been entered by the Court preserving the substance of the injunction pending final disposition of this matter. As part of its plan to comply with the agreed order, Saddlebrook filed applications with the regulatory agency to undertake various remediation efforts. Plaintiffs, however, filed petitions for administrative review of the applications, which administrative hearing was concluded in February 1992. On March 31, 1992, the hearing officer issued a recommended order accepting Saddlebrook's expert's testimony. The agency's governing board was scheduled to consider this recommended order on April 28, 1992, however, shortly before the hearing, the plaintiffs voluntarily dismissed their petitions and withdrew their challenges to the staff's proposal to issue a permit. At the April 28, 1992 hearing the governing board closed its file on the matter and issued the permits. Saddlebrook appealed the board's refusal to issue a final order. On July 9, 1993 a decision was rendered for Saddlebrook remanding jurisdiction to the governing board for further proceedings, including entry of a final order which was issued on October 25, 1993. The plaintiffs appealed the Appellate Court decision to the Florida Supreme Court and appealed the issuance of the final order to the Second District Court of Appeals. The Florida Supreme Court heard the appeal on May 3, 1994 and denied plaintiffs' appeal. The other appeal was voluntarily dismissed by the plaintiffs on June 17, 1994. On remand to the trial court, Saddlebrook's motion for summary judgment, based on collateral estoppel on the ground that 11 plaintiffs' claims were fully retried and rejected in a related administrative proceeding was granted on December 7, 1994. Plaintiffs filed for a rehearing which was denied. Plaintiffs have appealed the trial court's decision granting summary judgment. In August 1996, the appellate court affirmed all but three issues in the trial court's summary judgment order in favor of Saddlebrook. A hearing is set for April 4, 1997 to determine the scope of the three issues remaining for retrial. Until October 14, 1989, Saddlebrook disputed responsibility for ultimate liability and costs (including costs of corrective action). On that date, the Company and Saddlebrook entered into an agreement with regard to such matters. The agreement, as amended and restated on July 16, 1993, provides for the Company and Saddlebrook to split equally the costs of the defense of the litigation and the costs of certain related litigation and proceedings, the costs of the ultimate judgment, if any, and the costs of any mandated remedial work. Subject to certain conditions, the agreement permits Saddlebrook to obtain subordinated loans from the Company to enable Saddlebrook to pay its one-half of the costs of the latter two items. No loans have been made to date. The Company believes that the ultimate outcome of the aforementioned lawsuit will not have a material adverse effect on its financial statements. The Company in the normal course of business is subject to a number of lawsuits and claims both actual and potential in nature including a lawsuit claiming patent infringement that is scheduled for trial in 1997. While management believes that resolution of the patent infringement suit and other existing claims and lawsuits will not have a material adverse effect on the Company's financial statements, management is unable to estimate the magnitude of financial impact of claims and lawsuits which may be filed in the future. Item 4. Submission of Matters to a Vote of Security Holders None. PART II Item 5. Market For Registrant's Common Equity and Related Stock- holder Matters The information set forth under the heading "Market Prices, Security Holders and Dividend Information" appearing on page 47 of the Company's 1996 Annual Report to Stockholders is incorporated herein by reference. Item 6. Selected Financial Data The information set forth under the heading "Supplemental Information -Five Year Summary of Selected Financial Data" appearing on page 46 of the Company's 1996 Annual Report to Stockholders is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information set forth under the heading "Management's Discussion and Analysis" appearing on pages 48-49 of the Company's 1996 Annual Report to Stockholders is incorporated herein by reference. 12 Item 8. Financial Statements and Supplementary Data The Company's Consolidated Financial Statements and Summary of Accounting Policies and Notes thereto, together with the report thereon of Price Waterhouse LLP dated February 19, 1997, appearing on pages 31-45 of the Company's 1996 Annual Report to Stockholders are incorporated herein by reference. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure None. PART III Information required to be furnished in this part of the Form 10-K has been omitted because the Registrant will file with the Securities and Exchange Commission a definitive proxy statement pursuant to Regulation 14A under the Securities Exchange Act of 1934 not later than April 30, 1997. Item 10. Directors and Executive Officers of the Registrant The information set forth under the headings "Nominees for Election by the Holders of Class A Stock", "Nominees for Election by the Holders of Common Stock", "Executive Officers" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Registrant's Proxy Statement for the annual meeting of stockholders to be held on May 8, 1997 is incorporated herein by reference. Item 11. Executive Compensation The information set forth under the headings "Compensation Committee Interlocks and Insider Participation", "Compensation", "Compensation Committee Report on Executive Compensation" and "Performance Graph" in the Registrant's Proxy Statement for the annual meeting of stockholders to be held on May 8, 1997 is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management The information set forth under the heading "Security Ownership of Certain Beneficial Owners and Management" in the Registrant's Proxy Statement for the annual meeting of stockholders to be held on May 8, 1997 is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions The information set forth under the headings "Certain Transactions" (and the information set forth under the heading "Compensation Committee Interlocks and Insider Participation" which is cross-referenced under the heading "Certain Transactions") in the Registrant's Proxy Statement for the annual meeting of stockholders to be held on May 8, 1997 is incorporated herein by reference. 13 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) Financial statements and financial statement schedule filed as a part of this report are listed in the Index to Consolidated Financial Statements and Financial Statement Schedules on page 13 of this Form 10-K and are incorporated herein by reference. Exhibits required by Item 601 of Regulation S-K are listed in the Index to Exhibits on pages 19-20 of this Form 10-K, which is incorporated herein by reference. Each management contract or compensatory plan or arrangement required to be filed as an Exhibit to this report pursuant to Item 14 (c) of Form 10-K is so identified on the Index to Exhibits. (b) No reports on Form 8-K have been filed during the fourth quarter of the year for which this report is filed. 14 SIGNATURES 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. PITTWAY CORPORATION (Registrant) BY /s/ Paul R. Gauvreau Paul R. Gauvreau Financial Vice President and Treasurer Date: March 31, 1997 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 31, 1997. /s/ King Harris /s/ Leo A. Guthart King Harris, Director, President Leo A. Guthart, Director and Chief Executive Officer /s/ Paul R. Gauvreau /s/ Irving B. Harris Paul R. Gauvreau, Principal Irving B. Harris, Director Financial and Accounting Officer /s/ Eugene L. Barnett /s/ William W. Harris Eugene L. Barnett, Director William W. Harris, Director /s/ Sidney Barrows /s/ Jerome Kahn, Jr. Sidney Barrows, Director Jerome Kahn, Jr., Director /s/ Fred Conforti /s/ Leo F. Mullin Fred Conforti, Director Leo F. Mullin, Director /s/ Anthony Downs Anthony Downs, Director 15 PITTWAY CORPORATION INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE The following documents are filed as a part of this report: Page reference in Annual Report to Stockholders Financial Statements required by Item 8 of this Form: Consolidated Balance Sheet at December 31, 1996 and 1995........................................ 32-33 For each of the three years ended December 31, 1996 - Consolidated Statement of Income..................... 31 Consolidated Statement of Cash Flows................. 34 Consolidated Statement of Stockholders' Equity....... 35 Summary of Accounting Policies and Notes to Consolidated Financial Statements.................... 36-44 Report of Independent Accountants...................... 45 Page reference in Form 10-K Financial Statement Schedule required by Article 12 of Regulation S-X: Report of Independent Accountants on Financial Statement Schedule................................... 17 Consolidated Financial Statement Schedule II Valuation and Qualifying Accounts.................... 18 The consolidated financial statements of Pittway Corporation, listed in the above index together with the Report of Independent Accountants, which are included in the Company's 1996 Annual Report to Stockholders, are incorporated herein by reference. All other schedules have been omitted because the required information is not present, or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or notes thereto. Summarized financial information for the investment in affiliate, limited real estate partnerships and other ventures is omitted because, when considered in the aggregate, they do not constitute a significant subsidiary. With the exception of the aforementioned information and information incorporated by reference in Part I (in Item 1) and Part II (in Items 5, 6, 7 and 8) of this Form 10-K, the Company's 1996 Annual Report to Stockholders is not deemed to be filed as part of this report. 16 Report of Independent Accountants on Financial Statement Schedule To the Board of Directors of Pittway Corporation Our audits of the consolidated financial statements referred to in our report dated February 19, 1997 appearing on page 45 of the 1996 Annual Report to Stockholders of Pittway Corporation (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedule listed in the index on page 16 of this Form 10-K. In our opinion, the Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. /s/ Price Waterhouse LLP Price Waterhouse LLP Chicago, Illinois February 19, 1997 17 PITTWAY CORPORATION SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (Dollars in Thousands)
Balance at Charges to Deductions Balance beginning costs and from at end of period expenses reserve (A) of period 1996 Allowance for doubtful accounts $8,493 $5,170 $3,993 $9,670 Inventory obsolescence reserve 6,613 2,686 787 8,512 1995 Allowance for doubtful accounts $6,348 $4,901 $2,756 $8,493 Inventory obsolescence reserve 6,526 1,464 1,377 6,613 1994 Allowance for doubtful accounts $5,521 $3,167 $2,340 $6,348 Inventory obsolescence reserve 5,222 1,925 621 6,526 (A) Write-off of accounts considered uncollectible, net of recoveries, or write-off of obsolete inventory. Also includes valuation accounts of acquired or divested companies and foreign currency translation adjustments, net.
