FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
SELECTED FINANCIAL DATA
<Table>
<Caption>
2002 2001 2000 1999 1998 1997 1996 1995 1994 1993
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
OPERATING RESULTS
(DOLLARS IN MILLIONS):
Net sales (a) $1,057.2 $1,072.2 $1,106.1 $ 977.2 $936.8 $858.6 $814.1 $744.9 $611.1 $506.7
Income before income taxes
(a,b) $ 61.1 $ 64.5 $ 84.4 $ 79.3 $ 79.4 $ 81.5 $ 86.6 $ 77.8 $ 66.2 $ 57.6
Income from continuing
operations (a,b) $ 46.2 $ 46.6 $ 57.7 $ 54.4 $ 55.1 $ 56.9 $ 57.8 $ 51.9 $ 44.3 $ 39.0
Operating margin (a) 7.8% 8.6% 10.5% 10.4% 10.4% 11.2% 11.8% 12.1% 12.2% 12.4%
Return on average common
shareholders' equity
(b,c,d) 12.1% 13.3% 16.4% 17.0% 19.1% 20.6% 23.8% 22.0% 22.3% 21.0%
COMMON STOCK DATA
(PER SHARE) (E):
Income from continuing
operations--diluted $ 1.01 $ 1.03 $ 1.27 $ 1.18 $ 1.20 $ 1.24 $ 1.26 $ 1.13 $ .96 $ .85
Cash dividends $ .80 $ .78 $ .76 $ .74 $ .71 $ .67 $ .58 $ .50 $ .42 $ .36
Market price range:
High $ 27.07 $ 24.63 $ 24.13 $ 28.06 $27.50 $26.75 $28.25 $25.88 $21.38 $21.00
Low $ 16.00 $ 17.00 $ 14.75 $ 15.06 $20.00 $19.88 $20.88 $19.63 $16.88 $15.75
Average common shares
outstanding (in thousands) 45,939 45,443 45,521 45,958 45,846 45,840 45,885 45,776 45,948 46,155
FINANCIAL POSITION AT YEAR-END
(DOLLARS IN MILLIONS):
Working capital (f,g) $ 172.9 $ 151.6 $ 60.0 $ 71.6 $116.0 $ 41.6 $ 40.6 $ 48.8 $ 53.9 $ 52.8
Current ratio (f,g) 1.8 1.8 1.2 1.3 1.6 1.2 1.2 1.3 1.4 1.5
Total assets $1,168.4 $1,026.9 $1,001.4 $ 948.6 $836.0 $727.9 $703.9 $620.0 $521.6 $405.7
Long-term debt, net of
current portion (f) $ 279.5 $ 232.7 $ 125.4 $ 134.4 $137.2 $ 32.1 $ 34.3 $ 39.7 $ 34.9 $ 21.1
Shareholders' equity $ 398.1 $ 359.4 $ 357.4 $ 354.0 $321.8 $299.8 $272.8 $248.1 $220.3 $199.2
Debt-to-capitalization ratio
(f) 44% 44% 45% 42% 37% 30% 28% 29% 22% 1%
OTHER (DOLLARS IN MILLIONS):
New business (a) $1,121.2 $1,082.4 $1,113.7 $1,018.8 $967.9 $888.8 $851.3 $704.9 $631.5 $526.0
Backlog (a) $ 422.0 $ 352.2 $ 339.9 $ 329.5 $305.0 $254.7 $227.6 $190.0 $204.0 $167.6
Net cash provided by
operating activities $ 88.4 $ 95.1 $ 64.4 $ 57.7 $ 75.5 $ 64.2 $ 61.4 $ 62.9 $ 53.8 $ 48.8
Net cash (used for) investing
activities $ (57.3) $ (59.2) $ (64.8) $(105.1) $(93.0) $(38.4) $(54.2) $(88.1) $(96.9) $(38.1)
Net cash provided by (used
for) financing activities $ (38.1) $ (32.6) $ 5.2 $ 40.9 $ 22.2 $(27.5) $ (4.1) $ 29.9 $ 45.1 $(10.3)
Capital expenditures (a) $ 20.1 $ 18.4 $ 22.3 $ 23.4 $ 19.2 $ 18.2 $ 15.2 $ 14.2 $ 9.9 $ 9.1
Depreciation (a) $ 21.7 $ 20.0 $ 19.5 $ 17.1 $ 14.9 $ 13.3 $ 11.8 $ 10.5 $ 8.9 $ 7.5
Employees (a) 7,378 6,631 6,936 6,750 6,531 6,102 5,721 5,469 4,638 3,847
<Caption>
1992
----
OPERATING RESULTS
(DOLLARS IN MILLIONS):
Net sales (a) $462.1
Income before income taxes
(a,b) $ 51.7
Income from continuing
operations (a,b) $ 35.6
Operating margin (a) 12.3%
Return on average common
shareholders' equity
(b,c,d) 20.0%
COMMON STOCK DATA
(PER SHARE) (E):
Income from continuing
operations--diluted $ .77
Cash dividends $ .31
Market price range:
High $17.63
Low $12.38
Average common shares
outstanding (in thousands) 46,157
FINANCIAL POSITION AT YEAR-END
(DOLLARS IN MILLIONS):
Working capital (f,g) $ 49.5
Current ratio (f,g) 1.6
Total assets $363.7
Long-term debt, net of
current portion (f) $ 16.2
Shareholders' equity $179.0
Debt-to-capitalization ratio
(f) 2%
OTHER (DOLLARS IN MILLIONS):
New business (a) $455.0
Backlog (a) $143.4
Net cash provided by
operating activities $ 40.2
Net cash (used for) investing
activities $(26.9)
Net cash provided by (used
for) financing activities $(11.2)
Capital expenditures (a) $ 7.6
Depreciation (a) $ 6.8
Employees (a) 3,635
</Table>
- ---------------
(a) continuing operations only
(b) in 1996, includes gain on sale of subsidiary of $4.7 million pre-tax, $2.8
million after-tax or $.06 per share
(c) in 1995, includes the effect of a nonrecurring charge for a litigation
settlement related to a discontinued business of $4.2 million after-tax
(d) excludes cumulative effects of changes in accounting
(e) reflects 3-for-2 stock split in 1992 and a 4-for-3 stock split in 1994
(f) manufacturing operations only
(g) in 2001, increase largely attributable to refinancing of short-term debt
with funded long-term debt
26
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
DECEMBER 31,
--------------------------------
2002 2001
---- ----
ASSETS
Manufacturing activities:
Current assets
Cash and cash equivalents $ 9,782,000 $ 16,882,000
Accounts receivable, net of allowances for doubtful
accounts of $2,640,000 and $2,355,000,
respectively 181,843,000 158,994,000
Inventories--Note B 183,802,000 152,841,000
Prepaid expenses 19,390,000 13,608,000
-------------- --------------
Total current assets 394,817,000 342,325,000
Properties and equipment--Note C 143,932,000 113,742,000
Other assets
Goodwill, net of accumulated amortization 348,435,000 280,888,000
Other deferred charges and assets 44,046,000 36,450,000
-------------- --------------
Total manufacturing assets 931,230,000 773,405,000
-------------- --------------
Net assets of discontinued operations, including financial
assets 10,392,000 14,396,000
Financial services activities--Lease financing and other
receivables, net of allowances for doubtful accounts of
$1,002,000 and $1,005,000, respectively, and net of
unearned finance revenue--Note D 226,788,000 239,120,000
-------------- --------------
Total assets $1,168,410,000 $1,026,921,000
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Manufacturing activities:
Current liabilities
Short-term borrowings--Note E $ 16,432,000 $ 28,849,000
Accounts payable 76,082,000 53,292,000
Accrued liabilities
Compensation and withholding taxes 29,274,000 24,816,000
Customer deposits 28,326,000 17,584,000
Other 66,007,000 55,484,000
Income taxes--Note F 5,763,000 10,712,000
-------------- --------------
Total current liabilities 221,884,000 190,737,000
Long-term borrowings--Note E 279,544,000 232,678,000
Long-term pension liabilities 32,656,000
Deferred income taxes--Note F 33,495,000 29,280,000
-------------- --------------
Total manufacturing liabilities 567,579,000 452,695,000
-------------- --------------
Financial services activities--Borrowings--Note E 202,022,000 213,917,000
-------------- --------------
Total liabilities 769,601,000 666,612,000
-------------- --------------
Minority interest in subsidiary--Note K 744,000 873,000
Shareholders' equity--Notes I and J
Common stock, $1 par value, 90,000,000 shares
authorized, 48,394,000 and 47,378,000 shares issued,
respectively 48,394,000 47,378,000
Capital in excess of par value 91,114,000 73,177,000
Retained earnings--Note E 313,684,000 312,206,000
Treasury stock, 734,000 and 2,249,000 shares,
respectively, at cost (18,026,000) (45,486,000)
Deferred stock awards (3,136,000) (2,179,000)
Accumulated other comprehensive income (loss)
Foreign currency translation (18,084,000) (25,660,000)
Net derivative (loss), cash flow hedges (2,098,000)
Minimum pension liability (13,783,000)
-------------- --------------
Total shareholders' equity 398,065,000 359,436,000
-------------- --------------
Total liabilities and shareholders' equity $1,168,410,000 $1,026,921,000
============== ==============
</Table>
See notes to consolidated financial statements.
27
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<Table>
<Caption>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------------
2002 2001 2000
---- ---- ----
Net sales $1,057,201,000 $1,072,175,000 $1,106,127,000
Costs and expenses
Cost of sales (758,205,000) (759,914,000) (768,783,000)
Selling, general and administrative (217,053,000) (220,257,000) (220,690,000)
-------------- -------------- --------------
Operating income 81,943,000 92,004,000 116,654,000
Interest expense (20,075,000) (26,368,000) (31,401,000)
Other income (expense), net (895,000) (1,182,000) (839,000)
Minority interest 129,000
-------------- -------------- --------------
Income before income taxes 61,102,000 64,454,000 84,414,000
Income taxes--Note F (14,923,000) (17,864,000) (26,759,000)
-------------- -------------- --------------
Income from continuing operations 46,179,000 46,590,000 57,655,000
Income from discontinued operations, net of taxes 983,000 726,000
Cumulative effect of change in accounting, net of
taxes (7,984,000) (844,000)
-------------- -------------- --------------
Net income $ 38,195,000 $ 47,573,000 $ 57,537,000
============== ============== ==============
Basic income per share
Income from continuing operations $ 1.01 $ 1.03 $ 1.27
Income from discontinued operations, net of
taxes .02 .02
Cumulative effect of change in accounting, net
of taxes (.17) (.02)
-------------- -------------- --------------
Net income* $ .83 $ 1.05 $ 1.27
============== ============== ==============
Diluted income per share
Income from continuing operations $ 1.01 $ 1.03 $ 1.27
Income from discontinued operations, net of
taxes .02 .02
Cumulative effect of change in accounting, net
of taxes (.17) (.02)
-------------- -------------- --------------
Net income* $ .83 $ 1.05 $ 1.26
============== ============== ==============
</Table>
- ---------------
* amounts may not add to total due to rounding
See notes to consolidated financial statements.
