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 September 30, 2003 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 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 47,982,000 shares outstanding at October 31, 2003
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS INTRODUCTION 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. 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. It is suggested that these consolidated condensed financial statements 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, 2002. 2
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited) <TABLE> <CAPTION> Three months ended September 30, Nine months ended September 30, -------------------------------- ------------------------------- 2003 2002 2003 2002 ---- ---- ---- ---- <S> <C> <C> <C> <C> Net sales $ 287,810,000 $ 261,615,000 $ 890,802,000 $ 765,123,000 Costs and expenses: Cost of sales (209,764,000) (187,553,000) (655,316,000) (546,424,000) Selling, general and administrative (61,329,000) (52,474,000) (188,444,000) (158,096,000) ----------- ----------- ----------- ----------- Operating income 16,717,000 21,588,000 47,042,000 60,603,000 Interest expense (5,132,000) (4,739,000) (15,167,000) (14,586,000) Other income (expense), net 212,000 (1,251,000) 404,000 (1,537,000) Minority interest 3,000 40,000 212,000 25,000 ----------- ----------- ----------- ----------- Income from continuing operations before income taxes 11,800,000 15,638,000 32,491,000 44,505,000 Income taxes (1,861,000) (3,145,000) (6,138,000) (11,506,000) ----------- ----------- ----------- ----------- Income from continuing operations 9,939,000 12,493,000 26,353,000 32,999,000 Loss on disposal of discontinued operations, net of tax benefit of $222,000 (369,000) Cumulative effect of change in accounting (7,984,000) ----------- ----------- ----------- ----------- Net income $ 9,939,000 $ 12,493,000 $ 25,984,000 $ 25,015,000 =========== =========== =========== =========== COMMON STOCK DATA: Basic and diluted net income per share: Income from continuing operations $.21 $.28 $.55 $.73 Loss on disposal of discontinued operations (.01) Cumulative effect of change in accounting (.18) --- --- --- --- Net income* $.21 $.28 $.54 $.55 === === === === Weighted average common shares outstanding Basic 47,977,000 45,305,000 47,938,000 45,223,000 Diluted 48,051,000 45,358,000 47,977,000 45,371,000 Cash dividends per share of common stock $.20 $.20 $.60 $.60 </TABLE> * amounts above may not add due to rounding See notes to condensed consolidated financial statements. 3
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) <TABLE> <CAPTION> Three months ended September 30, Nine months ended September 30, -------------------------------- ------------------------------- 2003 2002 2003 2002 ---- ---- ---- ---- <S> <C> <C> <C> <C> Net income $ 9,939,000 $ 12,493,000 $ 25,984,000 $ 25,015,000 Other comprehensive income (loss), net of tax - Foreign currency translation adjustments 807,000 (394,000) 7,336,000 5,033,000 Net derivative gain (loss), cash flow hedges (466,000) (575,000) 1,821,000 (1,188,000) ---------- ---------- ---------- ---------- Comprehensive income $ 10,280,000 $ 11,524,000 $ 35,141,000 $ 28,860,000 ========== ========== ========== ========== </TABLE> See notes to condensed consolidated financial statements. 4
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> September 30, December 31, 2003 2002 (a) ------------- ------------- (Unaudited) <S> <C> <C> ASSETS Manufacturing activities - Current assets: Cash and cash equivalents $ 7,631,000 $ 9,782,000 Trade accounts receivable, net of allowances for doubtful accounts 204,166,000 181,843,000 Inventories: Raw materials 65,317,000 68,879,000 Work in process 61,503,000 63,971,000 Finished goods 55,405,000 50,952,000 Prepaid expenses 15,531,000 19,390,000 --------------- --------------- Total current assets 409,553,000 394,817,000 Properties and equipment: Land 6,378,000 6,251,000 Buildings and improvements 61,706,000 69,359,000 Machinery and equipment 237,708,000 233,677,000 Accumulated depreciation (180,888,000) (165,355,000) --------------- --------------- Net properties and equipment 124,904,000 143,932,000 --------------- --------------- Goodwill, net of accumulated amortization 362,038,000 348,435,000 Other deferred charges and assets 63,602,000 44,046,000 --------------- --------------- Total manufacturing assets 960,097,000 931,230,000 Net assets of discontinued operations, including financial assets 10,392,000 Financial services activities - Lease financing receivables, net of allowances for doubtful accounts 227,875,000 226,788,000 --------------- --------------- Total assets $ 1,187,972,000 $ 1,168,410,000 =============== =============== </TABLE> See notes to condensed consolidated financial statements. (a) The balance sheet at December 31, 2002 has been derived from the audited financial statements at that date. 5