18 INDEX TO EXHIBITS Sequential Number and Description of Exhibit Page Number*** 3.1 Restated Certificate of Incorporation of Registrant, as amended (incorporated by reference to Exhibit 3.1 of the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1996). 3.2 Certificate of Amendment of Restated Certificate of Incorporation of Registrant dated December 28, 1989 (incorporated by reference to Exhibit 3.2 of the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1996). 3.3 Certificate of Amendment to Restated Certificate of Incorporation dated May 9, 1996 (incorporated by reference to Exhibit 3.3 of the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1996). 3.4 Bylaws of Registrant, as amended (incorporated by reference to Exhibit 3.3 of the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995). 4. Composite Conformed Copy of separate Note Purchase Agreements Dated as of December 15, 1995, each, between the Registrant and one of Metropolitan Life Insurance Company, Metropolitan Property and Casualty Insurance Company, Nationwide Life Insurance Company, Employers Life Insurance Company of Wausau, and West Coast Life Insurance Company without exhibits(incorporated by reference to Exhibit 4.0 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995). 10.1 Pittway Corporation 1990 Stock Awards Plan, as amended (incorporated by reference to Exhibit 4.4 to the Registrant's Form S-8 Registration Statement No. 33 - 54753 filed with the Commission on July 27, 1994). 10.2 Pittway Corporation 1996 Director Stock Option Plan (incorporated by reference to Exhibit 4 of Registrant's Form S-8 Registration Statement No. 333 - 12615 filed with the Commission on September 25, 1996). 19 INDEX TO EXHIBITS - cont'd. Sequential Number and Description of Exhibit Page Number*** 10.3 Employment Agreement with King Harris dated as of January 1, 1996. (incorporated by reference to Exhibit 10.6 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995).** 10.4 Employment Agreement with Leo A. Guthart dated as of January 1, 1996. (incorporated by reference to Exhibit 10.7 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995).** 10.5 Employment Agreement with Thomas L. Kemp dated as of July 25, 1996. (incorporated by reference to Exhibit 10 of the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996).** 13. 1996 Annual Report to Stockholders.* 21. Subsidiaries of the Registrant. 23. Consent of Independent Accountants. 27. Financial Data Schedule (submitted only in electronic format). * Such report, except to the extent incorporated herein by reference, is being furnished for the information of the Securities and Exchange Commission only and is not to be deemed filed as a part of this Form 10-K. ** This document is a management contract or compensatory plan or arrangement required to be filed as an exhibit to this report pursuant to Item 14 (c) of Form 10-K. *** This information appears only in the manually signed original of this Form 10-K. 20 EX-13 2 EXHIBIT 13 PITTWAY CORPORATION DECEMBER 31, 1996 FORM 10-K Pittway Corporation and Subsidiaries CONSOLIDATED STATEMENT OF INCOME For The Years Ended December 31, 1996, 1995 and 1994 (Dollars in thousands, except per share)
1996 1995 1994 Net Sales $1,111,575 $945,669 $778,026 Operating Expenses: Cost of sales 678,903 581,694 475,420 Selling, general and administrative 322,106 283,717 232,524 Depreciation and amortization 28,166 21,014 20,160 1,029,175 886,425 728,104 Operating Income 82,400 59,244 49,922 Other Income (Expense): Gain on sale of investment 13,162 19,506 Gain from Cylink stock offering 23,279 Income from marketable securities and other interest 3,147 2,745 3,955 Interest expense (8,624) (5,778) (3,250) Income from investments 1,766 3,828 2,506 Miscellaneous, net 350 4,039 1,206 33,080 4,834 23,923 Income Before Income Taxes 115,480 64,078 73,845 Income Taxes (Note 5): Current 34,580 30,634 27,301 Deferred 7,858 (6,928) 1,708 42,438 23,706 29,009 Net Income $ 73,042 $ 40,372 $ 44,836 Net Income Per Share of Common and Class A Stock (Note 7) $ 3.49 $ 1.93 $ 2.15 Average Number of Shares Outstanding (in thousands)(Note 7) 20,921 20,912 20,911 See Summary of Accounting Policies and Notes to Consolidated Financial Statements.
Page 31 Pittway Corporation and Subsidiaries CONSOLIDATED BALANCE SHEET December 31, 1996 and 1995 (Dollars in thousands, except per share)
ASSETS 1996 1995 Current Assets: Cash and equivalents $ 32,409 $ 31,407 Marketable securities 26,026 25,586 Accounts and notes receivable, less allowance for doubtful accounts of $9,670 in 1996 and $8,493 in 1995 208,182 175,432 Inventories (Note 2) 203,254 152,636 Future income tax benefits (Note 5) 19,358 16,996 Prepayments, deposits and other 10,287 11,929 499,516 413,986 Property, Plant and Equipment, at cost: Buildings 43,413 25,797 Machinery and equipment 224,268 190,780 267,681 216,577 Less: Accumulated depreciation 132,867 109,021 134,814 107,556 Land 2,787 2,188 137,601 109,744 Investments: Marketable securities 37,814 20,000 Investment in affiliate 31,183 7,689 Real estate and other ventures 39,242 33,874 Leveraged leases (Note 3) 19,515 21,046 127,754 82,609 Other Assets: Goodwill, less accumulated amortization of $9,707 in 1996 and $8,432 in 1995 54,068 48,714 Other intangibles, less accumulated amortization of $10,668 in 1996 and $10,360 in 1995 5,022 5,422 Notes receivable 8,070 5,892 Miscellaneous 7,062 6,607 74,222 66,635 $839,093 $672,974 See Summary of Accounting Policies and Notes to Consolidated Financial Statements.
