-----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, O7IX0fSnfQcZ5WR6+PdFheyJ1ZsARFfi9biSVf7nVaXHJRuUjVnyVfY2TFkoYmiA kKAsr0/jAIv4Os1F9gRX2Q== 0000093469-98-000007.txt : 19981111 0000093469-98-000007.hdr.sgml : 19981111 ACCESSION NUMBER: 0000093469-98-000007 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981110 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-Q SEC ACT: SEC FILE NUMBER: 001-04821 FILM NUMBER: 98741332 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-Q 1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549-1004 FORM 10-Q [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 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, Chicago, Illinois 60606-5802 (Address of Principal Executive Offices) (Zip Code) 312/831-1070 (Registrant's Telephone Number, Including Area Code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date (November 1, 1998). Common Stock 7,877,664 Class A Stock 34,740,771 PITTWAY CORPORATION AND SUBSIDIARIES FORM 10-Q QUARTER ENDED SEPTEMBER 30, 1998 INDEX PART I. FINANCIAL INFORMATION Page ITEM 1. Financial Statements Consolidated Statement of Income - Three and Nine Months Ended September 30, 1998 and 1997 3 Consolidated Balance Sheet - September 30, 1998 and December 31, 1997 4 - 5 Consolidated Statement of Cash Flows - Nine Months Ended September 30, 1998 and 1997 6 Notes to Consolidated Financial Statements 7 - 11 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 - 14 PART II. OTHER INFORMATION ITEM 1. Legal Proceedings 14 - 16 ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters 17 ITEM 6. Exhibits and Reports on Form 8-K 17 SIGNATURES 18 2 PITTWAY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 (Unaudited; Dollars in Thousands, Except Per Share Data) Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 * 1998 1997 * CONTINUING OPERATIONS - NET SALES.............................. $344,488 $306,536 $974,165 $844,186 OPERATING EXPENSES: Cost of sales......................... 217,990 195,955 618,754 539,746 Selling, general and administrative... 86,881 81,059 254,204 225,327 Provision for patent litigation....... 43,000 Depreciation and amortization......... 9,316 7,476 26,192 21,070 314,187 284,490 942,150 786,143 OPERATING INCOME....................... 30,301 22,046 32,015 58,043 OTHER INCOME (EXPENSE): Equity in Cylink gain on divestiture.. 6,646 Equity in gain on Cylink capital transaction.......................... 6,396 6,396 Equity in Cylink charge-off........... (18,943) (18,943) Income from marketable securities and other interest................... 607 740 2,076 2,413 Interest expense...................... (3,259) (2,915) (9,832) (8,335) Income (loss) from investments........ (653) 478 5,804 1,909 Miscellaneous, net.................... (549) (603) (1,022) (894) (3,854) (14,847) 3,672 (17,454) INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES................... 26,447 7,199 35,687 40,589 PROVISION FOR INCOME TAXES............. 9,413 2,089 12,724 14,194 INCOME FROM CONTINUING OPERATIONS...... 17,034 5,110 22,963 26,395 DISCONTINUED OPERATIONS - Earnings from discontinued operations net of income taxes of $(266), $2,289, $4,018 and $7,686..... (373) 3,225 5,648 10,834 Provision for divestiture expenses, net of income taxes of $(383)......... (617) (373) 3,225 5,031 10,834 NET INCOME.............................. $ 16,661 $ 8,335 $ 27,994 $ 37,229 PER SHARE OF COMMON AND CLASS A STOCK (NOTE 3): Basic: Income from continuing operations.... $ .40 $ .12 $ .54 $ .63 Income from discontinued operations.. (.01) .08 .12 .26 Net income........................... $ .39 $ .20 $ .66 $ .89 Diluted: Income from continuing operations.... $ .39 $ .12 $ .54 $ .62 Income from discontinued operations.. (.01) .08 .11 .26 Net income........................... $ .38 $ .20 $ .65 $ .88 CASH DIVIDENDS DECLARED PER SHARE: Common................................ $ .0217 $ .0333 $ .0884 $ .1000 Class A............................... $ .0300 $ .0416 $ .1133 $ .1250 AVERAGE SHARES OUTSTANDING (000's)...... 42,503 41,972 42,263 41,950 AVERAGE SHARES AND DILUTIVE EQUIVALENTS OUTSTANDING (000's)........ 43,445 42,534 43,132 42,470 * Restated for discontinued operations. See accompanying notes. 3 PITTWAY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET SEPTEMBER 30, 1998 AND DECEMBER 31, 1997 (Unaudited; Dollars in Thousands) September 30, December 31, 1998 1997 * ASSETS CURRENT ASSETS: Cash and equivalents................... $ 18,929 $ 29,257 Marketable securities.................. 33,125 27,583 Accounts and notes receivable, less allowance for doubtful accounts of $11,028 and $9,691................... 