ITEM 1. BUSINESS
GENERAL
ITI Technologies, Inc. and its wholly-owned subsidiaries (the "Company" or "ITI") design, manufacture and market supervised wireless security systems and access control systems. The Company also has an ongoing product development program that focuses its efforts on developing new and improved security systems at lower costs and on utilizing its technology base to develop products for related markets. The Company's products are sold by a direct sales force to independent dealers located throughout the United States and Canada and on a private label basis to large security system installation companies.
The Company's wholly-owned subsidiary, Interactive Technologies, Inc. (the "Predecessor"), was incorporated in January 1980 under the laws of the State of Minnesota. In January 1985, the Predecessor incorporated a foreign international sales corporation, ITI International, Inc., as a wholly-owned subsidiary under the laws of The United States Virgin Islands. ITI Technologies, Inc. was incorporated in February 1992 under the laws of the State of Delaware for the purpose of acquiring the Predecessor. On May 11, 1992, the Company acquired the Predecessor from a United States holding company controlled by ADIA S.A. of Switzerland and certain members of the Predecessor's management (the "Acquisition"). In November 1994, the Company completed a public offering of 1,900,000 newly issued shares of common stock at $16.00 per share (the "Offering"). Prior to the Offering, there was no public market for the Company's common stock. In May 1995, in a subsequent offering, selling shareholders sold 3,225,000 shares and the Company sold 225,000 shares at $24.00 per share. The Company used the net proceeds from these offerings to retire debt that had been incurred at the time of the Acquisition. In April 1996, the Predecessor incorporated ITI Finance Corporation as a wholly-owned subsidiary under the laws of the State of Minnesota for the purpose of providing financing to the Company's independent dealer base. In August 1996, the Predecessor incorporated Interactive Care, Inc. as a wholly-owned subsidiary under the laws of the State of Minnesota to market and distribute the Company's personal emergency response products. Unless the context requires otherwise, the terms "Company" and "ITI" each shall refer to ITI Technologies, Inc. and its wholly-owned subsidiaries, the Predecessor, ITI International, Inc., Interactive Care, Inc. and ITI Finance Corporation.
As reported by the Company in a November 15, 1996, press release and in a Current Report on Form 8-K filed with the Securities and Exchange Commission on November 19, 1996, ITI received a letter on November 14, 1996, from ADT Security Systems, Inc. ("ADT") stating that ITI is currently not included in ADT's "future strategic product planning" and that ITI should "anticipate a reduction in purchase orders from ADT during the first quarter of 1997 . . . ." ADT has been ITI's largest single customer and accounted for over 41% of ITI's revenue in 1996. Although ADT initially indicated that ITI should anticipate a significant decrease in product orders in the first quarter of 1997, ADT subsequently indicated that a transition to an alternative product source could not be completed until September 1997. In January 1997, ITI received purchase orders from ADT for approximately $20.3 million of wireless security products to be delivered during 1997.
On November 22, 1996, the Company's Board of Directors authorized the repurchase of up to 900,000 shares of ITI common stock on the open market, depending upon market conditions and other factors. Pursuant to this authority, ITI repurchased 621,500 shares of its common stock with a value of $7.7 million on the open market during December 1996. The Board of Directors also adopted certain protections from hostile takeover actions against ITI by declaring a dividend of common stock purchase rights to stockholders of record on December 9, 1996. Such rights were issued pursuant to a Stockholder Rights Plan (the "Rights Plan") of a type commonly referred to as a "poison pill." The Rights Plan is designed to insure that all ITI stockholders will receive fair treatment in the event of any hostile, unsolicited offer to acquire or take control of ITI. While the Rights Plan is not intended to prevent any takeover of ITI, it should, however, deter any attempt to acquire ITI in a manner or on terms not approved by the Board.
INDUSTRY OVERVIEW
There are two primary types of security systems: (i) hardwire systems, consisting of a control panel and sensors that communicate through wires, and (ii) wireless systems, which utilize sensors that communicate with a central control panel using radio signals. Although wireless systems have existed for over 25 years, it has only been since ITI's introduction in 1983 of the first supervised wireless security system that any significant market has developed for such systems. The Company believes that several factors contribute to a favorable outlook for growth in the wireless security system market, including increasing use of wireless security systems, increasing violent crime rates, increased concern about crime, low penetration of security systems in United States households, improved technology and lower cost systems, and the availability of insurance discounts to homeowners who purchase security systems.
ITI SUPERVISED WIRELESS SECURITY SYSTEMS
A typical ITI wireless security system consists of four basic components: (i) a central control panel which coordinates and controls all security and home automation system functions and automatically reports emergency conditions and service information to a remote central monitoring facility; (ii) touchpads which enable the user to arm, disarm and give other commands to the system, including panic buttons to alert the central monitoring facility to police, fire and medical emergencies; (iii) a wide variety of sensors that detect intrusion, fire and other environmental conditions and report them to the system's central control panel; and (iv) sirens designed to frighten away an intruder and which alert the user to the particular alarm condition by audible signal or digitized voice while the control panel is reporting the condition to the central monitoring station. All of these devices are located in the protected home or business.
ITI's systems are very flexible and can be programmed by the end-user to offer varying degrees of security, depending on the end-user's protection desires. The systems have the ability in all security levels to detect fire and other environmental conditions and to respond to manual activation for police, fire and medical emergencies.
ITI offers a number of security systems to meet a variety of price points and customer performance requirements, including:
ULTRAGARD SYSTEM. ITI's UltraGard system was introduced in the second half of 1996 to address a gap in ITI's high-end product offerings. The UltraGard system features a 76-zone panel which operates on 12 volts (as opposed to the other products in ITI's line, which operate on 6 volts). This high performance system is well suited for commercial applications as well as the largest residential applications.
CARETAKER PLUS SYSTEM. ITI's first generation CareTaker wireless system, introduced in 1988, was the first security system on the market to incorporate digitized voice technology and to provide the end-user with the ability to control the system by using an on- or off-site touch-tone telephone. The features of the CareTaker Plus system include system remote service and diagnostic capabilities, ITI's patented Learn Mode technology, and the ability to accommodate both wireless and hardwire sensors. The CareTaker Plus system also can be used to monitor and control environmental conditions, such as adjusting the thermostat to control heating or air conditioning or turning lights on and off. This system has the capability to individually recognize up to 40 sensors and can be used with ITI's entire line of sirens, sensors, touchpads and other accessories. The CareTaker Plus system is suitable for use in both residential and commercial environments.
COMMANDER 2000 SYSTEM. ITI's Commander 2000 system was introduced in the first half of 1994 to succeed the RF Commander system, which was first introduced in 1990. The Commander 2000 system is an entry level wireless security system designed for use in smaller businesses, homes and apartments and has many of the advanced features found in more expensive systems. The Commander 2000 system has the capability to individually recognize up to 16 wireless sensors and can be used with substantially all of ITI's accessories.