Page 32
LIABILITIES AND STOCKHOLDERS' EQUITY 1996 1995 Current Liabilities: Notes payable (Note 4) $ 46,525 $ 32,212 Long-term debt due within one year (Note 4) 3,933 3,788 Dividends payable 1,724 1,766 Accounts payable 102,077 68,700 Accrued expenses 53,937 46,310 Income taxes payable 5,685 5,644 Retirement and deferred compensation plans 6,782 6,503 Unearned income 3,538 3,185 224,201 168,108 Long-Term Debt, less current maturities (Note 4): Notes payable, 6.70% and 6.81%, due in annual installments of $5 million beginning 1999 with the balance due 2005 75,000 75,000 Capitalized leases, principally at 5%-6%, due in monthly installments through 2002 4,921 6,186 Other 7,995 4,780 87,916 85,966 Deferred Liabilities: Income taxes (Note 5) 65,738 46,920 Other 14,366 8,954 80,104 55,874 Stockholders' Equity: Preferred stock, authorized 2,000,000 shares; none issued Common capital stock, $1 par value (Note 7) - Common stock, authorized 30,000,000 shares; 3,938,832 shares issued and outstanding 3,939 3,939 Class A stock, authorized 24,000,000 shares; 16,987,622 and 16,973,313 shares issued and outstanding in 1996 and 1995, respectively 16,987 16,973 Capital in excess of par value 21,714 21,423 Retained earnings 391,753 325,420 Cumulative marketable securities valuation adjustment 12,453 (2,019) Cumulative foreign currency translation adjustment 26 (2,710) 446,872 363,026 $839,093 $672,974
Page 33 Pittway Corporation and Subsidiaries CONSOLIDATED STATEMENT OF CASH FLOWS For The Years Ended December 31, 1996, 1995 and 1994 (Dollars in thousands)
1996 1995 1994 Cash Flows From Operating Activities: Net income $ 73,042 $ 40,372 $ 44,836 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 28,166 21,014 20,160 Gain on sale of investment, net of taxes (8,149) (11,776) Gain from Cylink stock offering, net of taxes (14,413) Deferred income taxes (876) (6,928) 1,708 Retirement and deferred compensation plans 4,915 9,275 2,010 Income/loss from investments adjusted for cash distributions received 404 2,277 (931) Provision for losses on accounts receivable 5,170 4,901 3,167 Gain on sale of assets (106) (2,575) (828) Change in assets and liabilities, excluding effects from acquisitions, dispositions and foreign currency adjustments: Increase in accounts and notes receivable (32,000) (34,229) (26,882) Increase in inventories (48,350) (17,457) (23,669) Decrease (increase) in prepayments and deposits 1,482 (2,068) (3,422) Increase in accounts payable and accrued expenses 37,063 7,628 19,919 Increase (decrease) in income taxes payable 114 (4,480) 7,137 Other changes, net (1,211) (3,904) 2,491 Net cash provided by operations 45,251 13,826 33,920 Cash Flows From Investing Activities: Capital expenditures (50,189) (42,056) (28,246) Proceeds from the sale of investment, net of taxes of $5,013 and $9,730 10,748 14,776 Proceeds from the sale of marketable securities 11,102 16,034 29,297 Purchases of marketable securities (10,600) (5,846) (37,261) Dispositions of property and equipment 793 3,202 795 Additions to investments (4,566) (5,984) (10,112) Dispositions of businesses 355 650 (Increase) decrease in notes receivable (4,351) (1,194) 4,267 Net assets of businesses acquired, net of cash (3,263) (12,931) (5,921) Net cash used by investing activities (50,326) (48,420) (31,755) Cash Flows From Financing Activities: Net increase (decrease)in notes payable 12,540 (14,090) 14,802 Proceeds of long-term debt 5,284 81,693 3,585 Repayments of long-term debt (5,338) (5,307) (5,488) Stock options exercised 133 Dividends paid (6,752) (6,699) (6,707) Net cash provided by financing activities 5,867 55,597 6,192 Effect of Exchange Rate Changes on Cash 210 45 94 Net Increase in Cash and Equivalents 1,002 21,048 8,451 Cash and Equivalents at Beginning of Period 31,407 10,359 1,908 Cash and Equivalents at End of Period $ 32,409 $ 31,407 $ 10,359 Supplemental Cash Flow Disclosure: Interest paid $ 8,552 $ 5,720 $ 3,388 Income taxes paid $ 35,166 $ 35,329 $ 22,173 See Summary of Accounting Policies and Notes to Consolidated Financial Statements.
Page 34 Pittway Corporation and Subsidiaries CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY For The Years Ended December 31, 1996, 1995 and 1994 (Dollars in thousands, except per share)
Cumulative Cumulative Marketable Foreign Capital In Securities Currency Common Stock Class A Stock Excess of Retained Valuation Translation Shares Par Value Shares Par Value Par Value Earnings Adjustment Adjustment Balance - December 31, 1993 2,626,024 $2,626 11,314,700 $11,315 $28,348 $253,628 $(3,853) Cumulative effect of change in accounting for marketable securities $ 141 Net income 44,836 Cash dividends declared: Common stock - $.267 per share (1,051) Class A stock - $.333 per share (5,657) Marketable securities valuation adjustment (3,191) Currency translation adjustment 988 Balance - December 31, 1994 2,626,024 2,626 11,314,700 11,315 28,348 291,756 (3,050) (2,865) Net income 40,372 Cash dividends declared: Common stock - $.267 per share (1,051) Class A stock - $.333 per share (5,657) Shares issued pursuant to performance awards 996 1 52 Three-for-two stock split (Including $7 payable for fractional shares) 1,312,808 1,313 5,657,617 5,657 (6,977) Marketable securities valuation adjustment 1,031 Currency translation adjustment 155 Balance - December 31, 1995 3,938,832 3,939 16,973,313 16,973 21,423 325,420 (2,019) (2,710) Net income 73,042 Cash dividends declared: Common stock - $.267 per share (1,051) Class A stock - $.333 per share (5,658) Shares issued pursuant to stock options 14,309 14 291 Marketable securities valuation adjustment 14,472 Currency translation adjustment 2,736 Balance - December 31, 1996 3,938,832 $3,939 16,987,622 $16,987 $21,714 $391,753 $12,453 $ 26 See Summary of Accounting Policies and Notes to Consolidated Financial Statements.
