FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ___________ Commission file number: 1-6003 FEDERAL SIGNAL CORPORATION (Exact name of Registrant as specified in its charter) Delaware 36-1063330 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1415 West 22nd Street Oak Brook, IL 60523 (Address of principal executive offices) (Zip code) (630) 954-2000 (Registrant's telephone number including area code) Not applicable (Former name, former address, and former fiscal year, if changed since last report) 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 by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b of the Exchange Act). Yes [x] No [ ] Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest practicable date. Title Common Stock, $1.00 par value 48,115,708 shares outstanding at April 30, 2004
FEDERAL SIGNAL CORPORATION INDEX TO FORM 10-Q <TABLE> <CAPTION> Page ---- <S> <C> Part I. Financial Information Item 1. Financial Statements Condensed Consolidated Statements of Income for the Three Months Ended March 31, 2004 and 2003.................................................................. 4 Condensed Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2004 and 2003............................................... 5 Condensed Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003........................................................................ 6 Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2004 and 2003.................................................................. 8 Notes to Condensed Consolidated Financial Statements....................................... 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 15 Item 3. Quantitative and Qualitative Disclosures About Market Risk................................. 19 Item 4. Controls and Procedures.................................................................... 19 Part II. Other Information Item 1. Legal Proceedings............................................................................ 20 Item 6. Exhibits and Reports on Form 8-K............................................................. 20 Signature..................................................................................................... 21 </TABLE> 2
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Forward-Looking Statements This Form 10-Q, reports filed by the Registrant with the Securities and Exchange Commission ("SEC") and comments made by management contain the words such as "may," "will," "believe," "expect," "anticipate," "intend," "plan," "project," "estimate" and "objective" or the negative thereof or similar terminology concerning the Registrant's future financial performance, business strategy, plans, goals and objectives. These expressions are intended to identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include information concerning the Registrant's possible or assumed future performance or results of operations and are not guarantees. While these statements are based on assumptions and judgments that management has made in light of industry experience as well as perceptions of historical trends, current conditions, expected future developments and other factors believed to be appropriate under the circumstances, they are subject to risks, uncertainties and other factors that may cause the Registrant's actual results, performance or achievements to be materially different. Risks, uncertainties and other factors that may impact the achievement of forward-looking statements include the cyclical nature of the U.S. state and municipal markets, success of research and development projects, negotiation and maintenance of strong supplier strategic alliances, risks associated with international operations such as foreign currency fluctuations and economic and political conditions, identification and integration of acquisitions, pricing pressures, competition, operational efficiencies and cost reductions, cash and debt management including interest rate swaps, tax strategies, maintenance and growth of the dealer network and customer relationships. ADDITIONAL INFORMATION The Registrant makes its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports available, free of charge, through its Internet website (http://www.federalsignal.com) as soon as reasonably practical after it electronically files or furnishes such materials to the SEC. All of the Registrant's filings may be read or copied at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. Information on the operation of the Public Filing Room can be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet website (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically. 3
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited) <TABLE> <CAPTION> Three months ended March 31, ------------------------------- 2004 2003 ------------- ------------- <S> <C> <C> Net sales $ 276,518,000 $ 291,951,000 Costs and expenses: Cost of sales (209,060,000) (217,602,000) Selling, general and administrative (58,590,000) (63,134,000) ------------- ------------- Operating income 8,868,000 11,215,000 Interest expense (4,865,000) (4,895,000) Other income (expense), net (970,000) 130,000 Minority interest (57,000) 173,000 ------------- ------------- Income before income taxes 2,976,000 6,623,000 Income taxes (777,000) (156,000) ------------- ------------- Net income $ 2,199,000 $ 6,467,000 ============= ============= COMMON STOCK DATA: Basic and diluted net income per share $ .05 $ .14 Weighted average common shares outstanding Basic 48,026,000 47,859,000 Diluted 48,117,000 47,864,000 Cash dividends per share of common stock $ .10 $ .20 </TABLE> See notes to condensed consolidated financial statements. 4