SIMON. ITI will introduce in 1997 a new entry-level wireless security system to be marketed under the Simon trademark, which is aimed at those in the industry looking for a low-cost wireless solution for mass marketing programs or where security equipment is either given away or installed at a loss in an effort to obtain a long-term monitoring contract. The Simon system has the capability to individually recognize up to 17 wireless sensors. Simon can be used with substantially all of ITI's existing sensors and can be used with ITI's new line of lower cost sensors based upon Surface Acoustic Wave, or SAW, radio technology, which will also be introduced in 1997.
CUSTOMIZED AND PRIVATE LABEL SYSTEMS. ITI has established relationships with large security companies to develop and manufacture customized, private label security systems. In developing these systems, the Company may modify its existing systems by adding customized control panel software and component packaging as requested by the customer.
SYSTEM FEATURES AND COMPONENTS
ITI's security systems incorporate several innovative and advanced features and components which increase product performance, reliability and marketability:
SUPERIOR SUPERVISED RADIO TECHNOLOGY. The Company believes its wireless security systems incorporate the most advanced radio technology currently available in supervised wireless systems. Each wireless sensor in an ITI system reports to the central control panel as a unique zone, enabling the central monitoring station personnel to identify and communicate to police or firefighters the exact location and nature of an emergency. If the control panel does not receive scheduled signals from a sensor, it reports the identity of the particular sensor to the central monitoring station and the end-user. This feature also allows service personnel to quickly find a malfunctioning sensor. Through the use of crystal-controlled radio transmitters and receivers, coupled with its patented Learn Mode and signaling protocol technologies, ITI has virtually eliminated the effects of interference and greatly increased the range of its systems within the limitations imposed by the FCC. This supervised radio technology enhances the reliability and performance of ITI's wireless systems and allows them to be used in larger premises, including many commercial facilities, where their use once was not feasible.
LEARN MODE TECHNOLOGY. ITI's patented Learn Mode technology enables control panels to automatically "learn" the identity and type of each factory-programmed sensor in its system when the system is installed. The Learn Mode technology is attractive to ITI's customers because each sensor is manufactured with a unique programmed identity. This learn mode process reduces the time and cost of installing sensors and programming the systems and allows the installation of large numbers of security systems in densely populated areas without interference with neighboring systems.
TOUCH-TONE TELEPHONE INTERFACE. ITI was the first to introduce the use of on- or off-site touch-tone telephones as touchpads to control security systems. When used with ITI's CareTaker Plus or UltraGard systems, touch-tone telephones have all the system control capabilities of the touchpads manufactured by ITI. These systems contribute to end-user convenience by enabling the end-user to control the system from on- or off-premises by using touch-tone telephones.
DIGITIZED VOICE TECHNOLOGY. ITI enhanced the "user-friendliness" and convenience of its systems by incorporating digitized voice technology. The UltraGard, CareTaker Plus, Commander 2000 and Simon security systems can "talk" to the end-user on-site with digitized voice, and the CareTaker Plus and UltraGard systems also "talk" over on- or off-site touch-tone telephones. Incorporating digitized voice technology allows the end-user to confirm commands, such as the level of protection or a disarming signal, or to receive a status report of protection levels and environmental conditions, such as the temperature inside the end-user's house. In response to various foreign sales opportunities, ITI has incorporated digitized voice response capabilities in several foreign languages into its systems.
BREADTH OF SENSOR LINE. ITI believes it offers the widest variety of wireless sensors currently available in the security system market. ITI's sensors, which can be used with all of ITI's security systems, include motion detectors; different types of intrusion sensors activated by sound, shock, or shattering glass; photoelectric smoke sensors; "rate-of-rise" fire sensors with a special thermostat activated by an unusually rapid temperature increase; pocket-sized emergency transmitters; and environmental sensors to detect such conditions as furnace failure. ITI's sensors also are the smallest available in any supervised wireless security system. The Company believes that its wide variety of sensors and their compact size offer it a significant competitive advantage. Most of ITI's sensors have long-life lithium batteries, thus increasing system reliability and convenience. ITI's current sensor line utilizes crystal-controlled radio transmitters. ITI will introduce in 1997 a new lower cost sensor line based on SAW radio technology, which will be used in connection with the Simon system. ITI will also introduce in 1997 its Quik Bridge family of wireless receivers, which will allow the ITI wireless sensor line to be used in connection with hardwire security panels manufactured by other security companies. See "Other Products -- The Quik Bridge Family" below.
INTERACTIVE CAPABILITIES. ITI's wireless systems and the central monitoring facility personnel can communicate over telephone lines using ITI's CS-4000 central station receiver. This interactive capability allows a technician to remotely perform certain kinds of service and programming on ITI's systems without leaving the central monitoring facility, avoiding delay and expensive on-site service calls.
HOME MANAGEMENT CAPABILITIES. ITI's energy management module, which is available with the CareTaker Plus and Ultragard systems, enables an end-user to adjust a thermostat using either a touchpad or an on- or off-site touch-tone telephone which can result in reduced energy costs to the end-user. ITI's CareTaker Plus, Ultragard, Commander 2000 and Simon systems also can be used to control lights through the use of touchpads. ITI has developed a power line signaling technology that allows its system control panels to activate sirens and light modules over the household electrical system. Sirens and lights thus can be installed and controlled virtually anywhere in the premises where there is an electrical outlet.
ALARM VERIFICATION. False alarms represent a troublesome issue for the security industry. In 1993, ITI introduced its Interrogator alarm verification module to address the false alarm issue. The Interrogator gives ITI's systems two-way voice capabilities through sensitive microphones and talk-back speakers that are placed strategically throughout a home or business. After an alarm has occurred and been reported to the central station, the Interrogator will allow the central station operator to either "listen in" or, if desired, "talk back" to the subject home or business. This built-in communicator helps enable the central station operator to verify alarms before dispatching the police or fire department. The Interrogator can digitally record and play back 16 seconds of an alarm event with the simple addition of the optional recording module. This enables the central station operator to listen to a recording of the actual emergency event as it happened. The Interrogator and the optional recording module work with all of ITI's security systems and also can be sold separately for use with other manufacturers' security systems.
OTHER PRODUCTS
In addition to developing new features for existing products, ITI's innovative product development programs have produced products for related markets using its existing technologies:
THE QUIK BRIDGE FAMILY. The Quik Bridge family is a group of wireless receivers equipped with interfaces that broaden the market opportunities for ITI Learn Mode sensors. ITI has introduced several Quik Bridge family members. The Quik Bridge Repeater extends the range of ITI sensors attached to ITI wireless receivers. The Quik Bridge Monobus Receiver supports adding ITI wireless sensors to Radionics hardwire panels. The Quik Bridge Loop Receiver supports adding ITI wireless sensors to any hardwire panel that supports a common loop ground and/or a relay unit connection. Future members of the Quik Bridge family will support adding ITI sensors to Access Control systems, and link home and office security environments.