Page 35 SUMMARY OF ACCOUNTING POLICIES (Dollars in thousands) Basis of Presentation The consolidated financial statements include the accounts of Pittway Corporation and its majority-owned subsidiaries (the "Company"). The Company follows the equity method of accounting for its investments in greater than 20%-owned but less than majority-owned affiliates. All share and per share data, as appropriate, reflect a 3-for-2 stock split paid March 1, 1996 (Note 7). All significant intercompany accounts and transactions have been eliminated. Certain prior year amounts have been reclassified to conform to the current year classification. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash Equivalents Cash equivalents are generally comprised of highly liquid instruments with original maturities of three months or less, such as treasury bills, certificates of deposit, commercial paper and time deposits. Marketable Securities The Company records its investments in marketable securities at market value. Changes in market value for these securities are reported, net of tax, in a separate component of stockholders' equity until realized. Inventories Inventories are stated at cost, which is lower than market. Costs included in inventories are raw materials, direct labor and manufacturing overhead. Cost of substantially all domestic inventories is determined by using the last-in, first-out (LIFO) method, while the remaining inventories are valued primarily using the first-in, first-out (FIFO) method. Property, Plant and Equipment Property, plant and equipment are recorded at cost and are depreciated over the estimated useful lives of the assets using the straight-line method for financial reporting purposes. Depreciation expense amounted to $25,661, $21,100 and $17,492 in 1996, 1995 and 1994, respectively. Investments Marketable securities consist of stock in United States Satellite Broadcasting ("USSB"), a satellite broadcast company. USSB was carried at cost at December 31, 1995. Investment in affiliate consists of an equity interest in Cylink Corporation ("Cylink"), an affiliate that manufactures encryption and data communication devices. Real estate and other ventures consist principally of equity interests in limited real estate partnerships and land held for development. The Company's adjusted basis in certain of the limited real estate partnerships is carried at zero, and investments in other partnerships and ventures are carried on a cost basis. Cash distributions received from these partnerships and ventures are recorded as income from investments. Leveraged leases consist of the rentals receivable net of the principal and interest on the related nonrecourse debt, estimated residual value of the leased property and unearned income. The unearned income is recognized as income from investments over the lease term. Intangible Assets Management believes that goodwill, trademarks and tradenames acquired in purchase transactions have continuing value. It is the Company's policy to amortize such costs over periods of up to 40 years except for the costs of such assets acquired prior to 1970. Intangible assets of approximately $3,356 related to pre-1970 acquisitions are not being amortized because the Company believes there has been no diminution of value. Other intangibles acquired in purchase transactions or developed, consisting of non-compete agreements, customer mailing lists, patents and software development costs are capitalized and amortized over their estimated useful lives. The carrying value of intangible assets is periodically reviewed by the Company and impairment is recognized when the projected, undiscounted net pretax cashflows derived from such intangible assets are less than their carrying value. Page 36 Research and Development Expenses Research and development costs are expensed as incurred. These costs amounted to $18,077, $16,599 and $11,849 in 1996, 1995 and 1994, respectively. Advertising and Promotion Expenses Advertising and promotion costs are expensed as incurred. These costs amounted to $20,512, $17,500 and $15,440 in 1996, 1995 and 1994, respectively. Income Taxes Provisions for income taxes recognize the tax effects of all transactions entering into the determination of net income for financial statement purposes, irrespective of when such transactions are reported for income tax purposes. In general, depreciation is computed on a straight-line method for financial reporting purposes and on accelerated methods for income tax purposes. Deferred income taxes and future income tax benefits have been recognized for all temporary differences. The Company uses the liability method of accounting for deferred income taxes. Product Liability and Workers Compensation Claims Provisions are made for estimated losses from product liability and workers compensation claims which are not covered by insurance. Translation of Foreign Currencies The functional currency of the Company's foreign operations is the local currency. Accordingly, assets and liabilities of foreign operations are translated to U.S. dollars at the rates of exchange on the balance sheet date; income and expense are translated at the average rates of exchange prevailing during the year. Translation adjustments are accumulated in a separate section of stockholders' equity. Transaction gains and losses are reflected in miscellaneous income and amounted to (expense) income of $(102), $(72) and $373 in 1996, 1995 and 1994, respectively. Stock-Based Compensation Statement of Financial Accounting Standards ("SFAS) No. 123, "Accounting for Stock-Based Compensation," encourages, but does not require companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has elected to continue accounting for stock-based compensation using the method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock. Compensation cost for other stock-based awards is based on the quoted market price of the Company's Class A stock at the date of grant for performance and bonus share awards and, for these awards and for stock appreciation rights, the changes in such stock price during each subsequent reporting period. Page 37 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share) Note 1 - Acquisitions and Dispositions During 1996, the Company acquired the assets and businesses of two foreign distributors of alarm systems and a manufacturer of glass break sensors. The total purchase price for these businesses was $3,263 cash and $2,619 payable over three years. During 1995, the Company acquired the assets and businesses of a manufacturer of residential burglar/fire alarm controls, a distributor of alarm and other security products and a foreign manufacturer of commercial intrusion alarms and control panels. The total purchase price for these businesses was $12,931 cash and $3,089 in notes. The Company sold a publication for $1 million cash, received in January 1996, and the assumption of related liabilities. The Company also sold its 51% interest in a business offering seminars to its minority stockholders for $354 cash and retained a $1 million note receivable due from this former subsidiary. During 1994, the Company acquired the assets and businesses of a direct mail production company, a designer of wide area network building control monitoring systems, a manufacturer of glass break sensors and a designer of closed-circuit television, access control and alarm systems. The total purchase price for these businesses was $5,921 cash. The Company also sold a publication for $650 cash. All the aforementioned acquisitions were accounted for as purchase transactions. The impact of these acquisitions on consolidated results of operations was not significant. These companies have been included in the consolidated financial statements from their respective dates of acquisition or to the dates of disposition. Note 2 - Inventories At December 31, 1996 and 1995 approximately 85% and 83%, respectively, of the total inventories are accounted for by the LIFO method. The recorded value of inventory approximates current cost. At year end, inventories consist of: 1996 1995 Raw materials $ 41,568 $ 33,666 Work-in-process 19,560 18,521 Finished goods - Manufactured by the Company 69,020 55,442 Manufactured by others 73,106 45,007 $203,254 $152,636 Note 3 - Leveraged Leases The Company is an equity participant in leveraged leases of an aircraft and communication satellite transponders. As the Company has no general liability for the nonrecourse debt attributable to the acquisition of such assets, the debt has been offset against the related rentals receivable. The net investment in leveraged leases consists of: 1996 1995 Rentals receivable (net of principal and interest on nonrecourse debt) $12,875 $13,179 Estimated residual value 11,432 12,532 Unearned and deferred income (4,792) (4,665) Investment in leveraged leases 19,515 21,046 Deferred income taxes (19,630) (20,523) Net investment $ (115) $ 523 A summary of the components of income from leveraged leases follows: 1996 1995 1994 Income before income taxes $ 433 $ 363 $ 1,142 Income tax benefit (cost) - Current (911) 106 3,201 Deferred 759 (233) (3,601) Income from