247,093 199,222 Inventories............................ 258,853 240,228 Future income tax benefits............. 18,462 16,246 Prepayments, deposits and other........ 8,913 8,823 585,375 521,359 PROPERTY, PLANT AND EQUIPMENT, at cost: Buildings.............................. 39,625 38,250 Machinery and equipment................ 221,900 194,479 261,525 232,729 Less: Accumulated depreciation......... (133,242) (109,118) 128,283 123,611 Land................................... 2,484 2,307 130,767 125,918 INVESTMENTS: Marketable securities (U.S.S.B.)....... 26,706 30,015 Investment in affiliate (Cylink)....... 27,476 20,441 Real estate and other ventures......... 40,886 43,388 Leveraged leases....................... 17,518 18,559 112,586 112,403 OTHER ASSETS: Goodwill, less accumulated amortization of $9,048 and $7,293.... 65,564 54,964 Other intangibles, less accumulated amortization of $5,733 and $5,489.... 3,248 3,207 Notes receivable....................... 19,136 7,534 Investment in discontinued operations.. 58,397 Miscellaneous.......................... 27,775 26,912 115,723 151,014 $944,451 $910,694 * Restated for discontinued operations. See accompanying notes. 4 PITTWAY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET SEPTEMBER 30, 1998 AND DECEMBER 31, 1997 (Unaudited; Dollars in Thousands) September 30, December 31, 1998 1997 * LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Notes payable........................... $ 40,580 $ 32,336 Long-term debt due within one year...... 5,644 5,730 Dividends payable....................... 1,238 1,719 Accounts payable........................ 164,391 151,410 Accrued expenses........................ 54,248 43,166 Income taxes payable.................... 1,566 7,175 Retirement and deferred compensation plans.................... 3,840 10,562 271,507 252,098 LONG-TERM DEBT, less current maturities... 98,578 95,215 DEFERRED LIABILITIES: Income taxes............................ 51,244 62,611 Litigation.............................. 43,000 Other................................... 13,598 13,636 107,842 76,247 STOCKHOLDERS' EQUITY: Preferred stock, none issued............ Common capital stock, $1 par value- Common stock.......................... 7,878 3,939 Class A stock......................... 34,703 17,052 Capital in excess of par value.......... 17,682 24,523 Retained earnings....................... 404,643 440,536 Cumulative marketable securities valuation adjustment.................. 6,795 8,823 Cumulative foreign currency translation adjustment............................ (5,177) (7,739) 466,524 487,134 $944,451 $910,694 * Restated for discontinued operations. See accompanying notes. 5 PITTWAY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE NINE MONTHS ENDED JUNE 30 1998 AND 1997 (Unaudited; Dollars in Thousands) 1998 1997 * CASH FLOWS FROM CONTINUING OPERATING ACTIVITIES: Income from continuing operations................ $ 22,963 $ 26,395 Adjustments to reconcile income from continuing operations to net cash provided by continuing operating activities: Depreciation and amortization.................. 26,192 21,070 Equity in Cylink's gain on divestiture......... (4,154) Gain on Cylink capital transaction............. (3,997) Equity in Cylink acquisition charge-off........ 11,839 Deferred income taxes.......................... 1,369 275 Retirement and deferred compensation plans..... (4,995) 4,581 Income/loss from investments adjusted for cash distributions received............... 1,220 (1,435) Provision for losses on accounts receivable.... 3,044 2,484 Provision for patent litigation................ 26,875 Change in assets and liabilities, excluding effects from acquisitions, dispositions and foreign currency adjustments: Increase in accounts and notes receivable.... (36,075) (34,721) Increase in inventories...................... (13,150) (26,043) Decrease (increase) in prepayments and deposits............................... 385 (1,306) Increase in accounts payable and accrued expenses................................... 16,232 174 Increase (decrease) in income taxes payable.. (3,229) 1,201 Other changes, net............................. (1,976) 2,383 Net cash provided by continuing operating activities..................................... 34,701 2,900 CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures............................. (26,864) (38,149) (Increase) decrease in marketable securities..... (5,445) 4,310 Disposition of property and equipment............ 