METER MINDER. The Meter Minder, introduced in September 1992, consists of a CareTaker Plus control panel with modified software which performs several functions for electric and gas utilities, including automatic meter reading, historical usage reporting, outage reporting, and remote power disconnect. ITI was selected to develop this product by the National Rural Electric Cooperative Association ("NRECA"), an industry trade association that includes approximately 950 electrical cooperatives providing service to 13 million households throughout the United States. The Meter Minder provides electric and gas utilities with a cost-effective means to collect a range of user data impossible to attain using conventional data collection techniques. Its software can be easily upgraded, allowing a radio receiver, touchpads, sensors, and sirens to be added at the utility customer's option to allow the Meter Minder to function as an automatic meter reader and a CareTaker Plus security system. The Meter Minder/CareTaker Plus system can then be monitored by the installing utility, providing the utility with ongoing monthly monitoring revenues. The Meter Minder originally was developed with a hardwire link between the utility meter and the Meter Minder control panel. ITI has recently developed a wireless link, which is being tested at several beta test sites.
CS 4000 COMPUTERIZED CENTRAL STATION RECEIVER. ITI's CS 4000 Computerized Central Station Receivers can be used by the central monitoring service providers to receive and monitor information from homes and businesses protected with ITI's and certain other manufacturers' security systems. Monitoring station personnel transmit emergency messages to police, fire, medical or other authorities. With the use of ITI's Interrogator alarm verification module, central monitoring station personnel also can hear what is occurring on the protected premises to confirm an alarm and gather more information regarding the condition.
ACCESS CONTROL SYSTEMS. ITI designs and manufactures access control systems for use in commercial facilities. While currently not a significant portion of the Company's sales volume, these systems complement ITI's security system product lines and can be sold through ITI's existing independent dealer network. Typically, an access control system requires a user to insert a card or other entry device into a reader, which then unlocks a door if the user is authorized to be in the area at that time.
LIFEGARD. Recognizing the growing elderly population, ITI introduced in 1996 its LifeGard personal emergency response system. Like a security system, LifeGard maintains a communication link with a monitoring company, in order to provide the fastest possible response during an emergency. Two-way voice with the monitoring company is initiated either when the owner presses one of at least two panic buttons, or when the system doesn't detect activity in the home after a certain elapsed time. The LifeGard system includes a control panel mounted on a base with a built-in Interrogator and includes a water-resistant panic pendant.
PRODUCT DEVELOPMENT
In the years ended December 31, 1996, 1995, and 1994, the Company had gross research and development expenditures of $6.3 million, $5.2 million and $4.3 million, respectively. The Company was reimbursed by customers in 1994 for $211,000 for research and development expenditures. There were no customer reimbursements received in 1995 or 1996. ITI's current product development efforts are primarily devoted to continuing the enhancement and expansion of its product lines and technologies.
SALES AND MARKETING
ITI sells to its independent dealer network, large security companies and other private label customers, electric and gas utility companies and customers in international markets. See the applicable discussion under "Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operations" and the Consolidated Financial Statements and Notes thereto.
SALES TO INDEPENDENT DEALER NETWORK. As of December 31, 1996, ITI had 32 sales people servicing and expanding its network of over 1,500 independent dealers. This group is supported by ITI's 49-person customer service organization. The Company uses its sales force and customer service personnel to implement sales strategies, monitor the performance and quality of its dealers, implement development programs, and provide "hotline" technical backup. Through its independent dealer network, ITI's products are sold extensively throughout the United States and Canada. ITI's dealer sales and support programs include sales aids (such as sales literature and demo kits), marketing literature, and instructional videos for both dealers and end-users. In addition, ITI provides its dealers with a wide variety of training programs and materials, including technical, sales, marketing and business management programs and a number of marketing newsletters. ITI recognizes its top dealers with an incentive program which includes an annual trip to the Company's national dealer sales meeting, which also reinforces the ties between ITI and its key dealers. The Company believes its dealer program gives it a competitive advantage and engenders dealer loyalty. The Company's Security Pro program enhances its independent dealer network. Dealers participating in this program are provided special marketing and sales literature and, from time-to-time, special product offerings.
SALES TO LARGE SECURITY COMPANIES AND OTHER PRIVATE LABEL ARRANGEMENTS. ITI designs and manufactures customized and private label systems for companies which sell the systems on a national and regional basis. These customers offer the potential for substantial sales volume, provide extensive geographic coverage, and, in many cases, offer the ability to sell ITI's products under nationally recognized brand names. Members of ITI's senior management team are involved in initiating and maintaining the Company's relationships with its private label customers.
SALES TO ELECTRIC AND GAS UTILITIES. Electric and gas utilities provide ITI with an additional distribution channel and the opportunity to develop related applications of its technologies. These utilities are increasingly seeking to enter unregulated industries, including the security systems industry, to increase their profits. This industry offers electric and gas utilities a logical complement to their businesses, as many already have the infrastructure in place to sell, install and repair security and home automation systems and provide monthly monitoring services. Several utility organizations have worked with ITI to develop products to sell to their customers, including NRECA. Over 60 electric and other utilities are now purchasing ITI's products. ITI has two sales representatives who sell to utilities with support from ITI's field sales force.
INTERNATIONAL SALES. Export sales, primarily to Canada, accounted for 8.7%, 9.8% and 12.4% of net sales for 1996, 1995 and 1994, respectively (see the Consolidated Financial Statements and Notes thereto). The Company believes that international markets offer it an important opportunity for sales growth. ITI currently sells its products in over 30 foreign countries through distributors and dealers. In response to various foreign sales opportunities, ITI has incorporated digitized voice response capabilities in several foreign languages and intends to expand its product development and marketing efforts to increase its international sales. The Company currently is designing its next generation of security systems to satisfy the power, telephone, radio and other regulatory standards necessary to sell the systems in the European Community.
COMPETITION
The security systems industry is highly competitive, with a large number of manufacturers providing a wide range of products, from simple sensor components to advanced and complete systems. Competition is based primarily on product reliability, the incorporation of advanced technological features, ease of installation, sales support, and price. ITI's competitors in the supervised wireless security system industry include Ademco Security Group (a division of Pittway Corporation), Linear Corp. (a subsidiary of Nortek, Inc.) and several smaller manufacturers. ITI also competes with numerous manufacturers of hardwire security systems, including Ademco Security Group, Napco Security Systems, Inc., Detection Systems, Inc., Digital Security Controls Ltd., C&K Components, Silent Knight Security Systems (an affiliate of Cargill Corporation), Aritech Corp. (a subsidiary of Sentrol, Inc.) and Radionics, Inc. (a subsidiary of Detection Systems, Inc.). Furthermore, the Company may encounter additional competition from future industry entrants. Some of these manufacturers have, and new competitors may have, substantially greater financial and other resources than ITI. While the Company believes that ITI's product development program, innovative and attractive product features, technology and engineering expertise, and established independent dealer network and customer relationships give it a competitive advantage over many other security system manufacturers, there can be no assurance that ITI will continue to develop and market products that will be accepted in the marketplace.