leveraged leases $ 281 $ 236 $ 742 Minimum annual rentals receivable (net of principal and interest on nonrecourse debt) under leveraged leases for the next five years beginning with 1997 are $975, $2,065, $1,751, $3,488, $483 and an aggregate of $4,113 thereafter. Note 4 - Debt The average annual interest rate on short-term notes payable was approximately 6.6% (5.7% domestic and 11.7% foreign) and 6.5% (5.9% domestic and 12.1% foreign) at December 31, 1996 and 1995, respectively. There are no compensating balance or commitment fee requirements associated with these short-term borrowings. The Company has guaranteed indebtedness of $1,250 relating to real estate ventures in which it participates. The Company's capitalized lease obligations are collateralized by certain equipment. Other long-term debt is unsecured, bearing interest principally at 6% to 8%, with maturities through 2003. Aggregate long-term maturities due annually for the five years beginning in 1997 are $3,933, $5,083, $7,701, $6,859, $6,039 and $62,234 thereafter. Page 38 Note 5 - Income Taxes Income before income taxes consists of: 1996 1995 1994 Domestic income $109,772 $60,148 $73,204 Foreign income 5,708 3,930 641 $115,480 $64,078 $73,845 The provision for income taxes consists of: 1996 1995 1994 Current - Federal $ 27,867 $25,107 $22,819 State and local 4,251 2,857 3,660 Foreign 2,462 2,670 822 34,580 30,634 27,301 Deferred - Federal 7,680 (6,696) 1,576 Foreign 178 (232) 132 7,858 (6,928) 1,708 $ 42,438 $23,706 $29,009 The difference between the actual income tax provision and the tax provision computed by applying the statutory federal income tax rate of 35% to income before income taxes is as follows: 1996 1995 1994 Income tax at statutory rate $40,418 $22,427 $25,846 Tax effect of - State income taxes, net of federal benefit 3,307 1,857 2,379 Foreign operations 642 1,062 730 Other items, net (1,929) (1,640) 54 Actual income tax provision $42,438 $23,706 $29,009 Effective income tax rate 36.7% 37.0% 39.3% The components of the deferred tax liabilities (assets) at December 31, 1996 and 1995 are comprised of the following: 1996 1995 Deferred tax liabilities - Leveraged leases $ 19,630 $ 20,523 Real estate ventures - Affordable housing 13,678 10,816 Other 4,265 5,500 Investment in affiliate 9,520 211 Investment in USSB 8,389 Purchased tax benefit leases 3,612 4,056 Depreciation 2,867 2,334 State income taxes, net of federal benefit 3,571 4,204 Other 4,072 3,964 Total deferred tax liabilities 69,604 51,608 Deferred tax assets - Inventory valuation (7,707) (6,954) Tax loss carryforwards (4,738) (4,275) Deferred compensation (5,635) (4,035) Bad debts (2,677) (2,339) Workers compensation (1,146) (2,685) Marketable securities (728) (1,354) Other (5,331) (4,317) Total deferred tax assets (27,962) (25,959) Valuation allowance 4,738 4,275 Net deferred tax liability $ 46,380 $ 29,924 The valuation allowance relates to tax loss carryforwards of which $1,058 as of December 31, 1996 will be credited to goodwill when and if utilized. The Company's federal income tax returns have been examined through 1992 without material adjustment of reported income. Note 6 - Retirement Plans The Company has various noncontributory retirement plans covering substantially all current and certain former domestic employees. Retirement benefits for employees in foreign countries are generally provided by national statutory programs. Benefits for domestic employees are based on years of service and annual compensation as defined by each plan. The Company's policy is to fund pension costs accrued. Page 39 The components of net pension income for the plans consist of: 1996 1995 1994 Service cost - benefits earned during the year $ 4,562 $ 4,005 $ 3,618 Interest cost on projected benefit obligation 4,265 4,042 3,851 Actual return on plan assets (13,804) (27,286) 4,840 Net amortization and deferred gains and losses 4,477 18,439 (13,071) Net pension income $ (500) $ (800) $ (762) The reconciliation of the funded status of the plans at year end follows: 1996 1995 Actuarial present value of benefit obligations - Vested benefit obligation $(53,089) $(50,883) Nonvested benefit obligation (3,300) (3,044) Accumulated benefit obligation (56,389) (53,927) Excess of projected benefit obligation over accumulated benefit obligation (9,616) (7,892) Projected benefit obligation (66,005) (61,819) Plan assets at fair value 109,287 101,548 Plan assets in excess of projected benefit obligation 43,282 39,729 Unrecognized net gain (34,460) (30,538) Unrecognized prior service cost 3,431 4,027 Unamortized transition net asset (5,860) (7,325) Prepaid pension cost included in the consolidated balance sheet $ 6,393 $ 5,893 Plan assets consist primarily of U.S. government obligations, investment grade corporate bonds and common and preferred stocks. The projected benefit obligation was determined using an assumed discount rate of 7% and an assumed rate of increase in compensation of 5% for both years. The expected long-term rate of return on plan assets was 7% for both years. Note 7 - Capital Stock and Earnings per Share In January 1996 the Board of Directors declared a 3-for-2 stock split in the form of a 50% stock dividend on the Company's Common and Class A stock, payable March 1, 1996 to stockholders of record February 14, 1996. All share and per share data, as appropriate, reflect this split. The effect of the split is presented retroactively within stockholders' equity at December 31, 1995 by transferring the par value for the additional shares issued from the capital in excess of par value account to the common stock accounts. Except for voting and dividend rights, the two classes of common capital stock are identical. Class A stockholders are entitled to one- tenth vote per share and have the right to elect 25% of all directors, but not less than two. Common stockholders are entitled to one vote per share and have the right to elect the remaining number of directors. Upon a change of control of the Company (as defined in the Company's certificate of incorporation), the Class A stock will automatically be changed into Common stock. Cash dividends declared on Class A stock are required to be 1 2/3 cents per share more than dividends declared on Common stock (up to a maximum of 6 2/3 cents per share per year). Net income per share of common capital stock is based on the combined weighted average number of Class A and Common shares outstanding which does not include shares issuable upon exercise of outstanding stock options or shares distributable as performance share awards because the dilutive effect is not significant. Note 8 - Stock Options and Awards The Company's 1990 stock awards plan (as amended in 1994) provides for the issuance of up to 1,500,000 shares of Class A stock to employees pursuant to options, performance and bonus share awards, stock appreciation rights ("SARs") and other awards. Certain awards are payable in the form of Class A stock or cash. Performance share awards, SARs and options vest ratably over terms of five years or less. Options and SARS are exercisable up to ten years from date of grant. Shares are issued or cash is paid pursuant to performance and bonus share awards upon specified maturity dates. In 1996, stockholders approved a stock option plan for non-employee directors. Options to acquire a maximum of 30,000 shares of Class A stock can be awarded at the market value on the date of the award. In 1996, options for 24,000 shares were granted at an exercise price of $47.50 per share. Options for 6,000 shares are exercisable at December 31, 1996 and options for 6,000 shares become exercisable in each of the next three years. Options expire at the earlier of ten years from the date of grant or five years after the optionee ceases to be a member of the Board. Page 40 Activity in options and performance and bonus share awards under the plan is summarized as follows: 1996 1995 1994 Outstanding at beginning of year 594,128 359,590 224,314 Awards and options granted 275,425 239,250 135,276 Shares issued for awards and for options exercised (14,349) (1,494) Awards and options redeemed for cash (8,466) (1,072) Awards and options cancelled (1,000) (2,146) Outstanding at end of year 845,738 594,128 359,590 Exercisable at end of year 283,618 81,600 0 Shares available for grant 451,267 717,226 953,258 Weighted average exercise price information follows: 1996 1995 1994 Outstanding at beginning of year $22.84 $18.75 $16.19 Awards and options granted 43.00 28.88 23.00 Shares issued for awards and for options exercised 7.86 20.08 Awards and options redeemed for cash 20.08 17.09 Awards and options cancelled 43.25 17.09 Outstanding at end of year 29.66 22.84 18.75 Exercisable at end of year 21.51 19.40 Significant option and performance and bonus award groups outstanding at December 31, 1996 and related weighted average exercise prices and remaining contractual life are as follows: Year of Vested or Average Remaining Grant Outstanding Exercisable Price Life (yrs) Non-qualified options - 1996 213,350 $43.32 9 1995 166,650 29.83 8 1994 135,275 23.00 7 1993 161,905 161,905 17.09 6 1990 18,450 18,450 9.04 3 Performance