28
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<Table>
<Caption>
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------
2002 2001 2000
---- ---- ----
Net income $ 38,195,000 $47,573,000 $57,537,000
Other comprehensive income (loss), net of related tax
provision (benefit)
Foreign currency translation adjustment, net of taxes
of $4,449,000 in 2002, ($2,053,000) in 2001 and
($2,853,000) in 2000 7,576,000 (3,495,000) (4,857,000)
Net derivative (loss), cash flow hedges, net of tax
benefit of ($1,232,000) in 2002 (2,098,000)
Minimum pension liability, net of tax benefit of
($8,094,000) in 2002 (13,783,000)
------------ ----------- -----------
Comprehensive income $ 29,890,000 $44,078,000 $52,680,000
============ =========== ===========
</Table>
See notes to consolidated financial statements.
29
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------
2002 2001 2000
---- ---- ----
Operating activities
Net income $ 38,195,000 $ 47,573,000 $ 57,537,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Cumulative effect of change in accounting 7,984,000 844,000
Depreciation 21,693,000 20,036,000 19,482,000
Amortization 2,302,000 10,222,000 9,575,000
Provision for doubtful accounts 1,721,000 1,087,000 881,000
Deferred income taxes 2,387,000 (458,000) (220,000)
Other, net 5,026,000 274,000 (102,000)
Changes in operating assets and liabilities,
net of effects from acquisitions of
companies Accounts receivable (5,052,000) 11,047,000 (10,012,000)
Inventories (2,126,000) 10,085,000 7,522,000
Prepaid expenses (4,211,000) (3,961,000) (120,000)
Accounts payable 12,056,000 (10,372,000) (9,567,000)
Customer deposits 9,549,000 7,536,000 (8,453,000)
Accrued liabilities (4,610,000) (1,972,000) (2,249,000)
Income taxes 3,436,000 4,016,000 (728,000)
------------- ------------- -------------
Net cash provided by operating activities 88,350,000 95,113,000 64,390,000
------------- ------------- -------------
Investing activities
Purchases of properties and equipment (20,144,000) (18,424,000) (22,288,000)
Principal extensions under lease financing
agreements (155,293,000) (174,457,000) (143,850,000)
Principal collections under lease financing
agreements 169,025,000 148,375,000 122,412,000
Payments for purchases of companies, net of cash
acquired, excludes $43,418,000 of common stock
issued in 2002 (48,059,000) (19,657,000) (24,401,000)
Other, net (2,858,000) 4,953,000 3,297,000
------------- ------------- -------------
Net cash used for investing activities (57,329,000) (59,210,000) (64,830,000)
------------- ------------- -------------
Financing activities
Increase (reduction) in short-term borrowings,
net (98,273,000) (91,696,000) 61,482,000
Increase (reduction) in long-term borrowings 97,211,000 105,130,000 (4,961,000)
Purchases of treasury stock (4,356,000) (13,155,000) (17,279,000)
Cash dividends paid to shareholders (35,983,000) (35,150,000) (34,534,000)
Other, net 3,280,000 2,294,000 524,000
------------- ------------- -------------
Net cash (used for) provided by financing
activities (38,121,000) (32,577,000) 5,232,000
------------- ------------- -------------
Increase (decrease) in cash and cash equivalents (7,100,000) 3,326,000 4,792,000
Cash and cash equivalents at beginning of year 16,882,000 13,556,000 8,764,000
------------- ------------- -------------
Cash and cash equivalents at end of year $ 9,782,000 $ 16,882,000 $ 13,556,000
============= ============= =============
</Table>
See notes to consolidated financial statements.
30
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A--SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include
the accounts of Federal Signal Corporation and all of its subsidiaries. All
significant intercompany balances and transactions have been eliminated.
CASH EQUIVALENTS: The company considers all highly liquid investments with
a maturity of three-months or less, when purchased, to be cash equivalents.
ALLOWANCE FOR DOUBTFUL ACCOUNTS: The company maintains an allowance for
doubtful accounts for estimated losses resulting from the inability of its
customers to make required payments on the outstanding accounts receivable. The
allowance is maintained at a level considered appropriate based on historical
and other factors that affect collectibility. These factors include historical
trends of write-offs, recoveries and credit losses; the monitoring of portfolio
credit quality; and current and projected economic and market conditions. If the
financial condition of the company's customers were to deteriorate, resulting in
an impairment of the ability to make payments, additional allowances may be
required.
INVENTORIES: Inventories are stated at the lower of cost or market. At
December 31, 2002 and 2001, approximately 45% and 48%, respectively, of the
company's inventories are costed using the LIFO (last-in, first-out) method. The
remaining portion of the company's inventories is costed using the FIFO
(first-in, first-out) method.
PROPERTIES AND DEPRECIATION: Properties and equipment are stated at cost.
Depreciation, for financial reporting purposes, is computed principally on the
straight-line method over the estimated useful lives of the assets. Property,
plant and equipment and other long-term assets (including amortizable intangible
assets) are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount may not be recoverable. If the sum of the
expected undiscounted cash flows is less than the carrying value of the related
asset or group of assets, a loss is recognized for the difference between the
fair value and carrying value of the asset or group of assets. Such analyses
necessarily involve significant judgment.
INTANGIBLE ASSETS: Intangible assets principally consist of costs in excess
of fair values of net assets acquired in purchase transactions. These assets are
assessed yearly for impairment at the beginning of the fourth quarter and also
between annual tests if an event occurs or circumstances change that would more
likely than not reduce the fair value of a reporting unit below its carrying
amount.
STOCK-BASED COMPENSATION PLANS: The company has two stock-based
compensation plans, which are described more fully in Note I. The company
accounts for these plans under the recognition and measurement principles of APB
Opinion No. 25, "Accounting for Stock Issued to Employees", and related
interpretations. No stock-based employee compensation cost is reflected in net
income, as all options granted under those plans had an exercise price equal to
the market value of the underlying common stock at the date of grant.
The weighted average fair value per share of options granted was $4.52 in
2002, $5.33 in 2001 and $4.86 in 2000. The fair value of options was estimated
at the grant date using a Black-Scholes option pricing model with the following
weighted average assumptions: risk free interest rates of 2.7% in 2002, 4.4% in
2001 and 5.0% in 2000; dividend yield of 4.1% in 2002, 3.5% in 2001 and 3.9% in
2000; market volatility of the company's common stock of .28 in 2002 and 2001
and .27 in 2000; and a weighted average expected life of the options of
approximately 8 years for 2002, 2001 and 2000.
31
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table illustrates the effect on net income and earnings per
share for the three-year period ended December 31, 2002 if the company had
applied fair value recognition provisions of Statement of Financial Accounting
Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation", to all
stock-based employee compensation. For purposes of pro forma disclosure, the
estimated fair value of the options is amortized to expense over the option's
vesting period.
<Table>
<Caption>
2002 2001 2000
---- ---- ----
Reported net income $38,195,000 $47,573,000 $57,537,000
Deduct: Total stock-based employee
compensation expense determined
under the fair-value method for all
awards, net of related tax effects 1,052,000 1,079,000 737,000
----------- ----------- -----------
Pro forma net income $37,143,000 $46,494,000 $56,800,000
=========== =========== ===========
Basic net income per common share
Reported net income $ .83 $ 1.05 $ 1.27
Pro forma net income $ .81 $ 1.03 $ 1.25
Diluted net income per common share
Reported net income $ .83 $ 1.05 $ 1.26
Pro forma net income $ .81 $ 1.02 $ 1.25
</Table>
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. Option valuation models require the use of highly
subjective assumptions including expected stock price volatility. The company
has utilized the Black-Scholes method to produce 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 company'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.
USE OF ESTIMATES: The preparation of financial statements in conformity
with accounting principles generally accepted in the United States 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.
WARRANTY: Sales of some of the company's products carry express warranties
based on the terms that are generally accepted in the company's marketplaces.
The company records provisions for estimated warranty at the time of sale based
on historical experience and periodically adjusts these provisions to reflect
actual experience. Infrequently, a material warranty issue can arise which is
beyond the scope of the company's historical experience. The company provides
for these issues as they become probable and estimable.
PRODUCT LIABILITY AND WORKER'S COMPENSATION LIABILITY: Due to the nature of
the company's products, the company is subject to claims for product liability
and worker's compensation in the normal course of business. The company is
self-insured for a portion of these claims. The company establishes a liability
using a third party actuary for any known outstanding matters, including a
reserve for claims incurred but not yet reported.
FINANCIAL INSTRUMENTS: The company enters into agreements (derivative
financial instruments) to manage the risks associated with interest rates and
foreign exchange rates. The company does not actively trade such instruments nor
enter into such agreements for speculative purposes. The company principally
utilizes two types of derivative financial instruments: 1) interest rate swaps
to manage its interest rate risk, and 2) foreign currency forward exchange
contracts to manage risks associated with sales and expenses (forecasted or
committed) denominated in foreign currencies.
On the date a derivative contract is entered into, the company designates
the derivative as one of the following types of hedging instruments and accounts
for the derivative as follows:
32
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Fair value hedge: A hedge of a recognized asset or liability or an
unrecognized firm commitment is declared as a fair value hedge. For fair value
hedges, both the effective and ineffective portions of the changes in the fair
value of the derivative, along with the gain or loss on the hedged item that is
attributable to the hedged risk, are recorded in earnings and reported in the
consolidated statements of income on the same line as the hedged item.
Cash flow hedge: A hedge of a forecasted transaction or of the variability
of cash flows to be received or paid related to a recognized asset or liability
is declared as a cash flow hedge. The effective portion of the change in the
fair value of a derivative that is declared as a cash flow hedge is recorded in
accumulated other comprehensive income. When the hedged item impacts the income
statement, the gain or loss included in accumulated other comprehensive income
is reported on the same line in the consolidated statements of income as the
hedged item. In addition, both the fair value of changes excluded from the
company's effectiveness assessments and the ineffective portion of the changes
in the fair value of derivatives used as cash flow hedges are reported in
selling, general and administrative expenses in the consolidated statements of
income.