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) <TABLE> <CAPTION> Three months ended March 31, 2004 2003 ----------- ----------- <S> <C> <C> Net income $ 2,199,000 $ 6,467,000 Other comprehensive income (loss), net of tax - Foreign currency translation adjustments (2,116,000) 3,039,000 Net derivative gain (loss), cash flow hedges (861,000) 1,443,000 ----------- ------------ Comprehensive income (loss) $ (778,000) $ 10,949,000 =========== ============ </TABLE> See notes to condensed consolidated financial statements. 5
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> March 31, December 31, 2004 2003 (a) --------------- --------------- (Unaudited) <S> <C> <C> ASSETS Manufacturing activities - Current assets: Cash and cash equivalents $ 2,038,000 $ 10,119,000 Trade accounts receivable, net of allowances for doubtful accounts 181,591,000 196,356,000 Inventories: Raw materials 67,149,000 65,865,000 Work in process 79,045,000 63,708,000 Finished goods 50,594,000 51,115,000 Prepaid expenses 18,738,000 16,389,000 --------------- --------------- Total current assets 399,155,000 403,552,000 Properties and equipment: Land 6,023,000 6,070,000 Buildings and improvements 63,152,000 63,292,000 Machinery and equipment 246,820,000 244,615,000 Accumulated depreciation (192,820,000) (188,404,000) --------------- --------------- Net properties and equipment 123,175,000 125,573,000 --------------- --------------- Goodwill 365,537,000 366,414,000 Other deferred charges and assets 61,616,000 60,759,000 --------------- --------------- Total manufacturing assets 949,483,000 956,298,000 Financial services activities - Lease financing receivables, net of allowances for doubtful accounts 224,745,000 230,111,000 --------------- --------------- Total assets $ 1,174,228,000 $ 1,186,409,000 =============== =============== </TABLE> See notes to condensed consolidated financial statements. (a) The balance sheet at December 31, 2003 has been derived from the audited financial statements at that date. 6
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS -- Continued <TABLE> <CAPTION> March 31, December 31, 2004 2003 (a) --------------- --------------- (Unaudited) <S> <C> <C> LIABILITIES Manufacturing activities - Current liabilities: Short-term borrowings $ 68,382,000 $ 70,837,000 Trade accounts payable 81,751,000 82,525,000 Customer deposits 28,596,000 21,224,000 Accrued liabilities and income taxes 105,162,000 109,784,000 --------------- --------------- Total current liabilities 283,891,000 284,370,000 Long-term borrowings 199,898,000 194,130,000 Long-term pension and other liabilities 36,775,000 38,692,000 Deferred income taxes 39,010,000 44,820,000 --------------- --------------- Total manufacturing liabilities 559,574,000 562,012,000 --------------- --------------- Financial services activities - Borrowings 196,652,000 201,347,000 Minority interest in subsidiary 598,000 541,000 SHAREHOLDERS' EQUITY Common stock - par value 48,524,000 48,439,000 Capital in excess of par value 93,190,000 91,898,000 Retained earnings 314,792,000 317,404,000 Treasury stock (14,850,000) (14,850,000) Deferred stock awards (3,202,000) (2,309,000) Accumulated other comprehensive loss (21,050,000) (18,073,000) --------------- --------------- Total shareholders' equity 417,404,000 422,509,000 --------------- --------------- Total liabilities and shareholders' equity $ 1,174,228,000 $ 1,186,409,000 =============== =============== </TABLE> See notes to condensed consolidated financial statements. (a) The balance sheet at December 31, 2003 has been derived from the audited financial statements at that date. 7
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) <TABLE> <CAPTION> Three months ended March 31, ----------------------------- 2004 2003 ------------ ------------ <S> <C> <C> Operating activities: Net income $ 2,199,000 $ 6,467,000 Depreciation and amortization 5,997,000 6,585,000 Pension contribution (3,604,000) Working capital changes and other (2,557,000) 4,848,000 ------------ ------------ Net cash provided by operating activities 2,035,000 17,900,000 Investing activities: Purchases of properties and equipment (4,272,000) (4,489,000) Principal extensions under lease financing agreements (33,546,000) (39,276,000) Principal collections under lease financing agreements 38,912,000 38,419,000 Other, net 1,466,000 1,193,000 ------------ ------------ Net cash provided by (used for) investing activities 2,560,000 (4,153,000) Financing activities: Increase (decrease) in short-term borrowings, net (7,150,000) 158,000 Increase (decrease) in long-term borrowings, net 158,000 (4,326,000) Purchases of treasury stock (116,000) Cash dividends paid to shareholders (4,780,000) (9,548,000) Other, net (904,000) (260,000) ------------ ------------ Net cash used for financing activities (12,676,000) (14,092,000) ------------ ------------ Decrease in cash and cash equivalents (8,081,000) (345,000) Cash and cash equivalents at beginning of period 10,119,000 9,782,000 ------------ ------------ Cash and cash equivalents at end of period $ 2,038,000 $ 9,437,000 ============ ============ Supplemental disclosures: Cash paid for interest $ 2,304,000 $ 373,000 Cash paid for income taxes 989,000 911,000 </TABLE> See notes to condensed consolidated financial statements. 8