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS -- Continued <TABLE> <CAPTION> September 30, December 31, 2003 2002 (a) ------------- ----------- (Unaudited) <S> <C> <C> LIABILITIES Manufacturing activities - Current liabilities: Short-term borrowings $ 72,216,000 $ 16,432,000 Trade accounts payable 88,393,000 76,082,000 Customer deposits 25,949,000 28,326,000 Accrued liabilities and income taxes 119,516,000 101,044,000 --------------- --------------- Total current liabilities 306,074,000 221,884,000 Long-term borrowings 198,222,000 279,544,000 Long-term pension and other liabilities 39,161,000 32,656,000 Deferred income taxes 36,157,000 33,495,000 --------------- --------------- Total manufacturing liabilities 579,614,000 567,579,000 --------------- --------------- Financial services activities -- Borrowings 199,391,000 202,022,000 Minority interest in subsidiary 532,000 744,000 SHAREHOLDERS' EQUITY Common stock -- par value 48,419,000 48,394,000 Capital in excess of par value 91,193,000 91,114,000 Retained earnings 310,885,000 313,684,000 Treasury stock (14,835,000) (18,026,000) Deferred stock awards (2,419,000) (3,136,000) Accumulated other comprehensive loss (24,808,000) (33,965,000) --------------- --------------- Total shareholders' equity 408,435,000 398,065,000 --------------- --------------- Total liabilities and shareholders' equity $ 1,187,972,000 $ 1,168,410,000 =============== =============== </TABLE> See notes to condensed consolidated financial statements. (a) The balance sheet at December 31, 2002 has been derived from the audited financial statements at that date. 6
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) <TABLE> <CAPTION> Nine Months Ended September 30, 2003 2002 ---- ---- <S> <C> <C> Operating activities: Net income $ 25,984,000 $ 25,015,000 Cumulative effect of change in accounting 7,984,000 Loss on disposal of discontinued operations 369,000 Depreciation 18,018,000 15,639,000 Amortization 1,676,000 1,622,000 Working capital changes and other 11,460,000 27,105,000 ------------- ------------- Net cash provided by operating activities 57,507,000 77,365,000 Investing activities: Purchases of properties and equipment (12,498,000) (12,931,000) Principal extensions under lease financing agreements (122,806,000) (117,992,000) Principal collections under lease financing agreements 121,613,000 125,661,000 Payment for purchases of companies, net of cash acquired (10,479,000) Proceeds from sale of discontinued operations 7,453,000 Other, net (1,255,000) (2,490,000) ------------- ------------- Net cash used for investing activities (7,493,000) (18,231,000) Financing activities: Decrease in short-term borrowings, net (68,771,000) (35,849,000) Increase (decrease) in long-term borrowings 44,629,000 (2,418,000) Purchases of treasury stock (117,000) (4,328,000) Cash dividends paid to shareholders (28,737,000) (26,921,000) Other, net 831,000 1,781,000 ------------- ------------- Net cash used for financing activities (52,165,000) (67,735,000) Decrease in cash and cash equivalents (2,151,000) (8,601,000) Cash and cash equivalents at beginning of period 9,782,000 16,882,000 ------------- ------------- Cash and cash equivalents at end of period $ 7,631,000 $ 8,281,000 ============= ============= </TABLE> See notes to condensed consolidated financial statements. 7
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. It is suggested that the condensed consolidated financial statements be read in conjunction with the financial statements and the notes thereto included in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2002. 2. 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 and nine months ended September 30, 2003 are not necessarily indicative of the results to be expected for the full year of 2003. 3. The following table illustrates the effect on net income and earnings per share for the nine-month periods ended September 30, 2003 and 2002 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> Nine Months Ended September 30, 2003 2002 ---- ---- <S> <C> <C> Reported net income $25,984,000 $25,015,000 Deduct: Total stock-based employee compensation expense determined under the fair-value method for all awards, net of related tax effects (595,000) (787,000) ---------- ---------- Pro forma net income $25,389,000 $24,228,000 ========== ========== Basic net income per common share: Reported net income $.54 $.55 Pro forma net income $.53 $.54 Diluted net income per share: Reported net income $.54 $.55 Pro forma net income $.53 $.53 </TABLE> The Registrant recorded stock-based employee compensation expense of $1,019,000 and $1,155,000 for the nine months ended September 30, 2003 and 2002, respectively. 