The company formally documents its hedge relationships, including
identification of the hedging instruments and the hedged items, as well as its
risk management objectives and strategies for undertaking the hedge transaction.
Derivatives are recorded in the consolidated balance sheets at fair value in
other assets and other liabilities. This process includes linking derivatives
that are designated as hedges of specific forecasted transactions. The company
also formally assesses, both at inception and at least quarterly thereafter,
whether the derivatives that are used in hedging transactions are highly
effective in offsetting changes in either the fair value or cash flows of the
hedged item. If it is determined that a derivative ceases to be a highly
effective hedge, or if the anticipated transaction is no longer likely to occur,
the company discontinues hedge accounting, and any deferred gains or losses are
recorded in selling, general and administrative expenses. Amounts related to
terminated interest rate swaps are deferred and amortized as an adjustment to
interest expense over the original period of interest exposure, provided the
designated liability continues to exist or is probable of occurring.
REVENUE RECOGNITION: Effective January 1, 2000, the company changed its
method of accounting for recognizing revenues as required by Staff Accounting
Bulletin No. 101 issued by the Securities and Exchange Commission. Effective
with the change, the company recognizes revenues when all of the following are
satisfied: persuasive evidence of an arrangement exists, the price is fixed or
determinable, collectibility is reasonably assured and delivery has occurred or
services have been rendered. In most instances, this occurs at the time that
title passes to the customer based on the respective sales agreement.
Infrequently, a sale qualifies for percentage of completion accounting. Sales
accounted for under this method were immaterial for the three-year period ended
December 31, 2002. Management believes that all relevant criteria and conditions
are considered when recognizing sales.
In years prior to 2000, the company recognized substantially all of its
revenues for product sales as products were shipped, as this method was then in
compliance with generally accepted accounting principles. See Note P.
INCOME PER SHARE: Basic net income per share is calculated using income
available to common shareholders (net income) divided by the weighted average
number of common shares outstanding during the year. Diluted net income per
share is calculated in the same manner except that the denominator is increased
to include the weighted number of additional shares that would have been
outstanding had dilutive stock option shares been actually issued. The company
uses the treasury stock method to calculate dilutive shares. See Note N for the
calculation of basic and diluted net income per share.
RECLASSIFICATION: Certain amounts in the 2001 balance sheet have been
reclassified to conform to the 2002 presentation.
33
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B--INVENTORIES
Inventories at December 31 are summarized as follows:
<Table>
<Caption>
2002 2001
---- ----
Finished goods $ 50,952,000 $ 50,148,000
Work in process 63,971,000 39,258,000
Raw materials 68,879,000 63,435,000
------------ ------------
Total inventories $183,802,000 $152,841,000
============ ============
</Table>
If the company had used the first-in, first-out cost method exclusively,
which approximates replacement cost, inventories would have aggregated
$192,342,000 and $161,913,000 at December 31, 2002 and 2001, respectively.
NOTE C--PROPERTIES AND EQUIPMENT
A comparative summary of properties and equipment at December 31 is as
follows:
<Table>
<Caption>
2002 2001
---- ----
Land $ 6,251,000 $ 5,606,000
Buildings and improvements 69,359,000 53,854,000
Machinery and equipment 233,677,000 198,047,000
Accumulated depreciation (165,355,000) (143,765,000)
------------- -------------
Total properties and equipment $ 143,932,000 $ 113,742,000
============= =============
</Table>
NOTE D--LEASE FINANCING AND OTHER RECEIVABLES
As an added service to its customers, the company is engaged in financial
services activities. These activities primarily consist of providing long-term
financing for certain U.S. customers purchasing vehicle-based products from the
company's Environmental Products and Fire Rescue groups. A substantial portion
of these receivables is due from municipalities and volunteer fire departments.
Financing is provided through sales-type lease contracts with terms that range
from one to ten years.
At the inception of the lease, the company records the product sales price
and related costs and expenses of the sale. Financing revenues are included in
income over the life of the lease. The amounts recorded as lease financing
receivables represent amounts equivalent to normal selling prices less
subsequent customer payments.
Lease financing and other receivables will become due as follows:
$74,259,000 in 2003, $37,577,000 in 2004, $33,767,000 in 2005, $22,492,000 in
2006, $15,820,000 in 2007 and $43,875,000 thereafter. At December 31, 2002 and
2001, unearned finance revenue on these leases aggregated $35,561,000 and
$36,134,000, respectively.
NOTE E--DEBT
Short-term borrowings at December 31 consisted of the following:
<Table>
<Caption>
2002 2001
---- ----
Commercial paper $115,435,000 $203,082,000
Notes payable 37,363,000 30,798,000
Current maturities of long-term debt 656,000 8,886,000
------------ ------------
Total short-term borrowings $153,454,000 $242,766,000
============ ============
</Table>
Of the above amounts, $137,022,000 and $213,917,000 are classified as
financial services activities borrowings at December 31, 2002 and 2001,
respectively.
34
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Long-term borrowings at December 31 consisted of the following:
<Table>
<Caption>
2002 2001
---- ----
6.79% unsecured note payable in annual installments
of $10,000,000 in 2007-2011 $ 50,000,000 $ 50,000,000
6.37% unsecured note payable in annual installments
of $10,000,000 in 2004-2008 50,000,000 50,000,000
6.60% unsecured note payable in annual installments
of $7,143,000 in 2005-2011 50,000,000 50,000,000
4.93% unsecured note payable in annual installments
of $8,000,000 in 2008-2012 40,000,000
5.24% unsecured note payable in 2012 60,000,000
5.49% unsecured note payable in 2006 65,000,000 65,000,000
7.99% unsecured note payable in 2004 15,000,000 15,000,000
7.59% unsecured note payable in 2002 8,000,000
Floating rate (5.80% at December 31, 2002) secured
note payable in monthly installments ending in
2011 4,540,000
Floating rate secured note payable in monthly
installments ending in 2004 2,207,000
Fair value adjustment of notes 10,146,000
Other 514,000 1,357,000
------------ ------------
345,200,000 241,564,000
Less current maturities 656,000 8,886,000
------------ ------------
Total long-term borrowings $344,544,000 $232,678,000
============ ============
</Table>
Of the above amounts, $65,000,000 is classified as financial services
activities borrowings at December 31, 2002.
Aggregate maturities of long-term debt amount to approximately $656,000 in
2003, $25,591,000 in 2004, $17,667,000 in 2005, $82,638,000 in 2006, $27,593,000
in 2007 and $180,909,000 thereafter. The fair values of these borrowings were
$316,300,000 and $242,500,000 at December 31, 2002 and 2001, respectively.
The 6.79%, 6.37%, 6.60%, 4.93%, 5.24% and 5.49% notes contain covenants
relating to a maximum debt-capital ratio and minimum net worth. The 7.99% note
contains various restrictions relating to maintenance of minimum working
capital, payments of cash dividends, purchases of the company's stock, and
principal and interest of any subordinated debt. At December 31, 2002, all of
the company's retained earnings were free of any restrictions and the company
was in compliance with the financial covenants of its debt agreements.
The company paid interest of $20,796,000 in 2002, $26,097,000 in 2001 and
$31,780,000 in 2000. Weighted average interest rates on short-term borrowings
were 1.75% and 2.65% at December 31, 2002 and 2001, respectively. See Note H
regarding the company's utilization of derivative financial instruments relating
to outstanding debt.
At December 31, 2002, the company had unused credit lines of $300,000,000,
of which $166,000,000 expires June 12, 2003 and $134,000,000 expires June 17,
2004. Commitment fees, paid in lieu of compensating balances, were
insignificant.
35
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE F--INCOME TAXES
The provisions for income taxes consisted of the following:
<Table>
<Caption>
2002 2001 2000
---- ---- ----
CURRENT:
Federal $ 5,562,000 $11,257,000 $19,119,000
Foreign 6,006,000 5,411,000 5,036,000
State and local 968,000 1,654,000 2,824,000
----------- ----------- -----------
12,536,000 18,322,000 26,979,000
DEFERRED:
Federal 2,330,000 (826,000) 426,000
Foreign (686,000) 140,000 (424,000)
State and local 743,000 228,000 (222,000)
----------- ----------- -----------
2,387,000 (458,000) (220,000)
----------- ----------- -----------
Total income taxes $14,923,000 $17,864,000 $26,759,000
=========== =========== ===========
</Table>
Differences between the statutory federal income tax rate and the effective
income tax rate are summarized below:
<Table>
<Caption>
2002 2001 2000
---- ---- ----
Statutory federal income tax rate 35.0% 35.0% 35.0%
State income taxes, net of federal tax benefit 1.8 1.9 2.0
Tax-exempt interest (5.3) (4.7) (3.3)
Exports benefit (1.5) (1.3) (1.2)
Reduction for prior years taxes (2.3) (1.3) (1.0)
Other, net (3.3) (1.9) 0.2
---- ---- ----
Effective income tax rate 24.4% 27.7% 31.7%
==== ==== ====
</Table>
The company had net current deferred income tax benefits of $6,608,000 and
$4,780,000 recorded in the balance sheet at December 31, 2002 and 2001,
respectively. The company paid income taxes of $8,662,000 in 2002, $15,193,000
in 2001 and $24,481,000 in 2000.
Net deferred tax liabilities (assets) comprised the following at December
31, 2002: Depreciation and amortization--$48,962,000; revenue recognized on
custom manufacturing contracts--$2,558,000; accrued pension
benefits--($4,639,000); accrued expenses deductible in future
periods--($17,194,000); net operating loss carryforwards of
subsidiaries--($5,400,000); valuation allowance for net operating loss
carryforwards--$5,400,000; and other--($2,800,000).
Net deferred tax liabilities (assets) comprised the following at December
31, 2001: Depreciation and amortization--$36,371,000; revenue recognized on
custom manufacturing contracts--$2,535,000; accrued pension
benefits--$4,507,000; accrued expenses deductible in future
periods--($18,675,000); net operating loss carryforwards of
subsidiaries--($4,271,000); valuation allowance for net operating loss
carryforwards--$4,271,000; and other--($238,000).
The majority of the net operating loss carryforwards of subsidiaries have
no expiration dates.