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF PRESENTATION The consolidated condensed financial statements of Federal Signal Corporation and subsidiaries included herein have been prepared by the Registrant, without an audit, pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Registrant believes that the disclosures are adequate to make the information presented not misleading. These consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2003. In the opinion of the Registrant, the information contained herein reflects all adjustments necessary to present fairly the Registrant's financial position, results of operations and cash flows for the interim periods. Such adjustments are of a normal recurring nature. The operating results for the three months ended March 31, 2004 are not necessarily indicative of the results to be expected for the full year of 2004. Effective January 1, 2004, the Registrant began reporting its interim quarterly periods on a 13-week basis ending on a Saturday with the fiscal year ending on December 31. Prior to 2004, the Registrant's interim quarterly periods ended on March 31, June 30, September 30 and December 31 year end. For convenience purposes, the Registrant uses "March 31, 2004" to refer to its financial results as of April 3, 2004 and for the 13-week period ended April 3, 2004. 2. STOCK-BASED COMPENSATION PLANS The following table illustrates the effect on net income and earnings per share for the three-month periods ended March 31, 2004 and 2003 if the Registrant had applied the fair value recognition provisions of SFAS No. 123 to all stock-based employee compensation. For purposes of pro forma disclosure, the estimated fair value of the options using a Black-Scholes option pricing model is amortized to expense over the option's vesting period. <TABLE> <CAPTION> Three months ended March 31, ---------------------------- 2004 2003 ------------ ------------ <S> <C> <C> Reported net income $ 2,199,000 $ 6,467,000 Add: Stock-based employee compensation expense included in reported net income, net of related tax effects 145,000 281,000 Deduct: Total stock-based employee compensation expense determined under the fair-value method for all awards, net of related tax effects (902,000) (476,000) ------------ ------------ Pro forma net income $ 1,442,000 $ 6,272,000 ============ ============ Basic net income per common share: Reported net income $ .05 $ .14 Pro forma net income $ .03 $ .13 Diluted net income per share: Reported net income $ .05 $ .14 Pro forma net income $ .03 $ .13 </TABLE> The stock-based employee compensation expense determined under the fair-value method for the three months ended March 31, 2004 was affected by the retirement and separation agreements relating to two executive officers. 9
The intent of the Black-Scholes option valuation model is to provide estimates of fair values of traded options that have no vesting restrictions and are fully transferable. Options valuation models require the use of highly subjective assumptions including expected stock price volatility. The Registrant has utilized the Black-Scholes method to calculate the pro forma disclosures required under SFAS No. 123 and 148. In management's opinion, existing valuation models do not necessarily provide a reliable single measure of the fair value of its employee stock options because the Registrant's employee stock options have significantly different characteristics from those of traded options and the assumptions used in applying option valuation methodologies, including the Black-Scholes model, are highly subjective. 3. INCOME TAXES The Registrant's effective tax rate totaled 26.1% and 2.4% for the three-month periods ended March 31, 2004 and 2003, respectively. A $1,863,000 tax benefit was recorded for the three months ended March 31, 2003 associated with the closure of a production facility in the United Kingdom. 4. POSTRETIREMENT BENEFITS The components of the Registrant's net periodic pension expense for its U.S. benefit plans are summarized as follows: <TABLE> <CAPTION> Three months ended March 31, ---------------------------- 2004 2003 ------------ ------------ <S> <C> <C> Service cost $ 1,175,000 $ 1,022,000 Interest cost 1,929,000 1,776,000 Expected return on plan assets (1,990,000) (1,961,000) Amortization of transition amount (58,000) (58,000) Other 410,000 229,000 ------------ ------------ Net periodic pension expense $ 1,466,000 $ 1,008,000 ============ ============ </TABLE> The Registrant contributed $3,000,000 to its U.S. benefit plans and $604,000 to its non-U.S. benefit plans during the first quarter of 2004. In April 2004, the Registrant contributed an additional $405,000 to its U.S. benefit plans; it does not anticipate any further funding in 2004. In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the "Act") became law. The Act introduced a prescription drug benefit under Medicare and a federal subsidy to sponsors of certain retiree health care benefit plans. The Act did not and will not have a material impact on the Registrant's accumulated postretirement obligations, results of operations or cash flows. 5. GOODWILL Changes in the carrying amount of goodwill for the quarter ended March 31, 2004, by operating segment, were as follows: <TABLE> <CAPTION> Environmental Fire Safety Products Rescue Products Tool Total ------------- ------------- ------------- ------------- ------------- <S> <C> <C> <C> <C> <C> Goodwill balance January 1, 2004 $ 139,937,000 $ 41,205,000 $ 102,421,000 $ 82,851,000 $ 366,414,000 Translation (168,000) (909,000) 302,000 (102,000) (877,000) ------------- ------------- ------------- ------------- ------------- Goodwill balance March 31, 2004 $ 139,769,000 $ 40,296,000 $ 102,723,000 $ 82,749,000 $ 365,537,000 ============= ============= ============= ============= ============= </TABLE> 10