MANUFACTURING
The Company's production processes include printed circuit board assembly, testing and calibration, and final assembly and testing. ITI's manufacturing engineering group designs its manufacturing test equipment, procedures and programs. A Mexican facility assembles less complex, high-volume circuit boards, such as transmitter boards, and ships them to North St. Paul, Minnesota for calibration, final assembly and testing. ITI has invested in various automated printed circuit board assembly and test equipment at both its North St. Paul, Minnesota and Mexican facilities to achieve manufacturing cost efficiencies and vertically integrate its production processes. From time to time, ITI uses certain contract manufacturers to perform some of its printed circuit board assembly and may increase its use of such companies to meet any increased demand. Certain of the chips, microprocessors and other products used in ITI's systems are obtained from single sources. If ITI could not obtain these components from these sources, there may be a 16-to 30-week lead time to obtain them from a different supplier. To help prevent delays in the shipment of its products, ITI maintains what it believes to be a sufficient amount of certain components in inventory or has made safety stock program arrangements with the suppliers.
INTELLECTUAL PROPERTY
The Company's success is dependent in part on its proprietary information, technology and know-how. The Company relies on a combination of trade secret and copyright protection and confidentiality agreements to establish and protect its proprietary rights. In addition, the Company holds ten patents covering various technologies, including its Learn Mode technology, and has several patent applications pending. The Company believes its Learn Mode technology in particular affords it significant competitive advantages because it has allowed ITI to substantially improve the performance and reliability of its products. The Company plans to aggressively protect its patents and other intellectual property and to pursue patents to protect its technology. However, there can be no assurance that the Company will be able to protect its proprietary information, technology and know-how, deter misappropriation of its proprietary rights, or prevent third party development of substantially similar technology and products. In addition, there can be no assurance that any patent applications filed by ITI will result in issued patents or that any patents issued are or will be sufficiently broad to protect the Company's technologies or provide the Company with any material competitive advantages. There also can be no assurance that the patents ITI has obtained in the past or may obtain in the future will not be contested, invalidated or circumvented. See applicable discussions under "Item 3. Legal Proceedings" and the Consolidated Financial Statements and Notes thereto for discussions of current litigation proceedings involving intellectual property issues.
The Company has occasionally received, and may receive in the future, communications from third parties asserting intellectual property rights relating to the Company's products and technologies. Upon receiving such claims, the Company evaluates their merits and risks and on occasion has negotiated licenses where third-party technology was necessary or useful for the development or manufacture of the Company's products. There can be no assurance that third parties will not assert claims against the Company with respect to existing or future products or that any licenses will be available on reasonable terms with respect to any third-party technology. The Company could incur substantial costs in redesigning its products or in defending any legal action taken against it.
GOVERNMENT REGULATION
Substantially all of the components in ITI's security systems require approval by the Federal Communications Commission ("FCC") before the systems may be marketed in the United States. Although the Company has obtained FCC approval of its products in the past, ITI cannot predict whether it will obtain FCC approvals for components of future products or whether FCC regulations might change with respect to the Company's current or future products. In addition, sales of ITI's products in countries outside of the United States usually are subject to similar types of approvals by regulatory authorities in those countries. The Company also is subject to various federal, state and foreign laws and regulations pertaining to the use of potentially dangerous material, to the discharge of material in the environment, and otherwise relating to the protection of the environment. The Company believes it has complied in all material respects with all such laws and regulations.
EMPLOYEES
On December 31, 1996, ITI had 477 full-time employees, consisting of 265 in manufacturing, 88 in engineering and product development, 49 in customer service, 34 in sales, 30 in management and administration, and 11 in marketing. These employees do not include the contract workers in the Mexican facility. None of ITI's employees are members of a collective bargaining unit, and ITI's management believes employee relations are good.
ITEM 2.

ITEM 2. PROPERTIES
ITI's principal manufacturing facilities are located in North St. Paul, Minnesota, in two adjacent leased buildings which together provide approximately 110,500 square feet of manufacturing and office space. The leases on the North St. Paul facility expire on September 1, 1999. The Company believes that its existing facilities will be adequate for its anticipated needs; however, if any additional space is needed, the Company also believes it would be available at competitive rates in the same buildings or in the immediate area of its North St. Paul facility. In addition, the Company is leasing additional distribution space at a location near its existing complex in North St. Paul, Minnesota, to facilitate shipments to major customers and to comply with the Company's disaster recovery plan. ITI also leases small warehouse and shipping point facilities in Anaheim, California; Richmond, Virginia; and Toronto, Ontario, Canada. In addition to these leased facilities, ITI utilizes a contract assembly plant in Navajoa, Mexico, consisting of approximately 22,000 square feet devoted exclusively to ITI's manufacturing needs.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
On August 17, 1995, the Company commenced an action for patent infringement against Pittway Corporation and its subsidiary, Ademco Distributions, Inc., in the United States District Court for the District of Minnesota, for infringing on its patented technology. It is the Company's intent to vigorously protect its patented technology from infringement. Costs associated with these actions are being capitalized as a patent asset associated with the related technology.
In addition, the Company experiences routine litigation in the normal course of its business. The Company does not believe that any of this routine litigation will have a material adverse effect on the financial condition or results of operations of the Company.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the Company's fourth quarter ended December 31, 1996.
PART II
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded in the over-the-counter market and is quoted on The Nasdaq National Market under the symbol "ITII." As of March 13, 1997, there were approximately 83 record holders of the Company's Common Stock.
The following table sets forth, on a quarterly basis, the high and low closing sale prices for the Company's Common Stock since January 1, 1995 through December 31, 1996:
HIGH LOW
Quarter: First $26-7/8 $20-1/4 Second 25-1/4 22-1/2 Third 29 22-3/4 Fourth 29-3/4 23-1/2
Quarter: First $29-3/4 $23-1/2 Second 34 26-3/4 Third 36-1/8 30-3/4 Fourth 35-5/8 11-3/8
The Company has never paid dividends on its Common Stock. The Company presently intends to retain all future earnings, if any, for the operation and expansion of its business and does not expect to pay any cash dividends on its Common Stock in the foreseeable future. See applicable discussion under "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."
ITEM 6.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The Acquisition was accounted for using the purchase method of accounting, which established a new basis of accounting. As a result, financial data for the period prior to the Acquisition is not comparable to financial data for subsequent periods. The quarterly financial data has not been audited or reviewed by the Company's independent accountants. The financial information set forth below should be read in conjunction with "Item 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
In November 1994, the Company completed the Offering of 1,900,000 newly issued shares of common stock at $16.00 per share. Concurrent with the Offering, all outstanding warrants (the "Warrants") issued during the May 11, 1992, Acquisition were exercised. The net proceeds of the Offering and exercise of the Warrants were used to repay in full $26.0 million of outstanding 13.5% Subordinated Notes and $7.5 million of a senior term loan from a bank ("Senior Term Loan"), plus accrued interest. Subsequent to the Offering, the Company replaced its existing bank credit facility with a new $15.0 million revolving credit facility and repaid the remaining $4.5 million outstanding balance of the Senior Term Loan with a like amount of borrowing under the new revolving facility. As a result of this recapitalization, the Company incurred an extraordinary charge to operations in the fourth quarter of 1994 of $820,000, net of $462,000 of income tax benefits, to write off unamortized discount and deferred financing charges related to the Warrants and retired debt.