Income before taxes consisted of the following:
<Table>
<Caption>
2002 2001 2000
---- ---- ----
United States $45,295,000 $48,335,000 $71,734,000
Non-U.S 15,807,000 16,119,000 12,680,000
----------- ----------- -----------
$61,102,000 $64,454,000 $84,414,000
=========== =========== ===========
</Table>
36
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE G--POSTRETIREMENT BENEFITS
The company and its subsidiaries sponsor a number of defined benefit
retirement plans covering certain of its salaried employees and hourly employees
not covered by plans under collective bargaining agreements. Benefits under
these plans are primarily based on final average compensation and years of
service as defined within the provisions of the individual plans. The company
also participates in several multiemployer retirement plans that provide defined
benefits to employees under certain collective bargaining agreements.
U.S. BENEFIT PLANS
The components of net periodic pension expense (credit) are summarized as
follows:
<Table>
<Caption>
2002 2001 2000
---- ---- ----
Company-sponsored plans
Service cost $ 3,291,000 $ 2,597,000 $ 2,251,000
Interest cost 5,372,000 4,635,000 4,537,000
Expected return on plan assets (7,073,000) (9,020,000) (8,961,000)
Amortization of transition amount (230,000) (230,000) (230,000)
Other 118,000 666,000 (228,000)
----------- ----------- -----------
1,478,000 (1,352,000) (2,631,000)
Multiemployer plans 445,000 534,000 636,000
----------- ----------- -----------
Net periodic pension expense (credit) $ 1,923,000 $ (818,000) $(1,995,000)
=========== =========== ===========
</Table>
The following summarizes the changes in the projected benefit obligation
and plan assets, the funded status of the company-sponsored plans and the major
assumptions used to determine these amounts.
<Table>
<Caption>
2002 2001
---- ----
Projected benefit obligation, January 1 $ 66,228,000 $60,656,000
Assumption of obligation in business acquisition 27,269,000
Service cost 3,291,000 2,597,000
Interest cost 5,372,000 4,635,000
Actuarial (gain)loss 6,231,000 3,972,000
Benefits paid (2,399,000) (5,632,000)
------------ -----------
Projected benefit obligation, December 31 $105,992,000 $66,228,000
============ ===========
Fair value of plan assets, January 1 $ 60,187,000 $68,078,000
Assumption of assets in business acquisition 18,390,000
Adjustment to prior year actual return (612,000)
Actual return on plan assets (7,043,000) (1,647,000)
Company contribution 5,000,000
Benefits paid (2,399,000) (5,632,000)
------------ -----------
Fair value of plan assets, December 31 $ 74,135,000 $60,187,000
============ ===========
Funded status of plan, December 31 $(31,857,000) $(6,041,000)
Unrecognized actuarial (gain)loss 36,652,000 18,285,000
Unrecognized prior service cost 2,007,000 (88,000)
Unrecognized net transition obligation (618,000) (848,000)
------------ -----------
Net amount recognized as prepaid benefit cost in the
balance sheet $ 6,184,000 $11,308,000
============ ===========
Amounts recognized in the balance sheet consist of:
Prepaid benefit cost $ 14,956,000 $11,308,000
Accrued benefit liability (32,656,000)
Intangible asset 2,007,000
Accumulated other comprehensive income, pre-tax 21,877,000
------------ -----------
Net amount recognized $ 6,184,000 $11,308,000
============ ===========
</Table>
37
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Plan assets consist principally of a broadly diversified portfolio of
equity securities and corporate and U.S. government obligations. Included in
plan assets at December 31, 2002 and 2001 were 503,400 and 653,400 shares of the
company's common stock valued at $9,776,000 and $14,551,000, respectively.
Dividends paid on the company's common stock to the pension trusts aggregated
$403,000 and $506,000, respectively, for the years ended December 31, 2002 and
2001.
The following table summarizes the significant assumptions used in
determining pension costs for the three-year period ended December 31, 2002 and
the company's assumptions for 2003:
<Table>
<Caption>
2003 2002 2001 2000
---- ---- ---- ----
Discount rate 6.75% 7.3% 7.7% 8.1%
Rate of increase in compensation levels 3.5% 3.5% 4% 4%
Expected long-term rate of return on plan assets 9.0% 9.5% 12% 12%
</Table>
The weighted average discount rates used in determining the actuarial
present value of all pension obligations at December 31, 2002 and 2001 were
6.75% and 7.3%, respectively. The discount rate at the end of the year is one of
the significant assumptions used in determining pension costs for the following
year. The company expects that the change in the above assumptions will increase
2003 pension costs by approximately $3,600,000 compared to 2002.
The company also sponsors a number of defined contribution pension plans
covering a majority of its employees. Participation in the plans is at each
employee's election. Company contributions to these plans are based on a
percentage of employee contributions. The cost of these plans, including the
plans of companies acquired during the three-year period ended December 31,
2002, was $5,396,000 in 2002, $5,252,000 in 2001 and $4,886,000 in 2000.
The company also provides certain medical, dental and life benefits to
certain eligible retired employees. These benefits are funded when the claims
are incurred. Participants generally become eligible for these benefits at age
60 after completing at least fifteen years of service. The plan provides for the
payment of specified percentages of medical and dental expenses reduced by any
deductible and payments made by other primary group coverage and government
programs. The company will continue to reduce the percentage of the cost of
benefits that it will pay since the company's future costs are limited to 150%
of the 1992 cost. Accumulated postretirement benefit liabilities of $5,562,000
and $3,988,000 at December 31, 2002 and 2001, respectively, were fully accrued.
The net periodic postretirement benefit costs have not been significant during
the three-year period ended December 31, 2002.
NON-U.S. BENEFIT PLAN
A wholly-owned subsidiary sponsors a defined benefit plan for substantially
all of its employees in the United Kingdom. Benefits under this plan are based
on final compensation and years of service as defined within the provisions of
the plan.
38
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Net periodic pension expenses or credits during the three-year period ended
December 31, 2002 were not significant. The following table summarizes the
changes in the projected benefit obligation and plan assets, the funded status
of the company-sponsored plans and the major assumptions used to determine these
amounts.
<Table>
<Caption>
2002 2001
---- ----
Projected benefit obligation, October 1 $34,192,000 $33,649,000
Service cost 500,000 468,000
Interest cost 2,106,000 2,101,000
Actuarial (gain)loss 3,461,000 (338,000)
Employee contributions 91,000 90,000
Benefits paid (1,689,000) (1,766,000)
Increase (decrease) due to translation 2,227,000 (12,000)
----------- -----------
Projected benefit obligation, September 30 $40,888,000 $34,192,000
=========== ===========
Fair value of plan assets, October 1 $33,881,000 $38,193,000
Actual return on plan assets (511,000) (2,815,000)
Company contribution 390,000 381,000
Employee contribution 91,000 90,000
Benefits paid (1,689,000) (1,766,000)
Plan expenses (155,000) (124,000)
Increase (decrease) due to translation 2,073,000 (78,000)
----------- -----------
Fair value of plan assets, September 30 $34,080,000 $33,881,000
=========== ===========
Funded status of plan, September 30 $(6,808,000) $ (311,000)
Unrecognized actuarial loss 12,949,000 6,438,000
----------- -----------
Net amount recognized as prepaid benefit cost in the
balance sheet $ 6,141,000 $ 6,127,000
=========== ===========
</Table>
Plan assets consist principally of a broadly diversified portfolio of
equity securities, U.K. government obligations and fixed interest securities.
The following significant assumptions were used in determining pension costs for
the three-year period ended December 31, 2002:
<Table>
<Caption>
2002 2001 2000
---- ---- ----
Discount rate 6.25% 6.5% 6.5%
Rate of increase in compensation levels 2.5% 3% 3%
Expected long-term rate of return on plan assets 8.0% 8.5% 8.5%
</Table>
The weighted average discount rate used in determining the actuarial
present value of all pension obligations at September 30, 2002 and 2001 were
5.5% and 6.25%, respectively.
NOTE H--DERIVATIVE FINANCIAL INSTRUMENTS
All derivative financial instruments are reported on the balance sheet at
their respective fair values. Changes in fair value are recognized either in
earnings or equity, depending on the nature of the underlying exposure being
hedged and how effective a derivative is at offsetting price movements in the
underlying exposure. All of the company's derivative positions existing at
December 31, 2002 qualified for hedge accounting under SFAS No. 133. Derivatives
documentation policies comply with the standard's requirements.
To manage interest costs, the company utilizes interest rate swaps in
combination with its funded debt. Interest rate swaps executed during 2002 and
2001 in conjunction with long-term private placements effectively converted
fixed rate debt to variable rate debt. At December 31, 2002, the company had
receive fixed, pay variable swap agreements with financial institutions having
notional amounts aggregating $205,000,000 which terminate in varying amounts
during 2006 to 2012. These agreements are accounted for as fair value hedges and
are 100% effective; no amounts were excluded from the assessment of hedge
effectiveness.
39
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
At December 31, 2002, the company also had agreements with financial
institutions to swap interest rates in which the company pays interest at a
fixed rate and receives interest at the three-month LIBOR rate. These agreements
had notional amounts aggregating $65,000,000 and terminate in varying amounts
during 2004 to 2008; the agreement allows the counterparties to cancel the swaps
at three-month intervals. If at any three-month extension date the counterparty
decides not to extend the swap, it is terminated and no further obligations are
due by either party. These interest rate swap agreements are accounted for as
cash flow hedges and are 100% effective; no amounts were excluded from the
assessment of hedge effectiveness.
The fair values of interest rate and currency swaps are based on quotes
from financial institutions. The following table summarizes the company's
interest rate swaps at December 31, 2002 and 2001:
<Table>
<Caption>
2002 2001
--------------- ---------------
FAIR FAIR
TOTAL VALUE TOTAL VALUE
----- ----- ----- -----
Pay fixed, receive variable
Notional amount $ 65.0 $(2.4) $ 25.0 $(1.4)
Average pay rate 4.8% 5.1%
Average receive rate 1.4% 2.0%
Receive fixed, pay variable
Notional amount $205.0 $ 3.6 $105.0 $(2.5)
Average pay rate 3.0% 3.2%
Average receive rate 5.6% 6.1%
</Table>
The company defers the benefits of terminated interest rate swaps and
amortizes the amount as an offset to interest expense over the life of the
underlying debt. The unamortized balance at December 31, 2002 and 2001 was
$6,732,000 and $2,496,000, respectively.
Foreign exchange forward contracts were $47,126,000 at December 31, 2002
and insignificant at December 31, 2001. Most of these contracts at December 31,
2002 were used to purchase Canadian dollars and expire at various dates in 2003;
the fair value of these contracts was ($316,000) at December 31, 2002.