6. OTHER INTANGIBLE ASSETS The components of the Registrant's other intangible assets as of March 31, 2004 were as follows: <TABLE> <CAPTION> Weighted- Gross Net average carrying Accumulated carrying useful life value amortization value ------------ ------------ ------------ ------------ (Years) <S> <C> <C> <C> <C> Amortizable: Developed software 6 $ 12,190,000 $ (4,006,000) $ 8,184,000 Customer relationships 20 1,850,000 (138,000) 1,712,000 Distribution network 40 1,300,000 (49,000) 1,251,000 Non-amortizable tradenames 2,510,000 2,510,000 ------------ ------------ ------------ Total $ 17,850,000 $ (4,193,000) $ 13,657,000 ============ ============ ============ </TABLE> Amortization expense for the three months ended March 31, 2004 totaled $302,000. The estimated aggregate amortization expense for the next five years is as follows: $908,000 in 2004 (remaining nine months), $1,634,000 in 2005, $1,492,000 in 2006, $1,185,000 in 2007, $1,158,000 in 2008, $1,089,000 in 2009 and $3,681,000 thereafter. Other intangible assets are included in the condensed consolidated balance sheets within "Other deferred charges and assets." 7. DERIVATIVE FINANCIAL INSTRUMENTS To manage interest costs, the Registrant utilizes interest rate swaps in combination with its funded debt. Interest rate swaps executed in conjunction with long-term private placements maturing between 2004 and 2012 effectively converted fixed rate debt to variable rate debt (fair value hedges). The Registrant is also party to agreements with financial institutions to swap interest rates in which the Registrant pays interest at a fixed rate on debt maturing between 2004 and 2010 and receives interest at variable LIBOR rates (cash flow hedges). The Registrant designates foreign currency forward exchange contracts as fair value hedges to protect against the variability in exchange rates on short-term intercompany borrowings and firm commitments denominated in foreign currencies maturing in 2004. The Registrant also manages the volatility of cash flows caused by fluctuations in currency rates by entering into foreign exchange forward and option contracts. These derivative instruments hedge portions of the Registrant's anticipated third party purchases and forecast intercompany sales denominated in foreign currencies maturing between 2004 and 2006. The following table summarizes the Registrant's derivative instruments as of March 31, 2004: <TABLE> <CAPTION> Notional Fair amount value ------------- ------------- <S> <C> <C> Interest rate contracts: Fair value swaps $ 230,000,000 $ (1,152,000) Cash flow swaps 95,000,000 (2,376,000) ------------- ------------- Total interest rate contracts $ 325,000,000 $ (3,528,000) ============= ============= Foreign currency contracts: Fair value forwards $ 24,136,000 $ (250,000) Cash flow forwards 41,795,000 1,246,000 Options 11,160,000 39,000 ------------- ------------- Total foreign currency contracts $ 77,091,000 $ 1,035,000 ============= ============= </TABLE> The Registrant expects $601,000 of pre-tax net gains that are reported in accumulated other comprehensive income as of March 31, 2004 to be reclassified into earnings during the next 12 months. The Registrant terminated various interest rate swaps associated with its debt portfolio in response to movements in the interest rate market. These transactions resulted in cash payments of $506,000 during the three months ended March 31, 2004 and cash receipts of $2,863,000 during the three months ended March 31, 2003. The cash impact is included in the condensed consolidated statements of cash flows within "Working capital changes and other." 11
8. RESTRUCTURING AND OTHER CHARGES During the first quarter of 2003, the Registrant approved a restructuring plan that principally included the closing of two manufacturing facilities to improve operating efficiencies and reduce costs. As a result of this plan, the Registrant recognized pre-tax restructuring and other charges of $1,636,000 for the three month period ended March 31, 2003. These charges are primarily aggregated within selling, general and administrative expenses. 9. LEGAL PROCEEDINGS The Registrant is subject to various claims, other pending and possible legal actions for product liability and other damages and other matters arising out of the conduct of the Registrant's business. The Registrant believes, based on current knowledge and after consultation with counsel, that the outcome of such claims and actions will not have a material adverse effect on the Registrant's consolidated financial position or the results of operations. However, in the event of unexpected future developments, it is possible that the ultimate resolution of such matters, if unfavorable, could have a material adverse effect on the Registrant's results of operations. The Registrant has been sued by firefighters in Chicago seeking damages and claiming that exposure to the Registrant's sirens has impaired their hearing and that the sirens are therefore defective. There were 33 cases filed during the period 1999-2004, involving a total of 2,396 plaintiffs pending in the Circuit Court of Cook County, Illinois. Also during 2003, an additional lawsuit was filed in Williamson County, Illinois against the Registrant and 15 other unrelated co-defendants seeking class certification for plaintiffs claiming damages to their hearing allegedly as a result of exposure to the Registrant's sirens and design defects in the unrelated co-defendant's fire trucks. The plaintiffs' attorneys have threatened to bring more suits if the Registrant does not settle these cases. The Registrant believes that these product liability suits have no merit and that sirens are necessary in emergency situations and save lives. The discovery phase of the litigation began in 2004; the Registrant intends to aggressively defend these matters. The Registrant successfully defended approximately 41 similar cases in Philadelphia in 1999 after a series of unanimous jury verdicts in favor of the Registrant. During the first quarter of 2004, a judge in Orange County, California entered a $10,185,000 judgment against Safety Storage, Inc. ("SSI") on grounds that SSI defrauded a third party creditor. The Registrant holds a 30% minority interest investment in SSI. As the judgment may force SSI into filing for bankruptcy reorganization under Chapter 11, SSI is currently in settlement negotiations with the third party creditor. The Registrant's potential loss exposure is estimated to range from $300,000 to its investment. The Registrant reduced its investment in SSI through a $300,000 charge to earnings in the first quarter of 2004 to $2,900,000 as of March 31, 2004. 10. NET INCOME PER SHARE The following table summarizes the information used in computing basic and diluted income per share: <TABLE> <CAPTION> Three months ended March 31, ---------------------------- 2004 2003 ------------ ------------ <S> <C> <C> Numerator for both basic and diluted income per share computations: Net income $ 2,199,000 $ 6,467,000 ============ ============ Denominator for basic income per share - weighted average shares outstanding 48,026,000 47,859,000 Effect of employee stock options (dilutive potential common shares) 91,000 5,000 ------------ ------------ Denominator for diluted income per share - adjusted shares 48,117,000 47,864,000 ============ ============ </TABLE> 12