In May 1995, the Company completed a secondary public offering. In connection with this offering, the Company issued an additional 225,000 shares for net proceeds of $5.0 million.
In November 1996, the Company's Board of Directors authorized the purchase of up to 900,000 shares of the Company's common stock on the open market, depending on market conditions and other factors. Pursuant to this authority, the Company repurchased 621,500 shares of its common stock at a total cost of $7.7 million through December 31, 1996.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage of net sales represented by certain items included in the Consolidated Statements of Operations:
Net sales to the ten largest security system customers and to all other customers were as follows:
YEAR ENDED DECEMBER 31, 1995, COMPARED TO YEAR ENDED DECEMBER 31, 1996
NET SALES. Net sales increased by $14.3 million, or 18.1%, from $79.0 million for 1995 to $93.3 million for 1996. The increase in net sales is primarily attributable to volume increases, as prices remained relatively stable over these periods. Sales to the Company's ten largest customers increased by $11.0 million, or 24%, over sales to the Company's ten largest customers in 1995. Sales to all other customers increased by $3.4 million, or 10% over 1995.
In November 1996, ADT informed the Company that it was no longer included in ADT's "future strategic product planning" and that ITI should "anticipate a reduction in purchase orders from ADT during the first quarter of 1997 . . . ." ADT has been ITI's largest single customer and accounted for over 41% of ITI's revenue in 1996. Although ADT initially indicated that ITI should anticipate a significant decrease in product orders in the first quarter of 1997, ADT subsequently indicated that a transition to an alternative product source could not be completed until September 1997. In January 1997, ITI received purchase orders from ADT for approximately $20.3 million of wireless security products to be delivered during 1997. Thereafter, ITI anticipates that it will continue to provide product to dealers participating in the ADT dealer program as well as product for repair and replacement purposes.
GROSS PROFIT. Gross profit increased from $36.9 million for 1995 to $45.1 million for 1996 and increased as a percentage of net sales from 46.7% to 48.3%. This increase was primarily due to volume- related efficiencies in the Company's manufacturing operations including favorable pricing for the Company's raw material requirements, which have more than offset continued margin pressures from the increase in sales to large customers.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. Marketing, general and administrative expenses increased from $13.0 million for 1995 to $15.0 million for 1996 but decreased as a percentage of net sales from 16.4% to 16.0%. The dollar increase was primarily due to an increase in the sales, marketing and customer service areas for employment costs along with other variable expenses related to the Company's increased sales volume.
RESEARCH AND DEVELOPMENT EXPENSE. Gross research and development expense increased from $5.2 million for 1995 to $6.3 million for 1996 as the Company continued its emphasis on research and development.
AMORTIZATION OF INTANGIBLE ASSETS. Amortization of acquisition related intangible assets was $912,000 for both 1995 and 1996.
NET INTEREST INCOME. Net interest income increased from $38,000 for 1995 to $815,000 for 1996. The Company is investing cash reserves in high quality, short-term investments.
INCOME TAX EXPENSE. Income tax expense increased from $6.5 million for 1995 to $8.7 million for 1996. The Company's effective income tax rates for these periods vary from the statutory rate primarily due to the non-deductibility for income tax purposes of the amortization of excess of cost over net assets acquired and state income taxes which were partially offset by the utilization of research and development tax credits.
YEAR ENDED DECEMBER 31, 1994, COMPARED TO YEAR ENDED DECEMBER 31, 1995
NET SALES. Net sales increased by $19.9 million, or 33.7%, from $59.1 million for 1994 to $79.0 million for 1995. The increase in net sales is primarily attributable to volume increases, as prices remained relatively stable over these periods. The increased volume is primarily due to an increase in sales to the Company's ten largest customers as those customers' security businesses continue to grow.
GROSS PROFIT. Gross profit increased from $26.8 million for 1994 to $36.9 million for 1995 and increased as a percentage of net sales from 45.3% to 46.7%. This increase was primarily due to volume- related efficiencies in the Company's manufacturing operations which have more than offset margin pressures due to the increase in sales to large customers, as the Company's top ten customers accounted for 57% of sales in 1995 as compared to 44% in 1994.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. Marketing, general and administrative expenses increased from $12.1 million for 1994 to $13.0 million for 1995 but decreased as a percentage of net sales from 20.5% to 16.4%. The dollar increase was primarily due to a $300,000 increase in employment costs, increased costs due to being a public company and other variable expenses related to the Company's increased sales volume.
RESEARCH AND DEVELOPMENT EXPENSE. Gross research and development expense increased from $4.3 million for 1994 to $5.2 million for 1995 as the Company continued its emphasis on research and development. The Company from time to time receives reimbursements from customers for research and development expenditures incurred at the customer's request. Research and development reimbursements were $211,000 in 1994. There were no reimbursements in 1995.
AMORTIZATION OF INTANGIBLE ASSETS. Amortization of acquisition related intangible assets was $912,000 for both 1994 and 1995.
NET INTEREST INCOME (EXPENSE). Net interest expense decreased from $4.3 million for 1994 to $38,000 of interest income for 1995. The reduction of interest expense was due to the repayment of the Senior Term Loan and Subordinated Notes from the net proceeds of the Company's stock offerings and exercise of the Warrants.
INCOME TAX EXPENSE. Income tax expense increased from $1.9 million for 1994 to $6.5 million for 1995. The Company's effective income tax rates for these periods vary from the statutory rate primarily due to the non-deductibility for income tax purposes of the amortization of excess of cost over net assets acquired.
LIQUIDITY AND CAPITAL RESOURCES
Since the Offerings, the Company has funded its operations primarily with cash from operations and, to a lesser extent, from the Company's revolving credit facility. The Company generated net cash from operating activities of $14.3 million for 1996 and $8.0 million for 1995. Net cash provided by operating activities for 1996 resulted primarily from $15.1 million of net income, $2.3 million of depreciation and amortization charges and $1.0 million of deferred income taxes, which more than offset the Company's $4.1 million use of cash for changes in operating assets and liabilities. Net cash from operating activities for 1995 resulted from $11.4 million of net income, $1.7 million of depreciation and amortization charges, and $1.0 million of deferred income taxes, partially offset by $6.1 million of net cash used by changes in operating assets and liabilities. Changes in operating assets and liabilities in both years were primarily due to increases in accounts receivable and inventories to support the Company's revenue growth.
Net cash used in investing activities, consisting primarily of the purchase of property and equipment, was $5.0 million and $2.7 million for 1996 and 1995, respectively. Although no significant commitments exist, the Company expects that purchases of property and equipment in 1997 will be approximately $3.0 million.