NOTE I--STOCK-BASED COMPENSATION
The company's stock benefit plans, approved by the company's shareholders,
authorize the grant of benefit shares or units to key employees and directors.
The plan approved in 1988 authorized, until May 1998, the grant of up to
2,737,500 benefit shares or units (as adjusted for subsequent stock splits and
dividends). The plan approved in 1996 and amended in 1999 authorizes the grant
of up to 2,500,000 benefit shares or units until April 2006. These share or unit
amounts exclude amounts that were issued under predecessor plans. Benefit shares
or units include incentive and non-incentive stock options, stock awards and
other stock units. The plan approved in December 2001 authorized the grant of up
to 1,000,000 benefit shares until December 2011. No grants were made under this
plan and the plan was canceled in July 2002.
Stock options are primarily granted at the fair market value of the shares
on the date of grant and become exercisable one year after grant at a rate of
one-half annually and are exercisable in full on the second anniversary date.
All options and rights must be exercised within ten years from date of grant. At
the company's discretion, vested stock option holders are permitted to elect an
alternative settlement method in lieu of purchasing common stock at the option
price. The alternative settlement method permits the employee to receive,
without payment to the company, cash, shares of common stock or a combination
thereof equal to the excess of market value of common stock over the option
purchase price. The company expects to settle all such options in common stock.
40
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Stock option activity for the three-year period ended December 31, 2002
follows (number of shares in 000's, prices in dollars per share):
<Table>
<Caption>
OPTION SHARES WEIGHTED AVERAGE PRICE ($)
----------------------- --------------------------
2002 2001 2000 2002 2001 2000
---- ---- ---- ---- ---- ----
Outstanding at beginning of
year 2,323 2,178 2,312 20.86 19.84 19.29
Granted 279 519 63 22.84 21.24 18.65
Canceled or expired (149) (88) (36) 21.87 19.93 21.74
Exercised (233) (286) (161) 18.09 14.09 11.05
----- ----- -----
Outstanding at end of year 2,220 2,323 2,178 21.33 20.86 19.84
===== ===== =====
Exercisable at end of year 1,452 1,602 1,588 21.28 21.10 19.95
===== ===== =====
</Table>
For options outstanding at December 31, 2002, the number (in thousands),
weighted average exercise prices in dollars per share, and weighted average
remaining terms were as follows:
<Table>
<Caption>
PERIOD IN WHICH OPTIONS WERE GRANTED
------------------------------------------------------
02-01 00-99 98-97 96-95 94-93 AGGREGATE
----- ----- ----- ----- ----- ---------
Number outstanding 729 422 464 362 243 2,220
Exercise price range ($):
High 25.67 26.13 25.38 24.75 20.62 26.13
Low 16.05 14.94 20.06 20.12 16.00 14.94
Weighted average:
Exercise price ($) 21.83 18.54 21.76 23.96 19.89 21.33
Remaining term (years) 9 7 5 3 1 6
</Table>
Stock award shares are granted to employees at no cost. Awards primarily
vest at the rate of 25% annually commencing one year from the date of award,
provided the recipient is still employed by the company on the vesting date. The
cost of stock awards, based on the fair market value at the date of grant, is
being charged to expense over the four-year vesting period. The following table
summarizes stock award grants for the three-year period ended December 31, 2002:
<Table>
<Caption>
2002 2001 2000
---- ---- ----
Number of shares granted 109,700 92,500 69,500
Fair value of shares granted $2,494,000 $1,677,000 $1,108,000
Weighted average fair value per share $ 22.73 $ 18.13 $ 15.94
Compensation expense recorded $1,537,000 $1,345,000 $1,499,000
</Table>
Under the 1988 plan, no benefit shares or units were available for future
grant during the three-year period ending December 31, 2002. Under the 1996
plan, the following benefit shares or units were available for future grant:
144,000 at December 31, 2002, 410,000 at December 31, 2001 and 937,000 at
December 31, 2000.
41
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE J--SHAREHOLDERS' EQUITY
The company has 90,000,000 authorized shares of common stock, $1 par value
and 800,000 authorized and unissued shares of preference stock, $1 par value.
The changes in shareholders' equity for each of the three years in the
period ended December 31, 2002 were as follows:
<Table>
<Caption>
ACCUMULATED
COMMON CAPITAL IN DEFERRED OTHER
STOCK PAR EXCESS OF RETAINED TREASURY STOCK COMPREHENSIVE
VALUE PAR VALUE EARNINGS STOCK AWARDS INCOME
--------- ---------- -------- -------- -------- -------------
Balance at December 31, 1999--46,889,000
shares issued $46,889,000 $66,762,000 $276,951,000 $(17,023,000) $(2,238,000) $(17,308,000)
Net income 57,537,000
Cash dividends declared (34,503,000)
Exercise of stock options:
Cash proceeds 82,000 961,000
Exchange of shares 79,000 697,000 (776,000)
Stock awards granted 69,000 1,039,000 (1,108,000)
Tax benefits related to stock compensation
plans 302,000
Retirement of treasury stock (52,000) (1,068,000) 1,120,000
Purchases of 988,000 shares of treasury
stock (17,279,000)
Amortization of deferred stock awards 1,499,000
Foreign currency translation adjustment,
net (4,857,000)
Other (344,000)
----------- ----------- ------------ ------------ ----------- ------------
Balance at December 31, 2000--47,067,000
shares issued 47,067,000 68,693,000 299,985,000 (34,302,000) (1,847,000) (22,165,000)
Net income 47,573,000
Cash dividends declared (35,352,000)
Exercise of stock options:
Cash proceeds 211,000 2,835,000
Exchange of shares 75,000 909,000 (984,000)
Stock awards granted 93,000 1,834,000 (1,927,000)
Tax benefits related to stock compensation
plans 402,000
Retirement of treasury stock (56,000) (1,258,000) 1,314,000
Purchases of 579,000 shares of treasury
stock (13,155,000)
Issued 93,000 shares from treasury for
purchases of companies 1,900,000
Amortization of deferred stock awards 1,345,000
Foreign currency translation adjustment,
net (3,495,000)
Other (12,000) (238,000) (259,000) 250,000
----------- ----------- ------------ ------------ ----------- ------------
Balance at December 31, 2001--47,378,000
shares issued 47,378,000 73,177,000 312,206,000 (45,486,000) (2,179,000) (25,660,000)
Net income 38,195,000
Cash dividends declared (36,717,000)
Exercise of stock options:
Cash proceeds 150,000 2,788,000
Exchange of shares 81,000 1,193,000 (1,274,000)
Stock awards granted 110,000 2,426,000 (2,536,000)
Tax benefits related to stock compensation
plans 178,000
Retirement of treasury stock (73,000) (1,396,000) 1,469,000
Purchases of 203,000 shares of treasury
stock (4,356,000)
Issued 750,000 shares and 1,639,000 shares
from treasury for purchases of companies 750,000 12,788,000 29,880,000
Issued 79,000 shares from treasury for
retirement plan match 1,873,000
Amortization of deferred stock awards 1,537,000
Foreign currency translation adjustment,
net 7,576,000
Net derivative (loss), cash flow hedges (2,098,000)
Record minimum pension liability, net of
tax (13,783,000)
Other (2,000) (40,000) (132,000) 42,000
----------- ----------- ------------ ------------ ----------- ------------
Balance at December 31, 2002--48,394,000
shares issued $48,394,000 $91,114,000 $313,684,000 $(18,026,000) $(3,136,000) $(33,965,000)
=========== =========== ============ ============ =========== ============
</Table>
In July 1998, the company declared a dividend distribution of one preferred
share purchase right on each share of common stock outstanding on and after
August 18, 1998. The rights are not exercisable until the rights distribution
date, defined as the earlier of: 1) the tenth day following a public
announcement that a person or group of affiliated or associated persons acquired
or obtained the right to acquire beneficial ownership of 20% or
42
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
more of the outstanding common stock or 2) the tenth day following the
commencement or announcement of an intention to make a tender offer or exchange
offer, the consummation of which would result in the beneficial ownership by a
person or group of 30% or more of such outstanding common shares. Each right,
when exercisable, entitles the holder to purchase from the company one
one-hundredth of a share of Series A Preferred stock of the company at a price
of $100 per one one-hundredth of a preferred share, subject to adjustment. The
company is entitled to redeem the rights at $.10 per right, payable in cash or
common shares, at any time prior to the expiration of twenty days following the
public announcement that a 20% position has been acquired. In the event that the
company is acquired in a merger or other business combination transaction or 50%
or more of its consolidated assets or earning power is sold, proper provision
will be made so that each holder of a right will thereafter have the right to
receive, upon the exercise thereof at the then current exercise price of a
right, that number of shares of common stock of the acquiring company which at
the time of such transaction would have a market value of two times the exercise
price of the right. The rights expire on August 18, 2008 unless earlier redeemed
by the company. Until exercised, the holder of a right, as such, will have no
rights as a shareholder, including, without limitation, the right to vote or to
receive dividends.
NOTE K--ACQUISITIONS
During the three-year period ended December 31, 2002, the company made the
following acquisitions, principally all for cash, except as otherwise noted.
In September 2002, the company acquired Leach Company of Oshkosh, WI, a
leading manufacturer of rear load refuse collection bodies. 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 company also acquired Wittke, Inc., 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 refuse truck bodies. Wittke sold direct to customers at
the time of the acquisition, and is particularly strong in the private
contractors and large waste hauling company market segments. The company
acquired Leach and Wittke using a combination of cash and stock for a total of
$101.6 million. As a result of these 2002 acquisitions, the company recorded
approximately $16.3 million of working capital, $20.2 million of fixed and other
assets and $65.1 million of costs in excess of fair value. The company also
assumed $10.1 million in debt. The assigned values of these acquisitions are
based upon preliminary estimates. An insignificant portion of the related
goodwill is expected to be deductible for tax purposes.
In March 2001, the company acquired all of the assets of Athey Products
Corporation from bankruptcy proceedings. Athey was a primary competitor to
Environmental Products Group's line of mechanical sweepers. Subsequent to the
purchase, the company sold off substantially all assets of Athey. In September
2001, the company acquired a majority interest in Plastisol Holdings B.V.,
located in the Netherlands. Plastisol is a small manufacturer of cabs and bodies
for fire apparatus using glassfiber reinforced polyester. The company also made
two small Tool Group acquisitions during 2001. As a result of the 2001
acquisitions, the company recorded approximately $5.8 million of working
capital, $9.4 million of fixed and other assets and $12.1 million of costs in
excess of fair value.