11. SEGMENT INFORMATION The following table summarizes the Registrant's operations by segment for the three-month periods ended March 31, 2004 and 2003: <TABLE> <CAPTION> Three months ended March 31, ------------------------------- 2004 2003 ------------- ------------- <S> <C> <C> Net sales Environmental Products $ 91,101,000 $ 84,712,000 Fire Rescue 71,553,000 98,662,000 Safety Products 69,255,000 67,188,000 Tool 44,609,000 41,389,000 ------------- ------------- Total net sales $ 276,518,000 $ 291,951,000 ============= ============= Operating income (loss) Environmental Products $ 2,609,000 $ 1,605,000 Fire Rescue (2,841,000) 2,123,000 Safety Products 7,718,000 6,530,000 Tool 5,734,000 4,472,000 Corporate expense (4,352,000) (3,515,000) ------------- ------------- Total operating income 8,868,000 11,215,000 Interest expense (4,865,000) (4,895,000) Minority interest (57,000) 173,000 Other income (expense) (970,000) 130,000 ------------- ------------- Income before income taxes $ 2,976,000 $ 6,623,000 ============= ============= </TABLE> There have been no material changes in total assets from the amount disclosed in the Registrant's last annual report. 12. COMMITMENTS AND GUARANTEES The Registrant issues product performance warranties to customers with the sale of its products. The specific terms and conditions of these warranties vary depending upon the product sold and country in which the Registrant conducts business, with warranty periods generally ranging from 6 months to 5 years. The Registrant estimates the costs that may be incurred under its basic limited warranty and records a liability in the amount of such costs at the time the sale of the related product is recognized. Factors that affect the Registrant's warranty liability include the number of units under warranty from time to time, historical and anticipated rates of warranty claims and costs per claim. The Registrant periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary. Changes in the Registrant's warranty liabilities for the three-month periods ended March 31, 2004 and 2003 were as follows: <TABLE> <CAPTION> Three months ended March 31, ----------------------------- 2004 2003 ------------ ------------ <S> <C> <C> Balance at January 1 $ 12,861,000 $ 13,714,000 Provisions to expense 3,477,000 2,884,000 Actual costs incurred (4,362,000) (4,067,000) ------------ ------------ Balance at March 31 $ 11,976,000 $ 12,531,000 ============ ============ </TABLE> The Registrant guarantees the debt of a third-party dealer that sells the Registrant's vehicles. The notional amounts of the guaranteed debt as of March 31, 2004 totaled $735,000. No losses have been incurred as of March 31, 2004. The guarantees expire between 2004 and 2006. 13
The Registrant also provides residual value guarantees on vehicles sold to certain customers. Proceeds received in excess of the fair value of the guarantee are deferred and amortized into income ratably over the life of the guarantee. The Registrant recorded these transactions as operating leases and recognized liabilities equal to the fair value of the guarantees. The notional amounts of the residual value guarantees totaled $3,480,000 as of March 31, 2004. No losses have been incurred as of March 31, 2004. The guarantees expire between 2004 and 2010. 13. NEW ACCOUNTING PRONOUNCEMENTS In December 2003, the FASB issued SFAS No. 132 (revised 2003), "Employers Disclosures about Pensions and Other Postretirement Benefits" to improve financial statement disclosures for defined benefit plans. SFAS 132 requires more detailed disclosures about plan assets, benefit obligations, cash flows, benefit costs and other relevant information. The disclosures are generally effective for fiscal years ending after December 31, 2003; a six month delay in the effective date was provided for non-U.S. plans. The Registrant adopted the additional disclosure provisions of SFAS 132 for its U.S. plans as of December 31, 2003. 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Federal Signal Corporation manufactures a broad range of municipal and industrial cleaning vehicles and equipment; fire rescue vehicles; safety, signaling and communication equipment and tooling products. Due to technology, marketing, distribution and product application synergies, the Registrant's business units are organized and managed in four operating segments: Environmental Products, Fire Rescue, Safety Products and Tool. The Registrant also provides customer and dealer financing to support the sale of vehicles. Consolidated Results of Operations The following table presents the Registrant's results of operations for the three months ended March 31, 2004 and 2003, respectively (in millions): <TABLE> <CAPTION> Three months ended March 31, ---------------------------- 2004 2003 ------------ ------------ <S> <C> <C> Net sales $ 276.5 $ 291.9 Cost of sales 209.0 217.6 ------------ ------------ Gross profit 67.5 74.3 Operating expenses 58.6 63.1 ------------ ------------ Operating income 8.9 11.2 