Net cash used in financing activities was $5.9 million in 1996. In 1996, the Company's Board of Directors authorized the purchase of up to 900,000 shares of the Company's common stock. In December 1996, the Company used $7.7 million of cash to purchase 621,500 shares of its common stock on the open market, which was partially offset by $1.8 million in cash provided by the issuance of common stock through the exercise of common stock options. Net cash provided by financing activities of $4.4 million in 1995 was primarily provided by the Company's 1995 stock offering which was partially offset by debt retirement.
A substantial amount of the Company's working capital is invested in accounts receivable and inventories. The Company periodically reviews accounts receivable for noncollectibility and inventories for obsolescence and establishes allowances it believes are appropriate. In addition, the Company periodically assesses the recoverability of intangible assets based on undiscounted cash flows.
During 1996, considering its cash position, the Company voluntarily decided to terminate its unsecured $15.0 million bank revolving credit facility, which required a commitment fee of 0.25% per annum on the unused portion of the revolving credit commitment. No amounts were outstanding under this facility at December 31, 1995, or at any time during 1996.
The Company believes that cash flow from operations and funds currently available will be adequate to fund its working capital and capital expenditure requirements for the foreseeable future.
EFFECT OF INFLATION AND FOREIGN CURRENCY TRANSACTIONS
The Company believes that inflation and foreign currency fluctuations have not had a material effect on its operations.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Consolidated Financial Statements and Notes thereto commencing at Page.
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There have been no changes in, or disagreements with, the accountants for the Company which require reporting under Item 9.
PART III
ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 is incorporated herein by reference to the sections entitled "Proposal 1 -- Election of Directors -- General, -- Information Regarding Nominees for Election as Directors, -- Board Actions and Committees, and -- Information Regarding Certain Executive Officers" contained in the Company's proxy statement to be filed with the Securities and Exchange Commission (the "Commission") within 120 days of December 31, 1996 ("Proxy Statement").
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by reference to the section entitled "Proposal 1 -- Election of Directors -- Executive Compensation, - -- Compensation Committee Interlocks and Insider Participation in Compensation Decisions, -- Compensation of Directors, -- Compliance with Section 16(a) of the Securities Exchange Act of 1934, -- Report of the Compensation Committee" and "Performance Graph" contained in the Proxy Statement to be filed with the Commission within 120 days of December 31, 1996.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated herein by reference to the section entitled "Principal Stockholders" contained in the Proxy Statement to be filed with the Commission within 120 days of December 31, 1996.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
No transactions have occurred that require reporting under this Item.
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The financial statements filed as part of this Annual Report on Form 10-K are described in the Index to Financial Statements appearing on page.
(b) The following Current Reports on Form 8-K were filed by the Company during the fourth quarter ended December 31, 1996.
(i) A Current Report on Form 8-K was filed by the Company on November 19, 1996, to report the information contained in the Company's press release of November 15, 1996, regarding the letter it had received from ADT stating that ITI is currently not included in ADT's "future strategic product planning" and that ITI should "anticipate a reduction in purchase orders from ADT during the first quarter of 1997 . . . ."
(ii) A Current Report on Form 8-K was filed by the Company on December 3, 1996, to report the adoption of a Stockholder Rights Plan under which the Company's Board of Directors declared a dividend distribution of one Common Stock Purchase Right on each outstanding share of ITI's Common Stock as of December 9, 1996.
(c) The following exhibits are hereby filed as part of this Annual Report on Form 10-K:
10.1 Strategic Supplier Agreement No. FD1106 between Interactive Technologies, Inc. and Honeywell Inc. dated November 20, 1996.
10.2 Letter Agreement dated December 23, 1996, between ADT Security Systems, Inc. and Interactive Technologies, Inc.
10.3 Long-Term Stock Incentive Plan (1992) (Amended and Restated as of May 8, 1996).
10.4 Lease Agreement dated April 28, 1995, between G.D. Packaging Machinery, Inc. and Interactive Technologies, Inc.
11.1 Statement regarding computation of per share earnings.
23.1 Consent of Coopers & Lybrand L.L.P.
The following exhibits are hereby incorporated into this Annual Report on Form 10-K by reference to exhibits filed with the Company's Registration Statement on Form S-1, as amended, which became effective on November 22, 1994 ("Registration Statement"); the exhibit number assigned to each exhibit as filed with the Registration Statement is set forth in parentheses after the description of the exhibit:
The following exhibit is hereby incorporated into this Annual Report on Form 10-K by reference to Exhibit 4.1 to the Registration Statement on Form 8-A filed by the Company with the Securities and Exchange Commission on December 6, 1996:
EXHIBIT NO. DESCRIPTION
4.2 Rights Agreement dated November 27, 1997 by and between ITI Technologies, Inc. and Norwest Bank Minnesota, N.A.
(d) The following report and consolidated financial statement schedule are filed as part of this Annual Report on Form 10-K: Report of Independent Accountants on Financial Statement Schedule and Schedule II -- Valuation and Qualifying Accounts.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Accountants Consolidated Statements of Operations Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Stockholders' Equity Notes to Consolidated Financial Statements
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of ITI Technologies, Inc.:
We have audited the accompanying consolidated balance sheets of ITI Technologies, Inc. and Subsidiaries as of December 31, 1995 and 1996, and the related consolidated statements of operations, cash flows and stockholders' equity for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of ITI Technologies, Inc. and Subsidiaries as of December 31, 1995 and 1996, and the consolidated results of their operations and their cash flows for each of the three the years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
COOPERS & LYBRAND L.L.P.
Minneapolis, Minnesota February 18, 1997
ITI TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31 (IN THOUSANDS, EXCEPT PER SHARE DATA)
The accompanying notes are an integral part of the consolidated financial statements.
ITI TECHNOLOGIES, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31 (IN THOUSANDS, EXCEPT PER SHARE DATA)
ASSETS
The accompanying notes are an integral part of the consolidated financial statements.
ITI TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31 (IN THOUSANDS)
The accompanying notes are an integral part of the consolidated financial statements.
ITI TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)
The accompanying notes are an integral part of the consolidated financial statements.
ITI TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
DESCRIPTION OF BUSINESS
ITI Technologies, Inc. and its wholly-owned subsidiaries (the "Company") design, manufacture and market supervised wireless security systems and access control systems. The Company also has an ongoing research and development program which focuses its efforts on developing new and improved security systems at lower costs and on utilizing its technology base to develop products for related markets. The Company's products are sold by a direct sales force to independent dealers located throughout the United States and Canada and on a private label basis to large security system installation companies.