In March 2000, the company acquired P.C.S. Company. Located near Detroit,
Michigan, P.C.S. offers a comprehensive line of tooling components for the
plastic injection mold and the die cast industries. The company also made a
small Environmental Products Group acquisition during the first quarter of 2000.
As a result of the 2000 acquisitions, the company recorded approximately $9.9
million of working capital, $3.8 million of fixed and other assets and $10.7
million of costs in excess of fair value.
All of the acquisitions in the three-year period ended December 31, 2002
have been accounted for as purchases. Accordingly, the results of operations of
the acquired companies have been included in the consolidated statements of
income from the effective dates of the acquisitions. Assuming the 2002 and 2001
43
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
acquisitions occurred January 1, 2001, the company estimates the following pro
forma amounts for the years ended December 31, 2002 and 2001:
<Table>
<Caption>
2002 2001
---- ----
Net sales $1,175,388,000 $1,197,791,000
Income from continuing operations 32,136,000 44,907,000
Net income 24,152,000 45,890,000
Basic income per share
Income from continuing operations $ .70 $ .99
Net income .53 1.01
Diluted income per share
Income from continuing operations $ .70 $ .98
Net income .52 1.01
</Table>
The company made no significant changes to the values originally assigned
to assets and liabilities recorded as a result of acquisitions made prior to
2002.
NOTE L--LEGAL PROCEEDINGS
The company 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 company's business. The company 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 company's
consolidated financial position or the results of operations.
The company has been sued by firefighters in Chicago seeking damages and
claiming that exposure to the company's sirens has impaired their hearing and
that the sirens are therefore defective. There were sixteen cases filed during
the period 1999-2002, involving a total of 1,004 plaintiffs pending in the
Circuit Court of Cook County, Illinois. The plaintiffs' attorneys have
threatened to bring more suits if the company does not settle these cases. The
company believes that these product liability suits have no merit and that
sirens are necessary in emergency situations and save lives. The company
successfully defended approximately 41 similar cases in Philadelphia in 1999
after a series of unanimous jury verdicts in favor of the company.
NOTE M--SEGMENT AND RELATED INFORMATION
The company has four continuing operating segments as defined under
Statement of Financial Accounting Standards No. 131, "Disclosures about Segments
of an Enterprise and Related Information". Business units are organized under
each segment because they share certain characteristics, such as technology,
marketing and product application, which create long-term synergies. The
principal activities of the company's operating segments are as follows:
ENVIRONMENTAL PRODUCTS--Environmental Products manufactures a variety of
self-propelled street cleaning vehicles, vacuum loader vehicles, municipal catch
basin/sewer cleaning vacuum trucks, refuse truck bodies and water blasting
equipment. Environmental Products sells primarily to municipal customers,
contractors and government customers.
FIRE RESCUE--Fire Rescue manufactures chassis; fire trucks, including Class
A pumpers, mini-pumpers and tankers; airport and other rescue vehicles, aerial
access platforms and aerial ladder trucks. This group sells primarily to
municipal customers, volunteer fire departments and government customers.
SAFETY PRODUCTS--Safety Products produces a variety of visual and audible
warning and signal devices; paging, local signaling, and building security,
parking and access control systems; hazardous area lighting; and equipment for
storage, transfer, use and disposal of flammable and hazardous materials. The
group's products are sold primarily to industrial, municipal and government
customers.
TOOL--Tool manufactures a variety of consumable tools which include die
components for the metal stamping industry, a large selection of precision metal
products for nonstamping needs and a line of precision cutting and grooving
tools including polycrystalline diamond and cubic boron nitride products for
superhard applications. The group's products are sold predominately to
industrial markets.
44
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Net sales by operating segment reflect sales of products and services and
financial revenues to external customers, as reported in the company's
consolidated statements of income. Intersegment sales are insignificant. The
company evaluates performance based on operating income of the respective
segment. Operating income includes all revenues, costs and expenses directly
related to the segment involved. In determining operating segment income,
neither corporate nor interest expenses are included. Operating segment
depreciation expense, identifiable assets and capital expenditures relate to
those assets that are utilized by the respective operating segment. Corporate
assets consist principally of cash and cash equivalents, notes and other
receivables and fixed assets. The accounting policies of each operating segment
are the same as those described in the summary of significant accounting
policies.
See Note K for a discussion of the company's acquisition activity during
the three-year period ended December 31, 2002.
Non-U.S. sales, which include sales exported from the U.S. and sales made
by non-U.S. operations, aggregated $293,248,000 in 2002, $267,531,000 in 2001
and $274,168,000 in 2000. Sales exported from the U.S. aggregated $77,517,000 in
2002, $87,064,000 in 2001 and $102,402,000 in 2000.
45
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
A summary of the company's continuing operations by segment for the
three-year period ended December 31, 2002 is as follows:
<Table>
<Caption>
2002 2001 2000
---- ---- ----
Net sales
Environmental Products $ 296,372,000 $ 280,708,000 $ 255,269,000
Fire Rescue 334,213,000 373,428,000 389,311,000
Safety Products 270,273,000 256,261,000 267,062,000
Tool 156,343,000 161,778,000 194,485,000
-------------- -------------- --------------
Total net sales $1,057,201,000 $1,072,175,000 $1,106,127,000
============== ============== ==============
Operating income
Environmental Products $ 22,961,000 $ 20,159,000 $ 23,101,000
Fire Rescue 11,239,000 27,194,000 24,940,000
Safety Products 41,432,000 37,917,000 43,721,000
Tool 18,716,000 19,290,000 35,298,000
Corporate expense (12,405,000) (12,556,000) (10,406,000)
-------------- -------------- --------------
Total operating income 81,943,000 92,004,000 116,654,000
Interest expense (20,075,000) (26,368,000) (31,401,000)
Other income (expense) (895,000) (1,182,000) (839,000)
Minority interest 129,000
-------------- -------------- --------------
Income before income taxes $ 61,102,000 $ 64,454,000 $ 84,414,000
============== ============== ==============
Depreciation and amortization
Environmental Products $ 4,452,000 $ 5,510,000 $ 5,030,000
Fire Rescue 4,511,000 5,199,000 5,304,000
Safety Products 6,378,000 9,316,000 8,978,000
Tool 7,530,000 9,418,000 8,907,000
Corporate 1,124,000 815,000 838,000
-------------- -------------- --------------
Total depreciation and amortization $ 23,995,000 $ 30,258,000 $ 29,057,000
============== ============== ==============
Identifiable assets
Manufacturing activities
Environmental Products $ 286,865,000 $ 153,406,000 $ 149,622,000
Fire Rescue 225,305,000 203,749,000 201,960,000
Safety Products 210,489,000 209,036,000 220,867,000
Tool 170,343,000 176,580,000 175,884,000
Corporate 38,228,000 30,634,000 24,343,000
-------------- -------------- --------------
Total manufacturing activities 931,230,000 773,405,000 772,676,000
-------------- -------------- --------------
Financial services activities
Environmental Products 65,542,000 72,581,000 69,055,000
Fire Rescue 161,246,000 166,539,000 145,175,000
-------------- -------------- --------------
Total financial services activities 226,788,000 239,120,000 214,230,000
-------------- -------------- --------------
Total identifiable assets $1,158,018,000 $1,012,525,000 $ 986,906,000
============== ============== ==============
Additions to long-lived assets
Environmental Products $ 100,899,000 $ 13,754,000 $ 5,574,000
Fire Rescue 5,178,000 6,466,000 4,958,000
Safety Products 5,817,000 4,105,000 5,333,000
Tool 11,421,000 19,373,000 19,857,000
Corporate 2,442,000 30,000 23,000
-------------- -------------- --------------
Total additions to long-lived assets $ 125,757,000 $ 43,728,000 $ 35,745,000
============== ============== ==============
Financial revenues (included in net
sales)
Environmental Products $ 6,511,000 $ 6,049,000 $ 6,113,000
Fire Rescue 9,632,000 9,490,000 8,082,000
-------------- -------------- --------------
Total financial revenues $ 16,143,000 $ 15,539,000 $ 14,195,000
============== ============== ==============
</Table>
46
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Due to the nature of the company's customers, a significant portion of the
Environmental Products and Fire Rescue financial revenues is exempt from federal
income tax.
A summary of the company's continuing operations by geographic area for the
three-year period ended December 31, 2002 is as follows:
<Table>
<Caption>
2002 2001 2000
---- ---- ----
UNITED STATES
Net sales $841,470,000 $891,708,000 $934,361,000
Operating income 66,130,000 76,630,000 103,704,000
Long-lived assets 408,822,000 376,890,000 344,367,000
ALL NON-U.S. (principally Europe)
Net sales $215,731,000 $180,467,000 $171,766,000
Operating income 15,813,000 15,374,000 12,950,000
Long-lived assets 127,591,000 42,883,000 69,027,000
</Table>
The company had no significant amounts of sales to or long-lived assets in
an individual country outside of the United States.
During 2000, the company decided to divest the operations of the Sign Group
and began to search for a qualified buyer of that business. The Sign Group
manufactures for sale or lease illuminated, non-illuminated and electronic
advertising sign displays primarily for commercial and industrial markets. It
also enters into contracts to provide maintenance service for the signs it
manufactures as well as for signs manufactured by others. The results of the
Sign operations are reported as discontinued operations in the financial
statements. Sign revenues for the years ended December 31, 2002, 2001 and 2000
were $43,245,000, $58,817,000 and $59,846,000, respectively. The company is
currently reviewing offers by potential acquirers of the Sign Group. The company
does not expect to record a loss on this sale.
The company incurred $3,627,000 in restructuring charges during 2001
principally resulting from reductions in work force through early retirement and
job eliminations. Of this amount, the Environmental Products Group incurred
costs of $798,000, the Fire Rescue Group incurred costs of $854,000, the Safety
Products Group incurred costs of $461,000 and the Tool Group incurred costs of
$1,514,000. In 2000, the company also incurred $3,744,000 in restructuring
charges relating to the consolidation of facilities and operations. Of this
amount, the Environmental Products Group incurred costs of $2,773,000 and the
Tool Group incurred $971,000. There was no remaining liability at December 31,
2002.