360 569 Additions to investments......................... (2) (57) Increase in notes receivable..................... (14,620) (1,264) Net assets of businesses acquired, net of cash... (12,654) (20,636) Net cash used by investing activities............ (59,225) (55,227) CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in notes payable.................... 7,030 27,451 Proceeds of long-term debt....................... 5,863 8,596 Repayments of long-term debt..................... (3,360) (8,166) Stock options exercised.......................... 5,906 956 Dividends paid................................... (5,072) (5,053) Net cash provided by financing activities........ 10,367 23,784 EFFECT OF EXCHANGE RATE CHANGES ON CASH............ 330 (227) NET CASH PROVIDED BY DISCONTINUED OPERATIONS....... 3,499 10,199 NET DECREASE IN CASH AND EQUIVALENTS............... (10,328) (18,571) CASH AND EQUIVALENTS AT BEGINNING OF PERIOD........ 29,257 32,477 CASH AND EQUIVALENTS AT END OF PERIOD.............. $ 18,929 $ 13,906 * Restated for discontinued operations. See accompanying notes. 6 PITTWAY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited; Dollars in Thousands) NOTE 1. BASIS OF PRESENTATION The accompanying consolidated financial statements include the accounts of Pittway Corporation and its majority-owned subsidiaries (the "Company" or "Registrant"). Periods prior to 1998 have been restated to reflect the discontinuation of certain businesses, as discussed in Note 2, and certain amounts have been reclassified to conform to the current year presentation. Except where otherwise indicated, the following notes relate to continuing operations consisting principally of alarm systems businesses. The accompanying consolidated financial statements are unaudited but reflect all adjustments of a normal recurring nature which are, in the opinion of management, necessary for a fair presentation of the financial statements contained herein. However, the financial statements and related notes do not include all disclosures normally provided in the Company's Annual Report on Form 10-K. Accordingly, these financial statements and related notes should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 1997. NOTE 2 DISCONTINUED OPERATIONS In December 1997 the Company announced its intention to distribute its investment in Penton Media, Inc. ("Penton"), a wholly-owned subsidiary of the Company, to stockholders in a tax-free spin-off. The distribution was completed on August 7, 1998. A provision was recorded in the second quarter for divestiture expenses totaling $617 net of taxes ($.02 per diluted share). At December 31, 1997 the investment in the net assets of the discontinued operations consisted of: Dec. 31, 1997 Current assets $ 39,126 Current liabilities (64,346) Net current assets (liabilities) (25,220) Net property, plant and equipment 27,242 Other non-current assets 76,923 Non-current liabilities (20,548) $ 58,397 Net sales of the discontinued operations prior to their disposition were: $14,466 and $50,728 for the quarters and $126,137 and $153,449 for the three quarters ended September 30, 1998 and 1997, respectively. 7 NOTE 3. EARNINGS PER SHARE AND STOCK SPLIT Basic net income per common share amounts were calculated by dividing earnings by the combined weighted average number of Class A and Common shares outstanding. Diluted net income per share amounts were based on the same reported earnings but assume the issuance of Class A stock upon exercise of outstanding stock options and distributable as performance and bonus share awards. At the May 1998 annual stockholders' meeting, stockholders approved an increase in the number of authorized shares to 100,000,000 for Class A stock and 120,000,000 for Common stock. In July 1998 the Board of Directors declared a 2-for-1 stock split in the form of a 100% stock dividend on the Company's Common and Class A Common stock, payable September 11, 1998 to stockholders of record September 1, 1998. All share and per share data reflect this split retroactively. NOTE 4. CHANGE IN ACCOUNTING POLICY Effective January 1, 1998, the Company adopted the provisions of Statement of Financial Accounting Standards No. (SFAS) 130 "Reporting Comprehensive Income." The statement requires the addition of comprehensive income and its components in the Company's annual financial statements. Other comprehensive income (loss) includes cumulative foreign currency translation adjustments and unrealized investment gains and losses, which are not included in income under current accounting principles. Total comprehensive income for the three and nine month periods ended