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. 4. Interest paid for the nine-month periods ended September 30, 2003 and 2002 was $13,781,000 and $13,598,000, respectively. Income taxes paid for these same periods were $3,260,000 and $5,785,000, respectively. 5. The Registrant's effective tax rates were 18.9% and 25.9% for the nine-month periods ended September 30, 2003 and 2002, respectively. The rate reduction is due to a $1,863,000 tax benefit was recorded in the quarter ended March 31, 2003 associated with the closure of a production facility in the United Kingdom and a higher proportion of tax-free municipal income in 2003. 6. In September 2002, the Registrant acquired Leach Company ("Leach"), a leading manufacturer of rear load refuse collection bodies located in Oshkosh, Wisconsin. Leach, whose market strength is primarily in government and municipal markets, utilizes a dealer channel similar to other Environmental Products Group operations. In October 2002, the Registrant also acquired Wittke, Inc. ("Wittke"), a manufacturer of dynamic truck-mounted refuse collection equipment located in Medicine Hat, Alberta and Kelowna, British Columbia. Wittke brand products include front load, side load and automated side load 8
refuse truck bodies. Wittke sold direct to customers at the time of acquisition, and is particularly strong in the private contractors and large waste hauling company market segments. The Registrant acquired Leach and Wittke using a combination of cash and stock totaling $101,260,000. As a result of these acquisitions in 2002, the Registrant recorded $12,733,000 of working capital, $19,600,000 of fixed and other long-term assets, $5,660,000 of intangible assets, $3,163,000 of restructuring costs incurred in connection with the shut down of an acquired, non-strategic components facility, $8,080,000 of long-term liabilities and $74,510,000 of goodwill. The Registrant also assumed $10,500,000 in debt. 7. The Registrant adopted SFAS No. 142, and accordingly discontinued the amortization of goodwill effective January 1, 2002. As part of the adoption, the Registrant completed a transitional goodwill impairment test and determined that $7,984,000 of goodwill related to a niche Tool group business was impaired. This amount was therefore recognized as a charge to net income as a cumulative effect of a change in accounting in 2002. The Registrant determined the fair value of the reporting unit by calculating the present value of expected future cash flows. Changes in the carrying amount of goodwill for the nine months ended September 30, 2003, by operating segment, are as follows: <TABLE> <CAPTION> Environmental Fire Safety Products Rescue Products Tool Total -------- ------ -------- ---- ----- <S> <C> <C> <C> <C> <C> Goodwill balance January 1, 2003 $128,857,000 $36,930,000 $99,985,000 $82,663,000 $348,435,000 Adjustments 9,461,000 9,461,000 Translation 400,000 2,165,000 1,445,000 132,000 4,142,000 ----------- ---------- ----------- ---------- ----------- Goodwill balance September 30, 2003 $138,718,000 $39,095,000 $101,430,000 $82,795,000 $362,038,000 =========== ========== =========== ========== =========== </TABLE> The adjustments reflect the finalization of property, equipment and intangible appraisals, restructuring plans and warranty campaigns relating to the 2002 acquisitions of Leach and Wittke. The components of the Registrant's other intangible assets as of September 30, 2003 are as follows: <TABLE> <CAPTION> Weighted- Gross Net Average Carrying Accumulated Carrying Useful Life Value Amortization Value ----------- ----- ------------ ----- (Years) <S> <C> <C> <C> <C> Amortizable: Customer relationships 20 $1,850,000 (93,000) $1,757,000 Distribution network 40 1,300,000 (32,000) 1,268,000 Non-amortizable: Tradenames 2,510,000 2,510,000 --------- -------- --------- Total $5,660,000 $(125,000) $5,535,000 ========= ======== ========= </TABLE> Amortization expense for the nine months ended September 30, 2003 totaled $125,000. The estimated aggregate amortization expense for the next five years is as follows: $31,000 in 2003 (remaining three months), $125,000 in 2004, $125,000 in 2005, $125,000 in 2006, $125,000 in 2007, $125,000 in 2008 and $2,369,000 thereafter. 