NOTE N--NET INCOME PER SHARE
The following table summarizes the information used in computing basic and
diluted income per share for the three-year period ending December 31, 2002:
<Table>
<Caption>
2002 2001 2000
---- ---- ----
Numerator for both basic and diluted
income per share computations--net
income $38,195,000 $47,573,000 $57,537,000
=========== =========== ===========
Denominator for basic income per
share--weighted average shares
outstanding 45,824,000 45,314,000 45,388,000
Effect of employee stock options
(dilutive potential common shares) 115,000 129,000 133,000
----------- ----------- -----------
Denominator for diluted income per
share--adjusted shares 45,939,000 45,443,000 45,521,000
=========== =========== ===========
</Table>
NOTE O--COMMITMENTS AND GUARANTEES
The company leases certain facilities and equipment under operating leases,
some of which contain options to renew. Total rental expense on all operating
leases was $8,483,000 in 2002, $7,985,000 in 2001 and $8,297,000 in 2000.
Sublease income and contingent rentals relating to operating leases were
insignificant. At December 31, 2002, minimum future rental commitments under
operating leases having noncancelable lease terms in excess of
47
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
one year aggregated $29,574,000 payable as follows: $8,047,000 in 2003,
$5,762,000 in 2004, $3,922,000 in 2005, $3,128,000 in 2006, $2,731,000 in 2007
and $5,984,000 thereafter.
At December 31, 2002 and 2001, the company had outstanding standby letters
of credit aggregating $21,472,000 and $19,858,000, respectively, principally to
act as security for retention levels related to casualty insurance policies and
to guarantee the performance of subsidiaries that engage in export transactions
to foreign governments and municipalities.
The company 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 company does business
with warranty periods generally ranging from 6 months to 5 years. The company
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 company'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
company periodically assesses the adequacy of its recorded warranty liabilities
and adjusts the amounts as necessary. Changes in the company's warranty
liabilities for the years ended December 31, 2002 and 2001 were as follows:
<Table>
<Caption>
2002 2001
---- ----
Balance at January 1 $ 6,786,000 $ 4,689,000
Provisions to expense 11,098,000 13,339,000
Actual costs incurred (12,608,000) (11,242,000)
Liabilities assumed in business acquisitions 8,438,000
------------ ------------
Balance at December 31 $ 13,714,000 $ 6,786,000
============ ============
</Table>
NOTE P--CHANGE IN ACCOUNTING-REVENUE RECOGNITION
In the fourth quarter of 2000, the company changed its method of accounting
for recognizing revenues for product sales. Effective with this change,
retroactively applied to January 1, 2000, the company recognizes revenues based
upon the respective terms of delivery for each sale agreement. This change was
required by Staff Accounting Bulletin (SAB) No. 101 issued by the Securities and
Exchange Commission. In years prior to 2000, the company recognized
substantially all of its revenues for product sales as products were shipped, as
this method was then in compliance with generally accepted accounting
principles.
For the year ended December 31, 2000, the company recognized sales of
$10,052,000 and the related operating income of $1,362,000 resulting from the
change in accounting method; these amounts were previously recognized in sales
and income in 1999 under the company's previous accounting method. These sales
and the related income also account for the cumulative effect of the change in
accounting method on prior years, which resulted in a charge to net income of
$844,000 (net of taxes of $518,000), or $.02 per diluted share. This charge
reflects the adoption of SAB No. 101 and is included in the year ended December
31, 2000. Pro-forma net income amounts for the three-year period ending December
31, 2002, assuming the change in method was retroactively applied to the
beginning of that period, are as follows:
<Table>
<Caption>
2002 2001 2000
---- ---- ----
Net income $38,195,000 $47,573,000 $58,381,000
Diluted net income per share $ .83 $ 1.05 $ 1.28
</Table>
NOTE Q--GOODWILL
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations", and No. 142, "Goodwill and Other Intangible Assets",
effective for fiscal years beginning after December 15, 2001. Under the new
rules, goodwill and intangible assets deemed to have indefinite lives are no
longer amortized but are subject to annual impairment tests in accordance with
these statements. Other intangible assets continue to be amortized over their
useful lives.
The company adopted SFAS No. 142 effective January 1, 2002 and accordingly
discontinued the amortization of goodwill. A reconciliation of previously
reported net income and earnings per share to the
48
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
amounts adjusted for the exclusion of goodwill amortization, net of the related
income tax effect, for the three-year period ended December 31, 2002 follows:
<Table>
<Caption>
2002 2001 2000
---- ---- ----
Reported net income $38,195,000 $47,573,000 $57,537,000
Add back: goodwill amortization, net of
tax 5,503,000 5,174,000
----------- ----------- -----------
Adjusted net income $38,195,000 $53,076,000 $62,711,000
=========== =========== ===========
Basic net income per common share
Reported net income $ .83 $ 1.05 $ 1.27
Goodwill amortization, net of tax .12 .11
----------- ----------- -----------
Adjusted net income $ .83 $ 1.17 $ 1.38
=========== =========== ===========
Diluted net income per common share
Reported net income $ .83 $ 1.05 $ 1.26
Goodwill amortization, net of tax .12 .11
----------- ----------- -----------
Adjusted net income $ .83 $ 1.17 $ 1.37
=========== =========== ===========
</Table>
As part of the adoption of SFAS No. 142, the company also 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 recognized
in the first quarter of 2002 as a charge to net income resulting from a
cumulative effect of a change in accounting. The company 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 year ended
December 31, 2002, by operating segment, were as follows:
<Table>
<Caption>
ENVIRONMENTAL
PRODUCTS FIRE RESCUE SAFETY PRODUCTS TOOL TOTAL
------------- ----------- --------------- ---- -----
Goodwill balance, December 31,
2001 $ 61,722,000 $33,356,000 $98,900,000 $86,910,000 $280,888,000
Impairment (7,984,000) (7,984,000)
Goodwill acquired 65,051,000 65,051,000
Translation and other 2,084,000 3,574,000 1,085,000 3,737,000 10,480,000
------------ ----------- ----------- ----------- ------------
Goodwill balance, December 31,
2002 $128,857,000 $36,930,000 $99,985,000 $82,663,000 $348,435,000
============ =========== =========== =========== ============
</Table>
Other intangible assets (amortized and not amortized) were insignificant
for the year ended December 31, 2002.
Under SFAS 142, the company is required to test its goodwill annually for
impairment, which is performed at the beginning of the fourth quarter. The
company performed this testing as required in the fourth quarter of 2002 and
determined that there was no impairment.
NOTE R--NEW ACCOUNTING PRONOUNCEMENTS
In September 2002, the Financial Accounting Standards Board 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 are currently 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.
SFAS No. 146 will be effective for exit or disposal activities that are
initiated after December 31, 2002. The company has no current exit or disposal
activities planned that would be affected by this statement.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure--An Amendment of FASB Statement No.
123". This statement provides for
49
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
transitions if a company elects to adopt SFAS No. 123 and also provides for some
additional disclosures in the financial statements for the year ended December
31, 2002. The company has adopted this statement. The company accounts for its
stock compensation under APB 25, and accordingly has added the additional
disclosures.
NOTE S--SELECTED QUARTERLY DATA (UNAUDITED)
(in thousands of dollars except per share amounts)
<Table>
<Caption>
FOR THE THREE-MONTH PERIOD ENDED
---------------------------------------------------------------------------------------
2002 2001
------------------------------------------ ------------------------------------------
MARCH JUNE SEPTEMBER DECEMBER MARCH JUNE SEPTEMBER DECEMBER
31 30 30 31 31 30 30 31
----- ---- --------- -------- ----- ---- --------- --------
Net sales $245,644 $257,864 $261,615 $292,078 $258,007 $286,817 $253,403 $273,948
Gross margin 69,890 74,747 74,062 80,297 79,940 85,681 72,129 74,511
Income from continuing
operations 9,794 10,712 12,493 13,180 11,626 16,712 8,853 9,399
Income from discontinued
operations 307 298 378
Cumulative effect of change in
accounting (7,984)
Net income 1,810 10,712 12,493 13,180 11,626 17,019 9,151 9,777
Per share data--diluted:
Income from continuing
operations .22 .24 .28 .28 .26 .37 .20 .21
Income from discontinued
operations .01 .01 .01
Cumulative effect of change
in accounting (.18)
Net income* .04 .24 .28 .28 .26 .37 .20 .22
Dividends paid per share .20 .20 .20 .20 .195 .195 .195 .195
Market price range per share
High 27.07 25.98 24.50 19.93 24.15 24.63 24.01 22.94
Low 19.90 21.55 18.10 16.00 18.40 18.80 17.00 17.20
</Table>
* amounts may not add due to rounding
The company incurred pre-tax restructuring charges (see Note M) of
$3,627,000 for the three-month period and year ending December 31, 2001.
50
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
To the Shareholders and Board of Directors
of Federal Signal Corporation
We have audited the accompanying consolidated balance sheets of Federal
Signal Corporation and subsidiaries as of December 31, 2002 and 2001 and the
related consolidated statements of income, comprehensive income and cash flows
for each of the three years in the period ended December 31, 2002. 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 auditing standards generally
accepted in the United States. 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 Federal Signal
Corporation and subsidiaries as of December 31, 2002 and 2001, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2002 in conformity with accounting
principles generally accepted in the United States.
As discussed in Notes A, P and Q to the financial statements, the company
changed its method of accounting for goodwill and other intangibles and revenue
recognition in 2002 and 2000, respectively.
[ERNST & YOUNG LLP SIGNATURE]
Chicago, Illinois
January 28, 2003
51
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
FINANCIAL REVIEW
CONSOLIDATED RESULTS OF OPERATIONS
Federal Signal Corporation's diluted income per share from continuing
operations for 2002 totaled $1.01 on sales of $1.06 billion. This compares to
earnings per share of $1.03 in 2001 on sales of $1.07 billion. The 1% sales
decline reflected essentially flat selling prices in 2002 on continued weak
industrial market conditions; the refuse body acquisitions in the fourth quarter
of 2002 increased sales approximately 2%. Sales to customers in the United
States declined 5% in 2002 and sales to non-U.S. customers increased 10% (3% in
functional currency). Orders increased 4% in 2002 to $1.1 billion, due to the
addition of the refuse truck body orders in the fourth quarter, and strength in
safety products markets, particularly the $19 million initial installment on the
Dallas/ Fort Worth International Airport parking revenue control system award
received in the third quarter. Net income in 2002 included an $8.0 million
after-tax charge relating to the cumulative effect of a change in accounting for
goodwill required by Statement of Financial Accounting Standards (SFAS) No. 142,
"Goodwill and Other Intangible Assets". Net income in 2001 included $5.5 million
of after-tax expense relating to goodwill amortization; goodwill was not
amortized in 2002 in accordance with SFAS No. 142.