September 30 was: Three Months Nine Months 1998 1997 1998 1997 Net income $16,661 $ 8,335 $27,994 $37,229 Other comprehensive income (loss) (7,410) (43) 534 (8,584) Total comprehensive income $ 9,251 $ 8,292 $28,528 $28,645 NOTE 5. ACQUISITIONS In the first nine months of 1998, the Company acquired the assets and businesses of one domestic distributor of security equipment and five foreign alarm businesses for stock and cash totaling $16,754. The five foreign operations consist of two manufacturers of fire alarm controls, one distributor of fire alarm systems and two distributors of security products. During the same period in 1997, the Company acquired the assets and businesses of one foreign distributor of security products and one domestic manufacturer and distributor of fire control products for $20,636 cash. All of these acquisitions were accounted for as purchase transactions in the consolidated financial statements from their respective dates of acquisition. The impact on consolidated results of operations was not significant. 8 NOTE 6. INVENTORIES The recorded value of inventories at September 30, 1998 and December 31, 1997 approximate current cost and consist of the following: 1998 1997 Raw materials $ 60,156 $ 58,323 Work in process 16,776 16,501 Finished goods - Manufactured by the Company 88,463 89,776 Manufactured by others 93,458 75,628 $258,853 $240,228 NOTE 7. MARKETABLE SECURITIES Information about the Company's marketable securities at September 30, 1998 and December 31, 1997 is as follows: 1998 1997 Current - Market Auction Preferred Stocks - Aggregate cost $ 33,066 $ 27,558 Net unrealized holding gain 59 25 Aggregate fair value $ 33,125 $ 27,583 Non-Current - USSB Common Stock - Aggregate cost $ 15,789 $ 15,789 Unrealized holding gain 10,917 14,226 Aggregate fair value $ 26,706 $ 30,015 Realized gains and losses are based upon the specific identification method. Such gains and losses on the market auction preferred stocks, for the nine months ended September 30, 1998 and 1997 were not significant. NOTE 8. INVESTMENT IN AFFILIATE In March 1998 the Company's affiliate, Cylink Corporation (Cylink), sold its wireless division for $60.5 million. The Company increased the carrying value of its investment in Cylink by $6,646 and recorded an after-tax gain of $4,154, or $.10 per diluted share, to reflect its equity in the gain on this divestiture. At September 30, 1998, the Company's 8.6 million shares of Cylink stock had a quoted market value of $38,727. The Company recorded an estimate of $867 for its equity in Cylink's loss for the third quarter of 1998 based on Cylink's announcement in October that it expected to report a loss of $.08 to $.10 per Cylink share for the quarter. On November 5, 1998, Cylink announced that it was conducting a review of its revenue recognition practices. Based on preliminary results of the review, Cylink stated that it expects to report substantial operating losses for each of the first three 9 quarters of 1998, including restated results for the first and second quarters. The report is expected near the end of November and will be subject to Cylink's annual audit. The adjustments to the Company's equity in Cylink's results of operations will be reflected when Cylink issues its report. The Company does not have sufficient information to estimate the magnitude of such adjustment at the present time. In September 1997, Cylink acquired Algorithmic Research, an information security company, for cash and Cylink stock totaling $76.2 million. The Company recorded a $4.0 million after-tax gain ($.09 per share) as a result of the stock issued in the acquisition and an $11.8 million after-tax expense ($.28 per share) for its equity in Cylink's write-off of "in-process technology" acquired in the transaction. NOTE 9. LEGAL PROCEEDINGS 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 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. On April 1, 1998, the trial court entered an order limiting the scope of the retrial in light of the appellate court's ruling. At an October 27, 1998 pretrial conference, the parties agreed to a mediation hearing. If the hearing is unsuccessful in settling the matter, retrial is expected to begin in 1999. The Company believes that the ultimate outcome of the aforementioned lawsuit will not have a material adverse effect on its financial statements. In 1995 a lawsuit was brought against the Company by Interactive Technologies, Inc. ("ITI"), seeking lost profits and royalty damages of up to $66,800 on account of Company sales of products which the