Interest expense and other 5.9 4.5 Income taxes 0.8 0.2 ------------ ------------ Net income $ 2.2 $ 6.5 ============ ============ </TABLE> The 5% reduction in sales to $276.5 million in 2004 was largely associated with lower North American sales of fire rescue equipment, mainly caused by lower truck completions in US plants during the quarter. Partly offsetting were increased sales in the other three groups. The reduction in operating income was attributable to lower operating earnings for Fire Rescue and a planned Corporate expense increase to $4.3 million from $3.5 million in 2003, due in part to higher legal costs associated with hearing loss claims and the Registrant's decision to aggressively defend against those loss claims, partly offset by stronger earnings for Environmental Products, Safety Products and Tool. Interest expense was flat with 2003 on essentially flat debt balances. Other expense of $1.0 million mainly reflects the settlement of three different dealer and distributor relationships or disagreements. The effective tax rate returned to a more normalized rate of 26.1%; the 2003 rate was sharply lower due to the one-time $1,863,000 tax benefit of a deduction associated with the closure of a production facility in the UK. Orders and Backlog First quarter orders increased 7.7% to $305.4 million from $283.6 million for the comparable period of 2003. US industrial and commercial orders rose 9.4% to $100.0 million, driven by increased demand for industrial safety products, tooling, street sweepers and industrial vacuum trucks. First quarter orders in international markets reached a record $103.9 million, up 32.0% from the prior year. The increase reflected strong export demand for fire rescue trucks, industrial vacuum trucks and street sweepers, and for aerial devices produced in Finland. Also contributing to the increase was the effect of the weaker dollar, which accounted for approximately one-third of the 32.0% rise. Partly offsetting the industrial and international increases was a 10.2% decline in US municipal market orders, due principally to weaker fire rescue orders. Quarter-end backlog rose to $392.5 million, up $30.7 million from year-end 2003. All groups experienced increased backlog, particularly Environmental Products, due to strong street sweeper and refuse truck body orders, and Fire Rescue, due to strong orders for products manufactured in our Finland-based aerial operation. 15
Environmental Products The following table summarizes the Environmental Products Group's operating results for the three months ended March 31, 2004 and 2003, respectively (in millions): <TABLE> <CAPTION> Three months ended March 31, ---------------------------- 2004 2003 ------------ ----------- <S> <C> <C> Net sales $ 91.1 $ 84.7 Operating income 2.6 1.6 Operating margin 2.9% 1.9% </TABLE> Environmental Products sales rose 7.5% to $91.1 million from $84.7 million in 2003 and operating margin improved slightly to 2.9% from 1.9% in the prior year. Sales increased significantly for street sweepers, sewer cleaners, industrial vacuum trucks and water blasters, consistent with stronger US industrial and international markets. Refuse truck body sales declined from the prior year despite higher orders due to the timing of receipt of new business. The group's operating earnings improved 62.6% from a weak prior year quarter on higher volumes and an improved sales mix. Partly offsetting were the adverse impact on production costs of the stronger Canadian dollar and higher steel prices, some of which will not be recouped from the market this year. Fire Rescue The following table summarizes the Fire Rescue Group's operating results for the three months ended March 31, 2004 and 2003, respectively (in millions): <TABLE> <CAPTION> Three months ended March 31, ---------------------------- 2004 2003 ------------ ------------ <S> <C> <C> Net sales $ 71.5 $ 98.6 Operating income (loss) (2.8) 2.1 Operating margin (4.0)% 2.2% </TABLE> Fire Rescue sales decreased 27.5% to $71.5 million. Operating margin was -4.0% versus 2.2% in 2003. Sales and earnings declined significantly due to lower truck completions in US plants. The year-over-year reduction in production was planned in part due to weak third quarter 2003 orders. This resulted in the reduced availability of trucks configured for production in the Ocala, Florida operations early in the first quarter of 2004. As planned, the Ocala operations completed the closure of a satellite production facility and moved this production into an existing plant, where lean enterprise initiatives had freed up production space. This consolidation will reduce fixed costs by about $.7 million per year. Production in the quarter was disrupted due to a bottleneck in a feeder plant caused in part by supply disruptions. Although operations improved later in the quarter, completed and sold trucks were lower than planned and overhead absorption was unfavorable. 16
Safety Products The following table summarizes the Safety Products Group's operating results for the three months ended March 31, 2004 and 2003, respectively (in millions): <TABLE> <CAPTION> Three months ended March 31, ---------------------------- 2004 2003 ----------- ------------ <S> <C> <C> Net sales $ 69.3 $ 67.2 Operating income 7.7 6.5 Operating margin 11.1% 9.7% </TABLE> Safety Products sales increased 3.1% to $69.3 million. Operating margin rose to 11.1% from 9.7% in 2003. The increase in revenue reflects strength in US industrial markets, which generally comprise about 45% of this group's sales. Sales of hazardous liquid containment and industrial signaling and lighting products were particularly strong. Partly offsetting were lower sales of airport parking equipment and US police products. Operating margins improved on the higher sales volume as well as the absence of costs incurred