PUBLIC OFFERINGS OF COMMON STOCK AND RECAPITALIZATION
In November 1994, the Company completed a public offering of 1,900,000 newly issued shares of common stock at $16.00 per share (the "Offering"). Prior to the Offering, there was no public market for the Company's common stock. Concurrent with the Offering, all outstanding warrants issued by the Company during the 1992 leveraged buy-out transaction (the "Acquisition") were exercised. The net proceeds of the Offering and exercise of the warrants, after deducting applicable issuance costs and expenses, were $27,843,000 and $5,980,000, respectively. The proceeds were used to repay in full $26,000,000 of outstanding 13.5% Subordinated Notes and $7,750,000 of the senior term loan, plus accrued interest. Subsequent to the Offering, the Company replaced its existing bank credit facility with a new $15,000,000 bank credit facility and exchanged the remaining $4,500,000 outstanding senior term loan with a like amount of borrowing under the new bank credit facility.
In connection with the Offering, Warrant exercise and retirement of debt, the Company incurred an extraordinary charge of $820,000, net of related income tax benefits of $462,000, or $0.12 per share, related to the write-off of unamortized discount and deferred financing charges. If the Offering and related recapitalization had occurred as of the beginning of 1993, pro forma net income per share would have been $0.63 for the year ended December 31, 1994. This pro forma per share amount is unaudited and is not necessarily indicative of the result that would have been obtained had these events actually occurred at the assumed date.
In May 1995, the Company completed a secondary public offering. In connection with this offering, the Company issued 225,000 additional shares for net proceeds of $5,034,000.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
USE OF ESTIMATES
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, 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.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH EQUIVALENTS
Cash equivalents include short-term investments with original maturities of three months or less. The Company's cash and cash equivalents are concentrated primarily in one financial institution.
INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out method) or market.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation and amortization of property and equipment is computed using the straight-line method over the estimated useful lives of the assets, ranging from three to seven years. The costs and related accumulated depreciation and amortization on asset disposals are removed from the accounts and any gain or loss is included in operations.
INTANGIBLE ASSETS
The excess of acquisition cost over amounts assigned to the net identifiable assets acquired in the Acquisition is being amortized on a straight-line basis over forty years. Total accumulated amortization at December 31, 1996, 1995 and 1994 was $3,054,000, $2,394,000 and $1,734,000, respectively.
The Company evaluates the carrying value of excess of acquisition cost over net assets acquired and other intangible assets based upon current and anticipated undiscounted cash flows.
Other identifiable intangible assets include value assigned to existing technology and trademarks at the date of the Acquisition, deferred financing costs, patents and other intangibles. Value assigned to trademarks is amortized on a straight-line basis over an estimated useful of forty years. Deferred financing costs associated with the Acquisition and the subsequent term loan modification, the balance of which was written off in 1994, were amortized to interest expense over the terms of the related debt using the straight-line method, which approximated the effective interest rate method. Patents and other intangibles are carried at cost less accumulated amortization calculated on a straight-line basis over their estimated useful lives, which range from three to twenty years.
INCOME TAXES
Deferred income taxes result from temporary differences between financial reporting and income tax reporting based on enacted rates in effect for the periods in which these differences are expected to reverse. Income tax expense is the tax payable for the period plus the change during the period in deferred tax assets and liabilities.
REVENUE RECOGNITION
Sales are recognized at the date of product shipment. Warranty costs are provided for at the time of the related sales.
RESEARCH AND DEVELOPMENT
Research and development costs are net of related reimbursements from customers. Reimbursements received by the Company totaled $211,000 for the year ended December 31, 1994. No reimbursements were received in 1996 or 1995.
INCOME (LOSS) PER SHARE
Per share amounts are computed by dividing by the weighted average shares outstanding during the period including common stock equivalents (using the modified treasury stock method) when the effect is not anti-dilutive. Further, as required by Securities and Exchange Commission regulations, common and common stock equivalent shares issued by the Company during the twelve-month period immediately preceding the filing of an initial public offering have been included in the calculation of shares used in these computations as if they were outstanding for all periods presented.
3. OTHER FINANCIAL STATEMENT DATA (IN THOUSANDS)
DECEMBER 31, 1995 1996
Accounts receivable: Accounts receivable $14,144 $15,493 Allowance for doubtful accounts (800) (900) Total $13,344 $14,593 Inventories: Raw materials $ 7,072 $ 7,358 Allowance for obsolescence (1,300) (1,400) 5,772 5,958 Work-in-process 4,065 3,519 Finished goods 4,640 7,150 Total $14,477 $16,627 Property and equipment: Machinery and equipment $ 5,685 $ 8,178 Furniture and fixtures 2,012 2,949 Leasehold improvements 433 668 8,130 11,795 Accumulated depreciation and amortization (3,035) (4,148) Total $ 5,095 $ 7,647 Other intangible assets: Trademarks and tradenames $10,079 $10,079 Technology and patents 367 1,591 All other 669 590 11,115 12,260 Accumulated amortization (1,282) (1,614) Total $ 9,833 $10,646 Other accrued expenses: Warranty $ 400 $ 400 Professional fees 495 416 All other 205 673 Total $ 1,100 $ 1,489 Income taxes: Deferred $ 3,301 $ 3,834 Other 460 578 Total $ 3,761 $ 4,412
Interest expense was $17,000, $216,000 and $4,365,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
SIGNIFICANT CUSTOMERS AND EXPORT SALES
During the years ended December 31, 1996, 1995 and 1994, one customer accounted for 41%, 39% and 22%, respectively, of consolidated net sales. At December 31, 1996 and 1995, this customer accounted for 27% and 39%, respectively, of consolidated accounts receivable.
Export sales, primarily to Canada, accounted for 8.7%, 9.8% and 12.4% of consolidated net sales for the years ended December 31, 1996, 1995 and 1994, respectively.
4. INCOME TAXES
Income tax expense, which excludes the tax benefit related to the extraordinary charge in 1994, consisted of the following (in thousands):
YEAR YEAR YEAR ENDED ENDED ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, 1994 1995 1996
Current: Federal $ 589 $5,190 $7,069 State 99 343 598 Deferred 1,208 955 988 $1,896 $6,488 $8,655
The Company paid taxes of $6,751,000, $3,642,000 and $132,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
The differences between the income tax expense and income taxes computed using the statutory federal income tax rate were as follows (in thousands):
A summary of the components of deferred tax assets (liabilities) follows (in thousands):
DECEMBER 31, DECEMBER 31, 1995 1996
Accrued expenses and valuation reserves not yet deducted for tax purposes $ 1,073 $ 1,228 Purchased NOL carryforwards 766 156 Net current deferred tax asset $ 1,839 $ 1,384
Depreciation $ (58) $ (225) Patent defense costs (456) Other intangible assets (3,243) (3,153) Net long-term deferred tax liability $(3,301) $(3,834)
5. REVOLVING CREDIT AGREEMENT
On December 12, 1994, subsequent to the Offering and recapitalization, the Company replaced its existing bank credit agreement with a new, unsecured $15,000,000 bank revolving credit facility and repaid the remaining $4,500,000 outstanding senior term loan with a like amount of borrowing under the new credit facility. The facility provided for interest calculated, at the Company's option, at LIBOR plus 1.0% or a commercial bank's base rate and required a commitment fee of 0.25% per annum on the unused portion of the revolving credit commitment. At December 31, 1995, there were no borrowings outstanding under this facility. During 1996, in consideration of its cash position, the company voluntarily decided to terminate this facility. No amounts were outstanding at any time during 1996. The Company paid $27,000, $201,000 and $4,192,000 of interest for the years ended December 31, 1996, 1995 and 1994, respectively.