plaintiff alleges infringed on its patent. The plaintiff also asserted trebling of damages, if awarded, based upon alleged willful infringement. The Company moved for summary judgment of non- infringement and, in December 1997, the Court issued its order granting the Company partial summary judgment, stating its products did not literally infringe upon plaintiff's patent claims. In March 1998, the jury handed down a verdict against the Company, which was entered by 10 the Court in April 1998, awarding damages of $35,954. The jury found that the Company did not willfully infringe. The company has recorded a provision of $43,000 in the first quarter of 1998 which considers the judgment and interest. The company has appealed the verdict. The Company in the normal course of business is subject to a number of lawsuits and claims both actual and potential in nature. While management believes that resolution of 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 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF CONTINUING OPERATIONS Continuing operations primarily represent the Company's alarm manufacturing and distribution operations. For the third quarter and first nine months of 1998, sales increased 12% to $344.5 million and 15% to $974.2 million over the respective periods in 1997. Domestic and international sales grew 12% and 15%, respectively, for the quarter and 15% and 17%, respectively, for the first nine months over the same periods last year. International business represents approximately 17% of total revenues from continuing operations in 1998 and 1997. Gross profit increased at a slightly higher rate than sales due to reduced material costs and to improved manufacturing techniques. Selling, general and administrative expenses increased 7% in the third quarter and 13% in the first nine months of 1998 primarily as a result of increased costs associated with the higher sales volume. Operating income increased 37% for the quarter to $30.3 million and 29% year to date to $75.0 million, excluding a charge of $43.0 million in the first quarter related to a patent lawsuit. Sales and operating income gains were achieved in spite of the Asian economic problems that continue to impact international markets. The Company's domestic manufacturing operations achieved increased revenues as a result of national account business, new product introductions and expanded market share. Improved operating efficiencies also had a positive impact on operating income. The Company's domestic distribution operations achieved double digit revenue and profit growth despite pricing pressure related to ongoing consolidation in the alarm installation market. Part of the increase also resulted from an acquisition in April 1998. Acquisitions had a slight impact on international revenues. Depreciation and amortization expense increased 25% in the third quarter and 24% for the first nine months, mainly as a result of capital additions in the manufacturing operations. 11 Excluding the Company's equity in Cylink's gain on divestiture, acquisition charge-off and capital transactions, other income (expense) was more favorable year-to-date in 1998 compared to 1997. The change was due to increased cash distributions from real estate ventures and a gain on the sale of an investment in the second quarter of 1998 partially offset by increased interest expense on higher borrowing levels and the Company's equity in Cylink's third quarter operating loss. Other income (expense) was less favorable in the current quarter compared to 1997 because of higher interest expense and the Cylink loss. Effective tax rates were 35.6% and 35.7% for the third quarter and first nine months of 1998 and 29.0% and 35.0% for the third quarter and first nine months of 1997. The lower rate in the 1997 third quarter resulted from favorable tax credits spread over a lower level of income. DISCONTINUED OPERATIONS Earnings from discontinued operations in the third quarter and nine months decreased from 1997 due to period costs related to trade shows acquired at the end of 1997, higher interest and amortization expenses related to these acquisitions, costs related to the spin-off and inclusion of operating results only through the August 7, 1998 spin-off date. PRO FORMA INFORMATION Following are pro forma operating results after excluding (a) discontinued operations, (b) the provision for patent litigation, (c) the Company's equity in Cylink's gain, charge-off and capital transactions and (d) related income tax effects: Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 Net sales $344,488 $306,536 $974,165 $844,186 Operating income 30,301 22,046 75,015 58,043 Income before income taxes 26,447 19,746 72,041 53,136 Provision for income taxes 9,413 6,794 26,357 18,899 Net income $ 17,034 $ 12,952 $ 45,684 $ 34,237 Net income per diluted share $ 0.39 $ 0.31 $ 1.06 $ 0.81 FINANCIAL CONDITION The Company's financial condition remained strong during the first nine months of 1998. Net working capital at September 30, 1998 was $313.9 million, up from $269.3 million at December 31, 1997. 