last year associated with the shutdown of a production facility in the UK; these improvements were partly offset by higher pension expenses. Tool The following table summarizes the Tool Group's operating results for the three months ended March 31, 2004 and 2003, respectively (in millions): <TABLE> <CAPTION> Three months ended March 31, ---------------------------- 2004 2003 ----------- ------------ <S> <C> <C> Net sales $ 44.6 $ 41.4 Operating income 5.7 4.5 Operating margin 12.9% 10.8% </TABLE> Tool sales rose 7.8% to $44.6 million. Operating margin rose to 12.9% from 10.8%. All product lines increased sales compared to prior year and last quarter, consistent with a 5% increase in daily orders from US industrial customers. Increased international orders mainly reflected the benefit of the stronger Euro. Activity in Germany and France declined in the quarter, but was offset by increases in Japan and Canada. Operating margins improved, as planned, due to the increase in sales and lower fixed costs, which benefited from the shutdown of a US plant during 2003. Seasonality of Registrant's Business Certain of the Registrant's businesses are susceptible to the influences of seasonal buying or delivery patterns. The Registrant's businesses which tend to have lower sales in the first calendar quarter compared to other quarters as a result of these influences are street sweeping, outdoor warning, municipal emergency signal products, parking systems and fire rescue products. Financial Position, Liquidity and Capital Resources The Registrant utilizes its operating cash flow and available borrowings under its revolving credit facility for working capital needs of its operations, capital expenditures, strategic acquisitions of companies operating in markets related to those already served, debt repayments, share repurchases and dividends. The Registrant anticipates that its financial resources and major sources of liquidity, including cash flow from operations and borrowing capacity, will continue to be adequate to meet its operating and capital needs in addition to its financial commitments. 17
The following table summarizes the Registrant's cash flows for the three months ended March 31, 2004 and 2003, respectively (in millions): <TABLE> <CAPTION> Three months ended March 31, ---------------------------- 2004 2003 ------------ ------------ <S> <C> <C> Operating cash flow $ 2.0 $ 17.9 Capital expenditures (4.3) (4.5) Financial services activities, net 5.4 (0.9) Borrowing activity, net (7.0) (4.2) Dividends (4.8) (9.5) Other 0.6 0.9 ------------ ------------ Decrease in cash and cash equivalents $ (8.1) $ (0.3) ============ ============ </TABLE> Operating cash flow totaled $2.0 million for the quarter, significantly below the prior year because of poor operations with the fire rescue and refuse truck businesses and a build-up of inventories, particularly at the Ocala operations due to production bottlenecks; inventories should decline in the second quarter. Also contributing to the reduction in operating cash flow was $3.6 million in discretionary pension contributions in 2004 and cash payments on the settlement and termination of certain derivative instruments in 2004 versus cash proceeds on terminations in the prior year. Cash proceeds received in 2003 from the favorable termination of six interest rate swaps accounts for the significant increase in cash paid for interest from $.4 million in 2003 to $2.3 million in 2004. Financial services activities generated $5.4 million in cash flow in the first quarter of 2004 as numerous customers paid off their loans early. At March 31, 2004, the Registrant's manufacturing debt was $268.3 million, up slightly from December 31, 2003 despite $7.0 million in debt repayments in the first quarter of 2004. These payments were largely offset by a $5.9 million non-cash decline in the fair value of designated interest rate swaps due to the rising interest rate environment. Likewise, the debt-to-capitalization ratio increased slightly to 41% from 40% as of December 31, 2003. The Registrant's debt facilities contain covenants relating to a maximum debt-to-capitalization ratio, minimum interest coverage and minimum net worth. As of March 31, 2004, the Registrant was in compliance with the financial covenants of its debt agreements. As of March 31, 2004, the Registrant had $182.0 million of availability under its $250.0 million unsecured revolving credit facility maturing in 2006. Borrowings under this facility bear interest at a variable rate of LIBOR plus a spread of .83%. The spread is subject to adjustment based on the level of outstanding borrowings. In October 2003, the Registrant announced a 50% reduction in the quarterly dividend from $.20 per share to $.10 per share in order to improve its long-term financial position in view of the further weakening of the U.S. state and municipal markets and the lack of a conclusive rebound in the industrial economy. This decision resulted in the $4.7 million decrease in dividends paid in 2004's first quarter. The Registrant focuses substantial effort on improving the utilization of its working capital. The Registrant's primary working capital as a percent of net sales was 25.4% and 23.3% as of March 31, 2004 and December 31, 2003, respectively. The increase in the ratio is primarily due to the build-up of inventories within the US Fire Rescue production facilities from the aforementioned operational issues. 18