8. During 2000, the Registrant decided to divest the operations of the Sign Group and began to search for a qualified buyer of that business. The Sign Group manufactured illuminated, nonilluminated and electronic advertising sign displays primarily for commercial and industrial markets and contracted to provide maintenance services for the signs it manufactured as well as signs manufactured by others. The Sign Group was carried as a discontinued business since the strategic decision was made to exit the business. On April 30, 2003, the Registrant completed the sale of the Sign Group to a third party for cash and a note receivable, which together approximated the net book value of the business. Sign Group revenues for the nine months ended September 30, 2003 and 2002 were $12,844,000 and $31,938,000, respectively. The Registrant retained certain assets and liabilities in conjunction with the sale. 9. 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 pretax restructuring and other charges of $4,600,000 for the nine month period ended September 30, 2003. These charges are primarily aggregated within selling, general and administrative expenses. A nominal amount of these costs remain unpaid as of September 30, 2003. 9
10. The Registrant is subject to various claims, other pending and possible legal actions for product liability and other damages 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. 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 are presently 26 cases filed during the period 1999-2003, involving a total of 1,663 plaintiffs pending in Circuit Court in Cook County, Illinois. An additional lawsuit has been filed in Williamson County, Illinois against the Registrant and three 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-defendants' 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 Registrant successfully defended approximately 41 similar cases in Philadelphia in 1999 after a series of unanimous jury verdicts in favor of the Registrant. 11. The following table summarizes the information used in computing basic and diluted income per share: <TABLE> <CAPTION> Three Months Ended September 30, Nine Months Ended September 30, -------------------------------- ------------------------------- 2003 2002 2003 2002 ---- ---- ---- ---- <S> <C> <C> <C> <C> Numerators for both basic and diluted income per share computations: Income from continuing operations $ 9,939,000 $ 12,493,000 $ 26,353,000 $ 32,999,000 Loss from discontinued operations, net of tax (369,000) Cumulative effect of change in accounting (7,984,000) ---------- ---------- ---------- ---------- Net income $ 9,939,000 $ 12,493,000 $ 25,984,000 $ 25,015,000 ========== ========== ========== ========== Denominator for basic income per share -- weighted average shares outstanding 47,977,000 45,305,000 47,938,000 45,223,000 Effect of employee stock options (dilutive potential common shares) 74,000 53,000 39,000 148,000 ---------- ---------- ---------- ---------- Denominator for diluted income per share -- adjusted shares 48,051,000 45,358,000 47,977,000 45,371,000 ========== ========== ========== ========== </TABLE> 10
12. The following table summarizes the Registrant's operations by segment for the three-month and nine-month periods ended September 30, 2003 and 2002. <TABLE> <CAPTION> Three Months Ended September 30, Nine Months Ended September 30, -------------------------------- ------------------------------- 2003 2002 2003 2002 ---- ---- ---- ---- <S> <C> <C> <C> <C> Net sales Environmental Products $ 88,014,000 $ 68,551,000 $ 260,952,000 $ 213,843,000 Fire Rescue 91,718,000 87,717,000 302,999,000 237,701,000 Safety Products 69,748,000 66,263,000 207,990,000 195,230,000 Tool 38,330,000 39,084,000 118,861,000 118,349,000 ------------- ------------- ------------- ------------- Total net sales $ 287,810,000 $ 261,615,000 $ 890,802,000 $ 765,123,000 ============= ============= ============= ============= Operating income Environmental Products $ 5,308,000 $ 6,189,000 $ 12,183,000 $ 18,707,000 Fire Rescue 1,225,000 3,127,000 8,741,000 8,347,000 Safety Products 9,605,000 10,047,000 24,039,000 28,145,000 Tool 3,511,000 5,294,000 12,197,000 14,464,000 Corporate expense (2,932,000) (3,069,000) (10,118,000) (9,060,000) ------------- ------------- ------------- ------------- Total operating income 16,717,000 21,588,000 47,042,000 60,603,000 Interest expense (5,132,000) (4,739,000) (15,167,000) (14,586,000) Other income (expense) 212,000 (1,251,000) 404,000 (1,537,000) Minority interest 3,000 40,000 212,000 25,000 ------------- ------------- ------------- ------------- Income before income taxes $ 11,800,000 $ 15,638,000 $ 32,491,000 $ 44,505,000 ============= ============= ============= ============= </TABLE> There have been no material changes in total assets from the amount disclosed in the Registrant's last annual report. 