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. 12 In the first nine months of 1998, the $72.5 million generated from net income from continuing operations excluding depreciation, amortization, the net gain from the Cylink divestiture, the provision for patent litigation and other non-cash items was partially used to fund the $37.8 million net increase in inventories, receivables and other working capital items. The $34.7 million net cash generated from operating activities, together with short-term borrowings of $7.0 million, net proceeds from the increase in long term debt of $2.5 million, $5.9 million received on the exercise of stock options and $3.5 million from discontinued operations were used to finance six acquisitions completed in the period totaling $12.6 million (in addition to $4.1 million of Pittway Class A Stock), $26.9 million of capital expenditures, a $14.6 million increase in notes receivable, $5.4 million of net purchases of marketable securities and $5.1 million of dividends. The Company continually investigates investment opportunities for growth in related areas and is presently committed to invest up to $29.5 million in certain affordable housing ventures through 2005. The Company has real estate investments in various limited partnerships with interests in commercial rental properties carried at a zero basis which are being offered for sale. Cash distributions received from these ventures are recorded as other income. The company has approximately $3.8 million accrued at September 30, 1998 to cover the deferred income tax liability that would be due if all the properties were sold. 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. ACCOUNTING CHANGES In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". The statement requires the Company to report financial and descriptive information about its reportable segments, determined using the management approach (i.e., internal management reporting). The statement is effective for fiscal years beginning after December 15, 1997. The Company will disclose segment information as determined under methods prescribed by SFAS No. 131 in its 1998 annual report. YEAR 2000 ISSUE All work necessary to upgrade the Company's systems for Year 2000 (Y2K) compliance is expected to be completed in a timely fashion and should not involve a significant amount of the Company's resources. The Company's Y2K project is proceeding on schedule. Although the Company expects its critical systems to be compliant, there is no guarantee that these results will be achieved. Specific factors that give rise to this uncertainty include a possible loss of technical resources to perform the work, failure to identify all susceptible systems, noncompliance by 13 third parties whose systems and operations impact the Company, and other similar uncertainties. Due to the general uncertainty inherent in the Y2K problem, resulting in part from the uncertainty of Y2K readiness of customers, third-party suppliers and other vendors, such as utilities, the Company is unable to determine at this time whether the consequences of Y2K failures will have a material impact on the Company's results of operations, liquidity or financial condition. **** This quarterly report, other than historical financial information, contains forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995, 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, 1997. These include risks and uncertainties relating to pending litigation, government regulation, competition and technological change, intellectual property rights, capital spending, international operations, and the Company's acquisition strategies. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Property Damage Claim 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 14 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 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 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. On April 1, 1998, the trial court entered an order limiting the scope of a retrial in light of the appellate court's ruling. At an October 27, 1998 pretrial conference, the parties agreed to a mediation hearing. If the hearing is unsuccessful in settling the matter, retrial is expected to begin in 1999. 