Contractual Obligations and Commercial Commitments The following table presents a summary of the Registrant's contractual obligations (in millions): <TABLE> <CAPTION> March 31, December 31, 2004 2003 ---------- ------------ <S> <C> <C> Long-term debt obligations $ 380.7 $ 380.6 Operating lease obligations 25.7 27.6 Fair value of interest rate swaps (3.5) (9.4) Fair value of foreign currency contracts (1.0) (2.5) ---------- ------------ $ 401.9 $ 396.3 ========== ============ </TABLE> The $5.9 million reduction in the fair value of the Registrant's interest rate swaps occurred as a result of contract settlements, contract terminations and market expectations that interest rates will increase in the future thereby shifting the implied yield curve higher. The strengthening of the US dollar against the Euro and Canadian dollar contributed to the $1.5 million decline in the fair value of the foreign currency contracts. Refer to Footnote 12 of the financial statements included in Part I of this Form 10-Q for a discussion of the Registrant's commercial commitments (guarantees). Critical Accounting Policies and Estimates As of March 31, 2004, there were no material changes to the Registrant's critical accounting policies and estimates disclosed in its Form 10-K for the year ended December 31, 2003. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Registrant is subject to market risk associated with changes in interest rates and foreign exchange rates. To mitigate this risk, the Registrant utilizes interest rate swaps and foreign currency forward and option contracts. The Registrant does not hold or issue derivative financial instruments for trading or speculative purposes and is not party to leverage derivatives. The Registrant manages its exposure to interest rate movements by maintaining a proportionate relationship between fixed-rate debt to total debt within established percentages. The Registrant uses funded fixed-rate borrowings as well as interest rate swap agreements to balance its overall fixed-to-floating interest rate mix. Of the Registrant's debt at March 31, 2004, 42% was used to support financial services assets. The Registrant is currently comfortable with a sizeable portion of floating rate debt to support these financial services assets, since a rise in borrowing rates would normally correspond with an increase in lending rates within a reasonable period. The Registrant also has foreign currency exposures related to buying and selling in currencies other than the local currency in which it operates. The Registrant utilizes foreign currency forward and option contracts to manage risks associated with sales and purchase commitments as well as forecast transactions denominated in foreign currencies. The information contained under the caption "Contractual Obligations and Commercial Commitments" included in Item 2 of this Form 10-Q discusses the changes in the Registrant's exposure to market risk during the first quarter of 2004. For additional information, refer to the discussion contained under the caption "Market Risk Management" included in Item 7 of the Registrant's Form 10-K for the year ended December 31, 2003. ITEM 4. CONTROLS AND PROCEDURES As required by Rule 13a-15 under the Securities Exchange Act of 1934, the Registrant's management, with the participation of the Registrant's Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Registrant's disclosure controls and procedures as of March 31, 2004. Based on that evaluation, the Registrant's Chief Executive Officer and Chief Financial Officer concluded that the Registrant's disclosure controls and procedures were effective as of March 31, 2004. As a matter of practice, the Registrant's management continues to review and document disclosure controls and procedures, including internal controls and procedures for financial reporting. From time to time, the Registrant may make changes aimed at enhancing the effectiveness of the controls and to ensure that the systems evolve with the business. During the quarter ended March 31, 2004, there were no changes in the Registrant's internal controls over financial reporting that has materially affected, or is reasonably likely to materially affect, the Registrant's internal control over financial reporting. 19
PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Footnote 9 of the financial statements included in Part I of this Form 10-Q is incorporated herein by reference. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit 10 General Release and Separation Agreement, dated February 29, 2004, by and between the Registrant and Kim A. Wehrenberg Exhibit 31.1 CEO Certification under Section 302 of the Sarbanes-Oxley Act Exhibit 31.2 CFO Certification under Section 302 of the Sarbanes-Oxley Act Exhibit 32.1 CEO Certification of Periodic Report under Section 906 of the Sarbanes-Oxley Act Exhibit 32.2 CFO Certification of Periodic Report under Section 906 of the Sarbanes-Oxley Act (b) Reports on Form 8-K filed during the quarter ended March 31, 2004: A Form 8-K was filed on January 30, 2004, under Items 7 and 12, reporting the Registrant's press release dated January 29, 2004 that disclosed its financial results for the fourth quarter and full year ended December 31, 2003. A Form 8-K was filed on February 18, 2004, under Items 7 and 12, reporting an amendment to the Registrant's Code of Ethics for CEO and Senior Financial Officers. 20
SIGNATURE 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. Federal Signal Corporation 5/5/04 By: /s/ Stephanie K. Kushner - ------ ------------------------------------------ Date Stephanie K. Kushner Vice President and Chief Financial Officer 21
EXHIBIT INDEX Exhibit No. Description 10 General Release and Separation Agreement, dated February 29, 2004, by and between the Registrant and Kim A. Wehrenberg, is filed herewith. 31.1 CEO Certification under Section 302 of the Sarbanes-Oxley Act, is filed herewith. 31.2 CFO Certification under Section 302 of the Sarbanes-Oxley Act, is filed herewith. 32.1 CEO Certification of Periodic Report under Section 906 of the Sarbanes-Oxley Act, is filed herewith. 32.2 CFO Certification of Periodic Report under Section 906 of the Sarbanes-Oxley Act, is filed herewith. 22