6. COMMITMENTS
The Company leases certain property and equipment under various noncancellable operating leases. Total rent expense of the Company was $521,000, $452,000 and $354,000 for the years ended December 31, 1996, 1995 and 1994.
At December 31, 1996, future minimum rentals required under noncancelable operating leases are as follows (in thousands):
1997 .................. $ 560 1998 .................. 535 1999 .................. 338 $1,433
7. LITIGATION
On August 17, 1995, the Company commenced an action for patent infringement against Pittway Corporation and its subsidiary, Ademco Distributions, Inc., in the United States District Court for the District of Minnesota. The Company intends to vigorously protect its patented technology from infringement. Costs associated with this action are being capitalized as a patent asset associated with the related technology. As of December 31, 1996, the Company has capitalized $1,250,000 of cost related to this lawsuit.
8. PROFIT SHARING PLAN
The Company has an Incentive Profit Sharing Plan (the "Plan") which qualifies under Section 401(k) of the Internal Revenue Code. Employees who are at least 19 years of age and have completed one year of service are eligible to participate in the Plan. The Company makes contributions equal to 1.5% of the participant's eligible compensation, subject to any statutory limits.
The Company's contribution to the Plan was $148,000, $141,000 and $125,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
9. STOCKHOLDERS' EQUITY
TREASURY SHARES
In 1996, the Board of Directors authorized, subject to market conditions and other factors, the purchase of up to 900,000 shares of the Company's common stock. In December 1996, the Company purchased 621,500 shares under this authorization.
STOCK INCENTIVE PLAN
In May 1995, the stockholders approved an amendment to the Long-term Stock Incentive Plan (1992) (the "Stock Plan") to provide for grants of up to 1,500,000 stock options, restricted stock, restricted stock units and stock appreciation rights ("SARs") to officers, directors and other key employees. Stock option activity was as follows:
NUMBER OF WEIGHTED-AVERAGE WEIGHTED-AVERAGE OPTIONS SHARES EXERCISE PRICE FAIR VALUE
Outstanding at December 31, 1993 655,700 $ 5.86 Granted during 1994 244,409 5.78 Canceled during 1994 (30,000) 6.25 Outstanding at December 31, 1994 870,109 5.83 Granted during 1995 461,500 23.63 $ 9.06 Exercised during 1995 (305,700) 6.75 Canceled during 1995 (9,400) 16.97 Outstanding at December 31, 1995 1,016,509 13.53 Granted during 1996 311,000 27.91 10.26 Exercised during 1996 (120,900) 5.31 Canceled during 1996 (15,450) 22.39 Outstanding at December 31, 1996 1,191,159 18.00
The following table summarizes information about stock options outstanding at December 31, 1996:
Options become exercisable over periods up to seven years from the date of grant and expire at various periods up to November 2006. All options were granted with an exercise price equal to or exceeding the fair value of the Company's Common Stock (the "Common Stock") at the date of grant, as determined by the Board of Directors for options granted prior to the Offering. Upon termination of employment, options not exercisable expire. Certain options outstanding became fully exercisable upon the completion of the Offering.
In February 1997, the Company offered an exchange agreement to all current employees previously awarded certain Series C Stock Options during the period beginning April 18, 1995, and ending December 31, 1996. The agreement offers such employees the ability to exchange their unexercised Series C Stock Options issued to them during the indicated period for new options in the identical number but with a five-year vesting period commencing January 28, 1997 and a new exercise price of $16.50, the market price of the stock on that date.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company has chosen not to adopt the expense recognition provisions of Statement of Financial Accounting Standards No. 123 "Accounting for Stock Based Compensation" ("SFAS No. 123"). Alternatively, the Company will continue using the intrinsic value methodology to account for stock-based compensation specified in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and its related amendments and interpretations.
Accordingly, no compensation expense has been recognized in the Company's financial statements for stock compensation awards. Had compensation expense for the Company's stock-based compensation plan been determined consistent with the fair-value-based method of SFAS No. 123, the Company's net income and net income per common and common equivalent share would have been reduced to the pro forma amounts indicated below.
The fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model with weighted average assumptions of no dividend yield; expected volatility of 25.1% and 27.6%; expected option lives of 5.3 and 5.2 years; and risk-free interest rates of 6.38% and 6.68% for 1996 and 1995, respectively.
1995 1996
Net income (in thousands) As reported $11,351 $15,092 Pro forma 9,828 13,936 Net income per common and As reported $ 1.23 $ 1.60 common equivalent share Pro forma 1.08 1.49
The pro forma information above only includes stock options granted in 1995 and 1996. Pro forma compensation expense under the fair-value-based method may increase over the next few years as additional stock option grants are considered.
WARRANTS
The Company had issued detachable warrants to purchase 1,196,000 shares of Common Stock, exercisable at $5.00 per share, in connection with the subordinated debt financing of the Acquisition. Concurrent with the Offering, all outstanding warrants were exercised.
STOCKHOLDER RIGHTS PLAN
In November 1996, the Company's Board of Directors declared a dividend distribution of one common share purchase right (a "Right") for each outstanding share of Common Stock payable to stockholders of record at the close of business on December 9, 1996. Each Right entitles the holder to purchase from the Company one-half of a share of Common Stock, or a combination of securities and assets of equivalent value, subject to adjustment, at a purchase price of $25.00. The Rights will only become exercisable on the tenth business day following (i) the public announcement that a person or group has acquired 20% or more of the Company's Common Stock; or (ii) the public announcement by a person or group of a tender or exchange offer that would result in ownership of 20% or more of the Company's Common Stock, unless such offer has been determined by the Company's Board, prior to the purchase of shares under such tender or exchange offer, to be fair to the Company's stockholders and in the best interests of the Company and its stockholders; or (iii) a determination by the Company's Board that a person is an Adverse Person and that such Person, alone or together with its affiliates, has become the beneficial owner of at least 15% of the Company's Common Stock. Prior to becoming exercisable, the Rights are redeemable at the discretion of the Company's Board and expire at the close of business on November 26, 2006.
ITI TECHNOLOGIES, INC. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
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.
ITI Technologies, Inc.
March 20, 1997 By: /S/ THOMAS L. AUTH Thomas L. Auth Its PRESIDENT AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this report is signed below by the following persons on behalf of the registrant on the dates and in the capacities indicated.
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and Stockholders of ITI Technologies, Inc.:
Our report on the consolidated financial statements of ITI Technologies, Inc. is included on page of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in Item 14(d) on page 22 of this Form 10-K.
In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.
COOPERS & LYBRAND L.L.P.
Minneapolis, Minnesota February 18, 1997
INDEX TO EXHIBITS