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. The Company believes that the ultimate outcome of the aforementioned lawsuit will not have a material adverse effect on its financial statements. 15 Patent Infringement Claim On August 16, 1995, Interactive Technologies, Inc. commenced a lawsuit in U.S. District Court against the Company alleging patent infringement. The plaintiff claimed the Company infringed on their patent by making, using and selling certain security system products in the United States, and that the infringement was willful. Plaintiff initially sought unspecified damages, and an injunction. The Company denied infringement, maintaining the plaintiff's patent was invalid, as well as unenforceable because the plaintiff committed inequitable conduct before the Patent Office when applying for the patent. During discovery, the plaintiff informed the Company it was seeking damages measured by its lost profits or not less than a reasonable royalty on sales of the Company. Fact discovery in the action closed on January 17, 1997. The Court conducted a Markman hearing in October 1997 to construe the patent claims asserted by plaintiff and issued its Order interpreting the claims on October 14, 1997. The Company moved for summary judgment of non-infringement. On December 2, 1997 the Court issued its Order granting partial summary judgment that the Company's products did not literally infringe the patent claims, and denying summary judgment of no infringement. Jury trial started on January 7, 1998. During the trial, the plaintiff indicated it was seeking lost profits and royalty damages of up to $66.8 million. The plaintiff also asserted trebling of damages, if awarded, based upon alleged willful infringement. On March 9, 1998 the jury handed down a verdict against the Company awarding damages of $36.0 million. The jury found that the Company did not willfully infringe. The Court entered judgment on the jury's verdict on April 9, 1998. Consequently, the company recorded a provision of $43.0 million in the first quarter of 1998, which considers the judgment and interest. The Company filed post-trial motions on April 20, 1998 for judgment as a matter of law in favor of the Company which were denied. The Company has appealed the verdict. The ultimate outcome of this matter is uncertain but will result in significant damages should the Company lose the appeal. Other The Company in the normal course of business is subject to a number of lawsuits and claims both actual and potential in nature. While management believes that resolution of 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. 16 ITEM 5. OTHER INFORMATION Pursuant to an amendment to Securities Exchange Act Rule 14a-4(c)(1) which became effective June 29, 1998, the persons acting under proxies solicited by the Company's Board of Directors in connection with the Company's 1999 annual meeting of stockholders will have discretionary authority to vote the shares represented thereby on any matter properly presented by a stockholder at such meeting that is not specifically set forth in the notice of such meeting if the Company does not have notice of such matter on or before February 15, 1999 (unless the date of the 1999 annual meeting is changed by more than 30 days from May 7, 1999 in which event such persons will have such discretionary authority if the Company does not have notice of such matter a reasonable time before the Company mails its proxy materials for such meeting). ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. Number Description 27.1 Financial Data Schedule for the quarter ended September 30, 1998 (submitted only in electronic format). 27.2 Restated Financial Data Schedule for the quarters ended March 31, 1998 and June 30, 1998 (submitted only in electronic format). 27.3 Restated Financial Data Schedule for the years ended December 31, 1996 and 1997 and the first three quarters of 1997 (submitted only in electronic format). (b) Reports on Form 8-K. On August 11, 1998, the Registrant filed a Form 8-K under item 2 reporting that on August 7, 1998 it completed the previously announced tax-free spin-off of Penton Media, Inc. to the Registrant's stockholders as part of an agreement by Penton to acquire Donohue Meehan Publishing Company for Penton stock and cash. The filing also reported under item 5 that the Registrant declared a 2-for-1 stock split in the form of a 100% stock dividend on its Common and Class A Common stock payable September 11, 1998 to stockholders of record September 1, 1998. The filing included an unaudited Pro Forma Condensed Consolidated Balance Sheet as of June 30, 1998 and unaudited Pro Forma Condensed Consolidated Statements of Income for the six month period ended June 30, 1998 and the year ended December 31, 1997 giving effect to the spin-off and stock split. 