13. 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. The Registrant assumed an estimated $13,134,000 of product performance warranties as a result of 2002 acquisitions. Changes in the Registrant's warranty liabilities for the nine-month periods ended September 30, 2003 and 2002 were as follows: <TABLE> <CAPTION> Nine Months Ended September 30, ----------------------------- 2003 2002 ---- ---- <S> <C> <C> Balance at January 1 $13,714,000 $ 6,786,000 Provisions to expense 10,308,000 8,133,000 Actual costs incurred (16,454,000) (8,113,000) Business acquisitions 4,696,000 50,000 ---------- ---------- Balance at September 30 $12,264,000 $ 6,856,000 ========== ========== </TABLE> The 2003 adjustments reflect the revised estimate of the warranty liability relating to the 2002 acquisitions of Leach and Wittke. 14. In September 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 146, "Accounting for Exit or Disposal Activities." SFAS No. 146 addresses significant issues regarding the recognition, measurement and reporting of costs that are associated with exit and disposal activities, including restructuring activities that were accounted for under EITF No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)." The scope of SFAS No. 146 also includes costs related to terminating a contract that is not a capital lease and termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred-compensation contract. The adoption of the provisions of SFAS No. 146 on January 1, 2003 did not have a material impact on the Registrant's consolidated financial position, results of operations or cash flows. 11
15. In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 requires the recognition of a liability for certain guarantee obligations issued or modified after December 31, 2002. FIN 45 also clarifies disclosure requirements to be made by a guarantor for certain guarantees. The disclosure provisions of FIN 45 were effective for fiscal years ending after December 15, 2002. The Registrant adopted the disclosure provisions of FIN 45 as of December 31, 2002 and the accounting requirements on January 1, 2003, which did not have a material impact on the Registrant's consolidated financial position, results of operations or cash flows. 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS THIRD QUARTER 2003 Comparison with Third Quarter 2002 Diluted earnings per share was $.21 from continuing operations for the third quarter of 2003 on sales of $288 million. These results compare to the $.28 per share earned on sales of $262 million in 2002's third quarter. Sales increased 10% as a result of refuse truck body acquisitions in late 2002 and also benefited from the currency translation relative to stronger European and Canadian currencies. Operating margins were lower in all groups, reflecting a lower margin sales mix in several segments. Environmental Products sales and orders increased 28% in the quarter, in large part due to the effects of the acquisitions of two refuse truck body businesses in late 2002. Street sweeper orders were flat with last year, while sales rose 3% due to higher shipments in Europe. The operating margin declined from 9.0% to 6.0% mainly due to the results of the refuse truck business and also lower finance revenues from leasing activities within the group. Refuse truck operating profits improved sequentially with each quarter of 2003; however, the margins remain well below the group average. The refuse truck business continues to experience weak demand in both municipal and industrial markets. A build-up in sales through the newly-established dealer channel has only partially compensated for the generally weaker marketplace. The low sales volumes resulted in reduced throughput and cost absorption, therefore lowering operating margins. As part of its strategic assessment and alignment of the refuse truck business with its other group operating units, the Registrant recently implemented a significant restructuring of its refuse truck workforce in Canada and the U.S., including an announced planned exit of a components production facility in Kelowna, British Columbia. At the reduced employment and fixed cost levels, the business expects volume and margins to improve as markets recover and dealer sales grow. The Registrant received a signed letter of intent to negotiate a new three-year contract to supply front-loading refuse truck bodies to Waste Management beginning in 2004. Upon execution of the new agreement, the Registrant will remain a key supplier to Waste Management for its Canadian and Western U.S. requirements, although absent a significant economic recovery, total volumes supplied