and bonus awards - 1996 61,075 35,980 41.87 4 1995 72,600 50,850 26.71 3 1993 16,433 16,433 20.08 1 The fair value of options at date of grant was $18.87 in 1996, $12.72 in 1995 and $7.94 in 1994 for the 1990 plan and $21.47 in 1996 for the director's plan. These values were determined by the Black-Scholes model with the following weighted average assumptions for 1996, 1995 and 1994, respectively: interest rate of 6.4%, 7.1% and 5.3%; volatility of 27%, 25% and 25%; annual dividends of $.33 per share and an expected life of 8 years for all three years. Total expense under these plans was $5,680, $5,748, and $1,065 in 1996, 1995 and 1994, respectively. If the Company had adopted SFAS No. 123 with respect to options, net income would have been $71,685 ($3.43 per share) in 1996 and $39,940 ($1.91 per share) in 1995. The pro forma effect on net income is not representative of the effect in future years because it does not take into consideration options granted prior to 1995. Note 9 - Fair Value of Financial Instruments The carrying amount of cash and equivalents, accounts receivable, accounts payable, accrued expenses and notes payable approximates fair value because of the short maturity of these instruments. The following table presents the carrying amounts and estimated fair values of the Company's other financial instruments at year end: 1996 1995 Carrying Fair Carrying Fair Amount Value Amount Value Financial assets - Current marketable securities $ 26,026 $ 26,026 $ 25,586 $ 25,586 Investment in USSB 37,814 37,814 20,000 121,280 Investment in affiliate 31,183 111,879 7,689 168,000 Affordable housing investments 20,342 20,342 17,325 17,325 Notes receivable 10,887 10,722 6,536 6,634 Financial liabilities - Long-term debt (91,849) (88,288) (89,754) (89,138) Page 41 The estimated fair values of marketable securities, the investment in USSB and the investment in affiliate are based on quoted market prices. The December 31, 1995 estimated fair value of the investment in USSB and investment in affiliate are priced at the public offering sales prices for their respective offerings in February 1996. The estimated fair values of the Company's investments in affordable housing projects were based upon available financial and other information. The estimated fair values of the notes receivable and long-term debt were calculated based upon the present value of estimated cash flows using appropriate discount rates. At December 31, 1996 and 1995, current marketable securities consisted of adjustable rate preferred stocks, which had gross unrealized holding losses of $1,911 and $3,366, respectively. Realized gains and losses on sales of marketable securities are based upon the specific identification method. Such gains totaled $63 and $198 in 1996 and 1995, respectively, and losses totaled $576 and $453 in 1996 and 1995, respectively. In February 1996 the Company sold 13% of its investment in USSB as part of an initial public offering of USSB common stock. The sale resulted in an after-tax gain of $8,149, or $.39 per share. The Company recorded a charitable donation of appreciated shares of USSB stock in the fourth quarter of 1996 resulting in a tax benefit of $849, or $.04 per share. Unrealized holding gains, in this investment, were $22,025 at December 31, 1996. The carrying value of the investment in affiliate increased by $23,279 to reflect the increase in the Company's equity in Cylink's net book value as a result of an initial public offering in February 1996. The after-tax gain recorded on the increase in Cylink's equity was $14,413, or $.69 per share. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts and the estimates presented above may not necessarily be indicative of the amounts that the Company could realize in a current market exchange. Note 10 - Lease Commitments The Company leases certain manufacturing facilities, warehouses, office space and equipment under noncancelable operating leases expiring at various dates through the year 2014. Most of the leases contain renewal options and certain equipment leases include options to purchase during or at the end of the lease term. Minimum annual rental commitments under all noncancelable leases for the next five years beginning with 1997 are $19,632, $16,818, $15,245, $12,570, $5,581 and an aggregate of $16,079 thereafter. Rental commitments are stated net of minimum sublease rentals aggregating $2,895. Total rent expense (including taxes, insurance and maintenance when included in the rent) amounted to $18,350, $16,930 and $15,661 in 1996, 1995 and 1994, respectively. Note 11 - Contingencies and Commitments In 1989 a judgment was entered against Saddlebrook Resorts, Inc. ("Saddlebrook"), a former subsidiary of the Company, in a lawsuit which arose out of the development of Saddlebrook's resort and a portion of the adjoining residential properties owned and developed by the Company. The lawsuit alleged damage to plaintiffs' adjoining property caused by surface water effects from improvements to the properties. Damages of approximately $8 million were awarded to the plaintiffs and an injunction was entered requiring, among other things, that Saddlebrook work with local regulatory authorities to take corrective actions. In 1990 the trial court entered an order vacating the judgment and awarding a new trial. In December 1994, Saddlebrook's motion for summary judgment based on collateral estoppel was granted on the ground that Plaintiffs' claims were fully retried and rejected in a related administrative proceeding. Plaintiffs have appealed the trial court's decision granting summary judgment. In August 1996, the appellate court affirmed all but three issues in the trial court's summary judgment order in favor of Saddlebrook. A hearing is set for April 4, 1997 to determine the scope of the three issues remaining for retrial. The Company believes that the ultimate outcome of the aforementioned lawsuit will not have a material adverse effect on its financial statements. The Company in the normal course of business is subject to a number of lawsuits and claims both actual and potential in nature including a lawsuit claiming patent infringement that is scheduled for trial in 1997. While management believes that resolution of the patent infringement suit and other existing claims and lawsuits will not have a material adverse effect on the Company's financial statements, management is unable to estimate the magnitude of financial impact of claims and lawsuits which may be filed in the future. Page 42 The Company has committed to invest up to a total of $11.1 million in certain affordable housing ventures through 2003. Note 12 - Segment Information The Company operates principally in two industry segments. The Alarm and Other Security Products segment designs, manufactures and sells an extensive line of burglar and commercial fire alarm equipment and distributes alarm and other security products manufactured by other companies. The Publishing segment produces national business magazines and related products, trade shows and conferences, and direct mail marketing programs. Sales within and between segments and geographic areas are made at approximate arm's-length prices. Operating income consists of sales less operating expenses. Sales and expenses which are not related to or identifiable with specific segments are included in General Corporate and Other. Identifiable assets are those assets that are specifically identified with the industry segments and geographic areas in which operations are conducted. Eliminations include sales between segments and geographic areas and related intercompany accounts. Export sales were not material and no single customer accounted for ten percent of sales.
Depreciation Operating Identifiable Capital and Industry Segments Net Sales Income Assets Expenditures Amortization 1996 Alarm and Other Security Products $ 922,869 $ 70,366 $538,967 $ 45,187 $ 22,051 Publishing 188,122 18,695 87,357 4,822 5,878 General Corporate and Other 584 (6,661) 212,769 180 237 Consolidated $1,111,575 $ 82,400 $839,093 $ 50,189 $ 28,166 1995 Alarm and Other Security Products $ 754,003 $ 54,021 $420,738 $ 36,835 $ 15,008 Publishing 191,263 11,941 88,721 5,154 5,788 General Corporate and Other 403 (6,718) 163,515 67 218 Consolidated $ 945,669 $ 59,244 $672,974 $ 42,056 $ 21,014 1994 Alarm and Other Security Products $ 600,643 $ 45,173 $327,677 $ 20,381 $ 13,993 Publishing 176,729 11,002 86,966 7,755 5,656 General Corporate and Other 654 (6,253) 148,644 110 511 Consolidated $ 778,026 $ 49,922 $563,287 $ 28,246 $ 20,160