17 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PITTWAY CORPORATION (Registrant) By /s/ Paul R. Gauvreau Paul R. Gauvreau Financial Vice President, Treasurer and Chief Financial Officer (Duly Authorized Officer and Principal Financial Officer) Date: November 10, 1998 18 EX-27.1 2 SEPTEMBER 1998 FDS
5 1,000 9-MOS DEC-31-1998 SEP-30-1998 18,929 33,125 258,121 11,028 258,853 585,375 264,009 133,242 944,451 271,507 98,578 0 0 42,581 423,943 944,451 974,165 974,165 618,754 618,754 26,192 3,044 9,832 35,687 12,724 22,963 5,031 0 0 27,994 .66 .65 Excluding a net after-tax charge of $26.9 million ($.62 per diluted share) from patent litigation and an after-tax gain of $4.2 million ($.10 per diluted share) from a divestiture by Cylink Corporation, a 29 percent owned affiliate of the Company, income from continuing operations would have been $45.7 million ($1.06 per diluted share).
EX-27.2 3 MARCH & JUNE 1998 FDS
5 This financial data schedule is restated to reflect the effects of a two-for-one stock split paid in September 1998. 1,000 3-MOS 6-MOS DEC-31-1998 DEC-31-1998 MAR-31-1998 JUN-30-1998 9,796 20,925 27,940 28,415 223,689 241,643 9,802 10,423 261,308 262,163 538,234 569,059 243,989 255,467 116,187 124,207 943,599 1,000,790 261,321 283,529 94,970 99,325 0 0 0 0 21,034 21,218 459,476 493,840 943,599 1,000,790 304,139 629,677 304,139 629,677 192,332 400,764 192,332 400,764 8,423 16,876 783 1,866 3,501 6,573 (16,841) 9,240 (6,498) 3,311 (10,343) 5,929 2,348 5,404 0 0 0 0 (7,995) 11,333 (.19) .27 (.18) .26 Included in total assets is an investment in discontinued operations of $62.1 million and $60.7 million at March 31, 1998 and June 30, 1998, respectively. Excluding a net after-tax charge of $26.9 million ($.63 per diluted share) from patent litigation and an after-tax gain of $4.2 million ($.10 per diluted share) from a divestiture by Cylink Corporation, a 29 percent owned affiliate of the Company, income from continuing operations would have been $12.4 million ($.29 per diluted share) and $28.6 million ($.67 per diluted share) for the three and six months ended March 31, 1998 and June 30, 1998, respectively.
EX-27.3 4 1997 FDS
5 This financial data schedule is restated to reflect the effects of a two-for-one stock split paid in September 1998. 1,000 YEAR 3-MOS 6-MOS 9-MOS YEAR DEC-31-1996 DEC-31-1997 DEC-31-1997 DEC-31-1997 DEC-31-1997 DEC-31-1996 MAR-31-1997 JUN-30-1997 SEP-30-1997 DEC-31-1997 32,477 9,192 13,125 13,906 29,257 26,026 24,033 21,787 22,812 27,583 184,798 189,271 206,498 218,154 208,913 7,601 8,486 8,766 9,079 9,691 199,895 226,907 227,267 226,554 240,228 459,343 465,144 486,506 498,504 521,359 208,942 222,269 234,795 230,847 235,036 98,058 104,648 110,606 103,957 109,118 817,308 850,824 873,129 877,807 910,694 198,363 224,647 236,360 236,629 252,098 87,714 84,312 90,970 90,068 95,215 0 0 0 0 0 0 0 0 0 0 20,926 20,981 20,984 20,987 20,991 425,946 436,776 445,518 452,219 466,143 817,308 850,824 873,129 877,807 910,694 923,453 252,492 537,650 844,186 1,143,772 923,453 252,492 537,650 844,186 1,143,772 587,323 161,879 343,791 539,746 723,547 587,323 161,879 343,791 539,746 723,547 22,288 6,746 13,594 21,070 28,141 4,223 974 1,849 2,484 4,299 8,590 2,406 5,420 8,335 10,852 96,367 15,116 33,390 40,589 63,290 34,675 5,546 12,105 14,194 22,682 61,692 9,570 21,285 26,395 40,608 11,350 2,726 7,609 10,834 14,906 0 0 0 0 0 0 0 0 0 0 73,042 12,296 28,894 37,229 55,514 1.75 .29 .69 .89 1.32 1.73 .29 .68 .88 1.31 Included in total assets is an investment in discontinued operations of $47.1 million, $49.7 million, $46.2 million, $47.7 million and $58.4 million at December 31, 1996, March 31,1997, June 30, 1997, September 30, 1997 and December 31, 1997 respectively. Excluding net after-tax charges of $7.8 million, or $.18 per diluted share, resulting from an acquisition by the Company's affiliate, Cylink Corporation, income from continuing operations was $34.2 million, or $.81 per diluted share, and $48.5 million or $1.14 per diluted share for the nine months ended September 30, 1997 and the year ended December 31, 1997, respectively.
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