to this customer under this prospective contract will likely be materially reduced. Fire Rescue third quarter orders totaled $83 million, down 10% sequentially and 22% versus the prior year. The reduction from 2002 reflected weaker U.S. municipal and governmental orders (down 8%), and the timing on international orders at the Registrant's Finland-based operation, which are even with the prior year for the nine-month period. Third quarter sales increased 5% to $92 million due to additional volumes of pass-through equipment sales associated with deliveries from the Registrant's Finland-based operation under a large contract with Brazil. Excluding these pass-through sales, segment revenues declined slightly, due to lower sales of aerial units and custom pumpers, partly offset by increased sales of rescue units. Operating earnings declined from the prior year, as increases at the Registrant's European operations were more than offset by an adverse sales mix and higher costs at our U.S. operations. Lower U.S. earnings were partly attributable to production disruptions following a realignment of the Registrant's Ocala, Florida based production facilities to accommodate a plant closure early next year. Also adversely affecting earnings were higher operating expenses associated in part with strategic initiatives. Safety Products orders declined significantly from last year, which included the booking of the initial $19 million portion of the Dallas/Ft. Worth International Airport parking project; absent this project, orders were flat. Sales increased 5% from the prior year to $70 million, with airport parking and European municipal vehicular lights and sirens showing gains. Sales also benefited from currency translation effects and pass-through installation and shipping costs which were at low margins. Operating margins averaged 13.8%, a decline from last year's third quarter, reflecting these lower margin sales as well as increased pension and medical costs in the quarter. Operating margin improved sequentially from the second quarter, which included restructuring costs associated with the closure of a U.K.-based business. 13
Tool sales declined 2% as weak U.S. automotive markets continued to adversely affect cutting tool sales. Precision punch and die component sales showed improvement, in part due to strengthening foreign currencies. Operating margins declined to 9.2% in light of the lower sales level and continued higher pension costs, and were also impacted by an unfavorable charge relating to inventory valuation. Gross margin for the Registrant decreased from 28.3% in the second quarter of 2002 to 27.1% in 2003 primarily due to continued weak demand in the refuse truck body business, municipal markets and automotive industry that led to low utilization of fixed costs as well as a lower margin sales mix, production disruptions at the Registrant's Ocala, Florida facility in anticipation of a plant closure in 2004 and higher pension costs. Selling, general and administrative expenses as a percent of net sales increased to 21.3% in the second quarter of 2003 from 20.1% in 2002 primarily due to higher pass-through commissions under a large fire truck contract with Brazil and strategic initiatives undertaken in the Fire Rescue Group. Interest expense increased 8% from the prior year due to higher average debt balances as a result of the refuse truck body acquisitions in 2002. The effective tax rate declined to 16% from last year's 20% reflecting the higher relative impact of tax credits and tax-free municipal income. The full-year effective tax rate is expected to be about 22%; the full-year rate also includes the first quarter effect of a one-time benefit of a tax deduction associated with the closure of a production facility in the U.K. Comparison of First Nine Months 2003 to Same Period 2002 Diluted earnings per share from continuing operations totaled $.55 on sales of $891 million. In the first nine months of 2002, sales aggregated $765 million and earnings per share were $.73. The increase in sales was largely associated with the refuse truck business acquisitions and high initial fire rescue backlogs. Despite higher sales, earnings declined due to a less favorable sales mix in several groups, costs associated with manufacturing facility shutdowns and the expenses associated with headcount reductions in all groups. Gross margin for the Registrant decreased to 26.4% in the first nine months of 2003 from 28.6% in 2002 primarily due to weak demand from municipal, refuse truck body and automotive customers coupled with a lower margin sales mix, restructuring activities and higher pension costs. Selling, general and administrative expenses as a percent of net sales increased to 21.2% in the first nine months of 2003 from 20.7% in 2002 primarily due to higher pass-through commissions partially offset by effective cost management. Interest expense increased to $15.2 million from $14.6 million as a result of increased debt due to the refuse truck body acquisitions partially offset by the lower interest rate environment. The effective tax rate of 18.9% for the first nine months of 2003 declined from 25.9% in 2002 due to a one-time benefit of a tax deduction associated with the closure of a production facility in the U.K. and a higher proportion of tax-free municipal income. 