Page 43 Operating Identifiable Geographic Areas Net Sales Income Assets 1996 Domestic Operations $ 985,696 $ 73,511 $716,356 European Operations 104,352 5,491 116,493 Other Foreign Operations 56,153 3,123 29,216 Eliminations (34,626) 275 (22,972) Consolidated $1,111,575 $ 82,400 $839,093 1995 Domestic Operations $ 860,687 $ 53,032 $590,063 European Operations 70,302 4,041 77,302 Other Foreign Operations 40,943 2,199 20,999 Eliminations (26,263) (28) (15,390) Consolidated $ 945,669 $ 59,244 $672,974 1994 Domestic Operations $ 721,956 $ 48,206 $513,001 European Operations 48,063 119 49,666 Other Foreign Operations 31,238 882 10,308 Eliminations (23,231) 715 (9,688) Consolidated $ 778,026 $ 49,922 $563,287 Note 13 - Quarterly Results (Unaudited) Quarterly results of operations for the years ended December 31, 1996 and 1995 are shown below: 1996 Quarters Total First Second Third Fourth For Year Net Sales $257,477 $272,361 $285,726 $296,011 $1,111,575 Gross Profit 93,030 99,391 102,322 109,763 404,506 Income, Excluding Investment Gains 10,632 12,624 12,756 14,468 (a) 50,480 Gain on Sale of Investment 8,149 8,149 Gain from Cylink Stock Offering 14,507 (94) 14,413 Net Income 33,288 12,530 12,756 14,468 (a) 73,042 Per Share - Income, Excluding Investment Gains .51 .60 .61 .69 (a) 2.41 Gain on Sale of Investment .39 .39 Gain from Cylink Stock Offering .69 .69 Net Income 1.59 .60 .61 .69 (a) 3.49 1995 Quarters Total First Second Third Fourth For Year Net Sales $220,404 $235,320 $239,131 $250,814 $ 945,669 Gross Profit 80,785 85,384 83,847 92,945 342,961 Net Income 8,720 10,730 9,180 11,742 (b) 40,372 Net Income Per Share .42 .51 .44 .56 (b) 1.93 (a) Net income for the 1996 fourth quarter includes a tax benefit of $849, or $.04 per share for a charitable contribution of appreciated securities. (b) Net income for the 1995 fourth quarter includes cash distributions received from real estate limited partnerships, a gain on the sale of a publication and insurance proceeds, less accruals related to certain litigation. The net after-tax effect of these items increased net income by $1,671, or $.08 per share. Page 44 REPORTS OF INDEPENDENT ACCOUNTANTS AND MANAGEMENT Report of Independent Accountants To the Board of Directors and Stockholders of Pittway Corporation In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income, of cash flows and of stockholders' equity present fairly, in all material respects, the financial position of Pittway Corporation and its subsidiaries at December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. These financial statements are the responsibility of Pittway Corporation's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ Price Waterhouse LLP Price Waterhouse LLP Chicago, Illinois February 19, 1997 Management's Responsibility for Financial Statements The financial statements of Pittway Corporation and its consolidated subsidiaries, and all other information presented in this Annual Report, are the responsibility of the management of the Company. These statements have been prepared in accordance with generally accepted accounting principles and reflect in all material respects the substance of events and transactions that should be included. Management is responsible for the accuracy and objectivity of the financial statements, including estimates and judgments reflected therein, and fulfills this responsibility primarily by establishing and maintaining accounting systems and practices adequately supported by internal accounting controls. Management believes that the internal accounting controls in use are satisfactory to provide reasonable assurance that the Company's assets are safeguarded, that transactions are executed in accordance with management's authorizations, and that the financial records are reliable for the purpose of preparing financial statements. Independent accountants were selected by the Board of Directors, upon the recommendation of the Audit Committee, to audit the financial statements in accordance with generally accepted auditing standards. Their audits, as well as those of the Company's internal audit department, include a review of internal accounting control policies and procedures and selective tests of transactions. The Audit Committee of the Board of Directors, which consists of three directors who are not officers or employees of the Company, meets regularly with management, the internal auditors and the independent accountants to review matters relating to financial reporting, internal accounting controls, and auditing. The independent accountants have unrestricted access to the Audit Committee. /s/ King Harris /s/ Paul R. Gauvreau King Harris Paul R. Gauvreau President and Chief Executive Officer Financial Vice President and Treasurer Page 45 SUPPLEMENTAL INFORMATION Five Year Summary of Selected Financial Data (Dollars in thousands, except per share data)
1996 1995 1994 1993 1992 Operating Results Net Sales of Continuing Operations $1,111,575 $945,669 $778,026 $650,105 $568,301 Operating Income from Continuing Operations 82,400 59,244 49,922 34,012 22,069 Income from Continuing Operations 73,042 (a) 40,372 44,836(c) 21,240 12,460 Income from Discontinued Operations 10,046 34,938(d) Cumulative Effect of Changes in Accounting Principles 1,535 Net Income 73,042 (a) 40,372 44,836(c) 32,821 47,398(d) Per Share (b): Income from Continuing Operations 3.49 (a) 1.93 2.15(c) 1.02 .60 Income from Discontinued Operations .48 1.68(d) Cumulative Effect of Changes in Accounting Principles .07 Net Income 3.49 (a) 1.93 2.15(c) 1.57 2.28(d) Cash Dividends Declared Per Share (b): Common .267 .267 .267 .30 .40 Class A .333 .333 .333 .367 .733 Capital Expenditures 50,189 42,056 28,246 29,478 17,187 Depreciation and Amortization 28,166 21,014 20,160 17,249 14,829 At Year End Assets of Continuing Operations 839,093 672,974 563,287 481,977 436,358 Investment in Discontinued Operations 137,648 Total Assets 839,093 672,974 563,287 481,977 574,006 Long-Term Debt 87,916 85,966 5,088 6,083 9,601 Stockholders' Equity(e) 446,872 363,026 328,130 292,064 419,501 Per Share(b)(e) 21.36 17.36 15.69 13.97 20.06 Market Price Per Share (b)(e): Common 52.13 44.25 26.00 22.67 25.33 Class A 53.50 45.17 26.83 21.50 23.00 (a) Includes the after-tax gain on the sale of investment in USSB and gain from Cylink stock offering of $8,149 ($.39 per share) and $14,413 ($.69 per share), respectively. (b) Per share data reflect the 3-for-2 stock split declared in January 1996. (c) Includes net gain on sale of First Alert stock of $11,776, or $.57 per share. (d) Includes net gain on disposal of discontinued operations of $16,558, or $.80 per share. (e) Stockholders' equity and market prices after December 31, 1992 reflect the spinoff of AptarGroup, Inc. in April 1993.
Page 46 Market Prices, Security Holders and Dividend Information The Company's Common stock (ticker symbol PRY) and Class A stock (ticker symbol PRYA) are traded on the New York Stock Exchange (American Stock Exchange prior to October 4, 1996). As of December 31, 1996, stockholders of record totaled approximately 500 for Common and 1,000 for Class A. The following table sets forth, on a quarterly basis, the high and low prices for the Common and Class A stock on the New York Stock Exchange or American Stock Exchange, along with the cash dividends declared, adjusted to reflect the three-for-two stock split declared in January 1996. Common Class A Dividends Declared High Low High Low Common Class A 1996 Quarter: First $50.00 $40.63 $49.75 $38.63 $.0667 $.0833 Second 49.75 43.50 50.50 41.63 .0667 .0833 Third 47.88 39.00 49.25 38.25 .0667 .0833 Fourth 53.50 42.25 55.75 44.38 .0667 .0833 1995 Quarter: First $30.67 $25.00 $31.00 $25.00 $.0667 $.0833 Second 31.17 28.00 30.75 28.25 .0667 .0833 Third 41.33 28.58 41.50 29.33 .0667 .0833 Fourth 44.92 38.17 46.00 37.58 .0667 .0833 Page 47 MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS In 1996, the Company achieved sales of $1.1 billion, an 18% increase over 1995 sales which were 22% higher than 1994. The increases principally reflect higher sales levels in the Company's alarm systems segment. Domestic sales grew 15% in 1996 and 19% in 1995 while international sales increased 44% in 1996 and 40% in 1995. International business relates to the alarm segment and represents 14% of total consolidated sales in 1996 and 12% in 1995. Approximately one-third of the foreign sales growth in 1996 results from two European acquisitions late in 1995 and early in 1996. Such growth in 1995 was mainly attributable to the expansion of existing European operations. Gross profit increased 18% in 1996 and 21% in 1995 principally due to the expanded sales levels. Selling, general and administrative expenses increased 14% in 1996 and 22% in 1995 as a result of increased costs associated with the higher sales volume and, in 1995, deferred compensation accruals related to outstanding stock-based awards. Alarm product sales accounted for 83% of consolidated revenues in 1996 (80% in 1995) and increased 22% in 1996 and 26% in 1995. The increases were due to continued market growth and market share gains in key product categories and ongoing expansion in the worldwide alarm systems market. The Company's domestic distribution business made significant gains by expanding its outlet network internally, through an acquisition in November 1995 and by capitalizing on the early 1995 bankruptcy of a major competitor. The Company's manufacturing units benefited from the continued acceptance of numerous new product offerings and from expanded worldwide distribution capabilities. Operating income for the segment increased 30% in 1996 and 20% in 1995 primarily because of the expanded sales volume. Research and development expense increased 9% to $18.1 million in 1996 and increased 40% to $16.6 million in 1995 as the Company expended record amounts on research and new product development. Publishing sales declined 2% in 1996 due to the inclusion in the prior year results of a seminar business, which was sold in June 1995. Excluding this business, 1996 sales increased 5% to $188 million. In 1996, total magazine advertising revenue increased 6% reflecting increases in both ad pages and page rates on an improved mix of magazines. In 1995 sales increased 8% resulting from modest increases in advertising pages and page rates, and higher ancillary product revenues. Operating income increased 66% in 1996, excluding the seminar business sold in 1995, and increased 9% in 1995. The gains are attributable to increased advertising revenues, higher profits from ancillary revenues and significant gains from improved operating efficiencies. Postal rates were steady in 1996 and paper prices declined slightly from 1995 year end levels. Operating income in 1995 was adversely impacted by significantly higher paper costs, postage costs, and the aforementioned deferred compensation costs. Depreciation and amortization expense increased both in 1996 and 1995 as a result of capital additions, principally in the alarm segment. Other income (expense) in 1996 included a pretax gain of $13.2 million on the sale of 622,500 shares of USSB stock in connection with its initial public offering and a pretax gain of $23.3 million on the increase in the Company's investment in Cylink resulting from its initial public offering. Excluding these gains, other income was less in 1996 because of higher interest expense, partially offset by the Company's equity in increased earnings at Cylink, and because 1995's results included significant gains from the sale of a magazine, settlement of an insurance claim and higher real estate distributions. Other income was lower in 1995 compared to 1994 due to the inclusion of a $19.5 million pretax gain on the sale of the Company's 16.7% ownership in First Alert, Inc. common stock in 1994. Excluding this gain, other income was slightly greater due to increased cash distributions from real estate ventures, a larger gain on the sale of publications and insurance proceeds partially offset by higher interest expense, reduced income from marketable securities and leveraged leases and a greater loss at Cylink. Page 48 Effective tax rates were 36.7% in 1996, 37.0% in 1995, and 39.3% in 1994. An analysis of the Company's effective tax rate appears in Note 5 to the Consolidated Financial Statements. FINANCIAL CONDITION The Company's financial condition remained strong through 1996. Management anticipates that operations, borrowings and marketable securities will continue to be the primary source of funds needed to meet ongoing programs for capital expenditures, to finance acquisitions and investments and to pay dividends. In 1996, income before the USSB and Cylink gains and before depreciation and amortization provided $78.6 million of net cash which was partially used to finance the net increase in working capital items. The remaining $45.3 million of cash generated from operations, along with $12.5 million net increases in short- term borrowings and $11.2 million of net proceeds from the sale of USSB stock and other marketable securities, were used to fund $50.2 million in capital expenditures, the acquisition of three businesses for $3.3 million, $6.8 million of dividends paid to stockholders, $4.6 million of additional investments in affordable housing and other ventures and a $4.4 million net increase in notes receivable. The Company continually investigates investment opportunities for growth in related areas and is presently committed to invest up to $11.1 million in certain affordable housing ventures through 2003. The Company has real estate investments in various limited partnerships with interests in commercial rental properties which may be sold or turned over to lenders due to the weak commercial real estate market of the past several years. Such events have no effect on net income although they do have a negative impact on the Company's cash position because tax payments become due when the properties are sold or returned to the lenders. The Company has approximately $4.3 million accrued at December 31, 1996 to fully cover the remaining tax payments that would be due if all the properties were sold or returned to the lenders. The Company presently intends to hold its existing investments in preferred stocks, USSB and Cylink, although occasional sales of preferred and USSB stocks may be made selectively as conditions warrant. In January 1997, the Company paid approximately $36 million to acquire two businesses. The acquisitions were financed by short-term bank borrowings. The impact of inflation on the Company's results of operations has lessened in recent years, although inflation does increase the Company's cost of doing business. The Company attempts to offset the impact of inflation through productivity and technological improvements, cost containment programs and by increasing its selling prices over time as allowed by market conditions. In addition, substantially all domestic inventories are valued on the last-in, first-out (LIFO) method, which generally results in reporting the cost of goods sold at approximately current costs. **** This annual report, other than historical financial information, contains forward-looking statements that involve a number of risks and uncertainties. Important factors that could cause actual results to differ materially from those indicated by such forward-looking statements are set forth in Item 1 of the Company's annual report on Form 10-K for the year ended December 31, 1996. These include risks and uncertainties relating to government regulation, competition and technological change, intellectual property rights, capital spending, international operations, and risks associated with the Company's acquisition strategies. Page 49 EX-21 3 EXHIBIT 21 PITTWAY CORPORATION DECEMBER 31, 1996 FORM 10-K Approximate Percentage of State or Voting Securities Country of Owned by Name of Company Incorporation Immediate Parent Pittway Corporation Ademco Distribution, Inc. Delaware 100 ADI-Lenox Club, Inc. Delaware 100 Ademconet, Inc. Delaware 100 Radscan, Inc. Delaware 100 Fire Burglary Instruments, Inc. New York 100 Ademco Security Group, Inc. California 100 Ademco Communications Partners, Inc. Delaware 100 Fire-Lite Alarms, Inc. Connecticut 100 Notifier Engineered Systems Company Delaware 100 MicroLite Corporation California 100 Penton Publishing, Inc. Delaware 100 Curtin & Pease/Peneco, Inc. Florida 100 Chilpub, Inc. Delaware 100 Final Frontier Pittway I, Inc. Illinois 100 Final Frontier Pittway II, Inc. Illinois 100 Pittway Corporation of Canada Canada 100 Pittway Fire Safety, Inc. Delaware 100 Ademco de Juarez, S.A. de C.V. Mexico 100 ADI of Puerto Rico, Inc. Puerto Rico 100 Ademco Italia S.p.A. Italy 100 Ademco (Hong Kong) Limited Hong Kong 100 Pittway Foreign Sales Corp. U.S. Virgin Islands 100 Fire Control Instruments, Inc. * Delaware 100 * This company was acquired in January 1997. EXHIBIT 21 - cont'd PITTWAY CORPORATION DECEMBER 31, 1996 FORM 10-K Approximate Percentage of State or Voting Securities Country of Owned by Name of Company Incorporation Immediate Parent Pittway Corporation (continued) Pittway International, Ltd. Delaware 100 ADI de Mexico S.A. de C.V. Mexico 100 Notifier de Mexico S.A. de C.V. Mexico 100 System Sensor de Mexico S.A. de C.V. Mexico 100 Notifier Espana S.A. Spain 100 Notifier (Benelux) S.A. Belgium 100 Notifier Deutschland GmbH Germany 100 Notifier, Ltd. (Singapore) Delaware 100 System Sensor, Ltd. Delaware 100 Xi'an System Sensor Electronics, Ltd. China 55 Pittway UK Limited England 100 Notifier Limited England 100 System Sensor Europe Limited England 100 Ademco Microtech Limited England 100 Pittway Australia Pty., Ltd. Australia 100 Ademco-Sontrix Espana, S.A. Spain 100 Notifier Italia S.r.l. Italy 100 Pittway Tecnologica S.p.A. Italy 100 Ademco Security and Communications Group, B.V. Netherlands 100 Notifier Australia Pty., Ltd. Australia 60 Notes: All of the above subsidiaries are included in the Registrant's consolidated financial statements. Parent-subsidiary or affiliate relationships are shown by marginal indentation. EX-23 4 EXHIBIT 23 PITTWAY CORPORATION DECEMBER 31, 1996 FORM 10-K CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 33-35168, 33-54753 and 333-12615) of Pittway Corporation of our report dated February 19, 1997 appearing on page 45 of the Annual Report to Stockholders which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report on the Financial Statement Schedule, which appears on page 17 of this Form 10-K. /s/ Price Waterhouse LLP Price Waterhouse LLP Chicago, Illinois March 27, 1997 EX-27 5
5 1,000 YEAR DEC-31-1996 DEC-31-1996 32,409 26,026 217,852 9,670 203,254 499,516 270,468 132,867 839,093 224,201 87,916 0 0 20,926 425,946 839,093 1,111,575 1,111,575 678,903 678,903 28,166 5,170 8,624 115,480 42,438 73,042 0 0 0 73,042 3.49 3.49
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