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 and Liquidity at September 30, 2003 Operating cash flow aggregated $58 million year to date. Compared to the first nine months of 2002, operating cash flow, though strong, was $20 million lower than the prior year. During the quarter, the company made a $4 million discretionary contribution to its pension funds. While inventory productivity continued to show improvement, outstanding receivables rose in light of the disproportionate increase in foreign sales with longer payment terms and the mix of customer sales. The Registrant expects to generate approximately $75-80 million of operating cash flow in 2003. Manufacturing debt was again reduced in the quarter; now at $270 million, manufacturing debt represented 42% of capitalization, down from 44% at the beginning of the year, and up slightly from 41% a year ago. 14
ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures As required by Rule 13a-15 under the Securities Exchange Act of 1934, the Registrant carried out an evaluation under the supervision and with the participation of the Registrant's management, including the Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of the design and operation of the disclosure controls and procedures as of September 30, 2003. Based upon that evaluation, the management, including the CEO and CFO, concluded that the disclosure controls and procedures were effective to ensure that information required to be disclosed by the Registrant in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. In connection with the rules and as a matter of practice, the Registrant 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. There have been no significant changes in the internal controls or in other factors that could significantly affect internal controls subsequent to the date the Registrant carried out its evaluation. (b) Changes in internal controls None. PART II. OTHER INFORMATION Responses to items two, three and four are omitted since these items are either inapplicable or the response thereto would be negative. ITEM 1. LEGAL PROCEEDINGS Footnote 10 of the financial statements included in Part I of this Form 10-Q is incorporated herein by reference. ITEM 5. OTHER INFORMATION Mr. Robert M. Gerrity and Mr. Robert S. Hamada have been appointed to the Registrant's Board of Directors. Mr. James A. Lovell, Jr. retired from the Registrant's Board of Directors, having served for 19 years. The Registrant has two directors that qualify as financial experts, as defined in the Sarbanes-Oxley Act and Securities and Exchange Commission regulations, on its Audit Committee. They are Ms. Joan E. Ryan, Senior Vice President and Chief Financial Officer of SIRVA, Inc., and Mr. Charles R. Campbell, Chairman of the Audit Committee, a principal in The Everest Group and formerly Senior Vice President and Chief Financial and Administrative Officer of the Registrant until 1995. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit 3(ii) -- By-Laws of Federal Signal Corporation, as amended October 17, 2003 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 September 30, 2003: A Form 8-K was filed on July 23, 2003, under Items 7 and 9, reporting the Registrant's press release dated July 22, 2003 that disclosed its financial results for the second quarter ended June 30, 2003. A Form 8-K was filed on September 26, 2003, under Items 5 and 7, reporting that the Registrant reduced its earnings guidance for the third quarter to $.20 to $.22 per share from the previous estimate of $.29 to $.33 provided in July 2003 as a result of 15
lower than expected demand from U.S. municipal customers, lower production at U.S. Fire Rescue operations and delays in installation of key airport parking systems. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Federal Signal Corporation 11/14/03 By: /s/ Stephanie K. Kushner - -------- ----------------------------------------------- Date Stephanie K. Kushner, Vice President and Chief Financial Officer 16