Net sales declined 3% in 2001 to $1.07 billion compared to the $1.11
billion in 2000. Income from continuing operations was $46.6 million in 2001
compared to $57.7 million in 2000. Diluted income per share from continuing
operations was $1.03 in 2001 compared to $1.27 in 2000; earnings were adversely
affected by $.05 in restructuring charges in both 2001 and 2000. Net income in
2001 was $47.6 million, or $1.05 per diluted share compared to $57.5 million, or
$1.26 per diluted share, in 2000. Net income per share amounts included $.02 per
share in both 2001 and 2000 from the discontinued operations of the Sign Group.
Net income in 2000 also included a $.02 per share charge relating to the
cumulative effect of a change in accounting for revenue recognition required by
Staff Accounting Bulletin (SAB) No. 101 issued by the Securities and Exchange
Commission. The 2001 sales results of the company's continuing operations
reflected a very weak industrial economy in the U.S. as well as order and sales
delays in the company's Fire Rescue and Safety Products groups. Sales prices in
2001 were essentially flat with the prior year reflecting the weaker industrial
market conditions; the effects of acquisitions on 2001 sales comparisons to 2000
were insignificant. Sales to customers in the United States declined 3% in 2001
and sales to non-U.S. customers declined 2% (1% in functional currency).
Incoming orders declined 3% in 2001 with orders from U.S. customers off 3% from
a year ago and orders from non-U.S. customers down 1%.
The company focuses on operating margin, rather than either the gross
margin component or the selling, general, and administrative (SG&A) cost
component of operating margin when setting overall Federal Signal performance
targets and monitoring results. The reasons for this focus are: 1) the distinct
differences in the cost structures of the company's businesses, and 2) the
varying growth rates of these individual businesses. This combination dictates
that the separate operating margin components are only useful in managing
individual business performance. In looking at total profitability of the
company's U.S. and non-U.S. operations, the company recognizes that some of its
U.S. operations have benefited from selling their products through distribution
channels of non-U.S. operations. The following table summarizes the company's
gross margins and operating margins for the last five years (percent of sales):
<Table>
<Caption>
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Net sales 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales 71.7 70.9 69.5 69.2 69.0
----- ----- ----- ----- -----
Gross profit margin 28.3 29.1 30.5 30.8 31.0
SG&A expenses 20.5 20.5 20.0 20.4 20.6
----- ----- ----- ----- -----
Operating margin 7.8% 8.6% 10.5% 10.4% 10.4%
===== ===== ===== ===== =====
</Table>
Gross profit margins of 28.3% in 2002 are somewhat lower than the average
of the 1998-2001 period (30.3%) largely reflecting three significant factors: a
very slow industrial economy reduced sales of the company's high-margin
industrial products and resulted in a temporary shift to lower gross margin
products; reduced throughput and higher production costs adversely affected Fire
Rescue Group profitability; and competitive price pressures reduced the
potential for price increases on the company's products. SG&A expenses as a
percent of sales were 20.5% in 2002, essentially flat with the average of the
preceding four-year period. Operating margin
52
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
FINANCIAL REVIEW (CONTINUED)
was 7.8% in 2002 compared to 2001's 8.6%. This compares to the average of 10.0%
for the 1998-2001 period. Operating margins in 2002 declined largely as a result
of the same reasons gross margins declined.
Certain of the company's businesses are susceptible to the influences of
seasonal buying or delivery patterns. The company'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, fire rescue products, outdoor
warning, municipal emergency signal products, parking systems and signage.
GROUP OPERATIONS
ENVIRONMENTAL PRODUCTS
In 2002, orders were 7% above the prior year, due mainly to the refuse
truck body acquisitions. Global sweeper orders declined 2%, as increased
international business was more than offset by a 15% reduction in U.S. orders.
U.S. municipal orders trended down during the course of the year in light of
deteriorating state and local governmental budgets. Revenues rose 6%, mainly due
to the refuse truck body acquisitions. Operating income increased 3%, with
improved operating results for sweepers, more than offsetting lower margins on
other product lines resulting from product mix and lower volumes.
In 2001, Environmental Products Group sales rose 10% and new orders rose
2%. Earnings before restructuring charges decreased 19%. Sales growth was strong
in U.S. municipal sweepers, augmented by the acquisition of the assets of Athey
Products Corporation in March. Industrial vacuum truck and industrial water
blaster sales were down moderately for the full year, but slowed dramatically in
the last half of the year. Operating earnings declined substantially as
continuing vacuum truck plant consolidation costs and new-product-related costs,
plus a lower margin sales mix, reduced operating margin. The group incurred
restructuring charges of $.8 million in 2001.
FIRE RESCUE
In 2002, orders for Fire Rescue increased 1%, as strong orders at European
businesses more than offset a modest decline elsewhere. Sales declined 11%,
largely as a result of operating difficulties at U.S. production facilities.
During 2002, these plants experienced reduced throughput and higher production
costs resulting from a trend toward more complex units as well as development
costs associated with prototype units. Operating income fell 60% as a result of
the higher production costs and lower sales.
In 2001, Fire Rescue Group earnings before restructuring charges were up
12% on a 4% decline in sales. New orders declined 2%. New orders and sales
declined on essentially flat worldwide markets as orders were delayed in the
U.S. by a Federal government subsidy program for fire apparatus and by the
September 11 events which changed fire department priorities in the fourth
quarter. Earnings increased significantly as group manufacturing operations
continued to improve, raising overall operating margin. The group incurred $.9
million in restructuring charges in 2001.
SAFETY PRODUCTS
In 2002, orders for Safety Products rose 6%, due to large airport parking
and control systems awards and success in increasing market share for European
police products. Revenue rose 5%, due to increased deliveries of outdoor warning
systems and European police products. Operating income improved 3% due to higher
revenues, partly offset by increased pension expense.
In 2001, Safety Products Group earnings before restructuring charges fell
12% on a 4% sales decline. New orders increased 4%. New orders were up for all
major product lines except industrial. Sales fell as substantial projects in
parking equipment and outdoor warning systems were delayed into 2002. The delay
between orders and installation of these projects was the major cause of the
group's reduced earnings and margins in 2001.
TOOL
In 2002, sales declined 3%, a reflection of lower cutting tools sales,
which represent about one-quarter of tool product sales. Despite relatively
strong automotive production, low capital investment resulted in continued
weakness for these products. Operating income declined 14% because of lower
sales volumes, and the effect of
53
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
FINANCIAL REVIEW (CONTINUED)
lower fixed cost absorption caused by inventory reductions made possible by
successful lean enterprise initiatives. Pricing pressures on cutting tools also
adversely affected operating income.
In 2001, Tool Group earnings, before restructuring charges of approximately
$1.5 million, fell 43% on a 17% decline in sales. New orders declined 19%. New
orders, sales and earnings all declined sharply in very weak global industrial
markets; the most severe decline was in North America and the earnings weakness
was across all major product lines. Markets continued to weaken throughout 2001.
Notwithstanding the sales decline, the group held its leading market shares and
increased that share in certain product lines.
SIGN (DISCONTINUED OPERATIONS)
In 2000, the company decided to divest the Sign Group and began searching
for a buyer of this business. The group saw markets weaken in 2002 and 2001. The
results of this group are reported as discontinued operations in the company's
consolidated financial statements. Due to the slower economic environment in
2002 and 2001, it has taken longer to sell the entity than originally planned.
At year-end the company was in negotiations with a third party for the sale of
the Sign Group. The company does not expect to record a loss on this sale.
CORPORATE AND OTHER
Corporate expense was $12.4 million in 2002, down slightly from the $12.6
million in 2001. Interest expense declined $6.3 million, or 24%, in 2002 largely
as a result of a much lower short-term interest rate environment in 2002. The
much lower interest rates were partially offset by increased borrowings in the
fourth quarter of 2002 related to cash paid in the acquisitions of businesses.
The decrease in interest expense of $5.0 million in 2001 was largely as a result
of the lower short-term interest rate environment that was partially offset by a
significant refinancing of short-term debt with funded debt at higher interest
rates. Weighted average interest rates on short-term borrowings were 2.0% in
2002, 4.6% in 2001 and 6.5% in 2000.
At the end of 2002, the company changed its assumptions for discount rates
used in determining the actuarial present values of accumulated and projected
benefit obligations for its postretirement plans. The company reduced the
discount rate to 6.75% at the end of 2002 from the 7.3% used at the end of 2001
for its U.S. plan because of the lower interest rate environment experienced at
the end of 2002. In January 2003, the company established its other significant
cost assumptions for its U.S. benefits as follows: expected long-term rate of
return on plan assets--9.0%; rate of increase in compensation levels--3.5%. The
company expects that the change in these assumptions will increase 2003 pension
costs by approximately $.05 per share compared to 2002. The company incurred
approximately $.7 million in nonrecurring pension costs in 2001 as a result of
the company's fourth quarter 2001 restructuring.
The company's effective tax rate in 2002 of 24.4% was down from the 27.7%
in 2001 and the 31.7% in 2000. The lower tax rate in 2002 reflects the increased
mix of tax-exempt revenues earned by the company's Environmental Products and
Fire Rescue groups, lower tax rates of the company's foreign operations,
eliminating the amortization of non-deductible goodwill for financial reporting
purposes due to the adoption of SFAS No. 142 and reduction in reserve needs for
now-closed tax issues.
During the fourth quarter of 2002, the company recorded an after-tax charge
of $13.8 million to other comprehensive income representing the effect of an
additional minimum pension liability. Like many companies, the company's pension
plan performance was adversely affected by low asset returns and lower interest
rates.
FINANCIAL SERVICES ACTIVITIES
The company maintains a large investment ($227 million and $239 million at
December 31, 2002 and 2001, respectively) in lease financing and other
receivables that are generated by its environmental products and fire rescue
operations. For the five-year period ending December 31, 2002 these assets
continued to be leveraged in accordance with the company's stated financial
objectives (see further discussion in "Financial Position and Cash Flow").
54
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
FINANCIAL REVIEW (CONTINUED)
Financial services assets have repayment terms ranging from one to ten
years. The decrease in these assets resulted from the company's 2001 decision to
cease lending to customers in certain commercial and industrial markets.
FINANCIAL POSITION AND CASH FLOW
For the full year, operating cash flow totaled $88 million, down $7 million
from 2001 in part because of a discretionary $5 million pension contribution
made in view of the company's strong cash position and weak pension asset
performance. During 2002, the company saw reductions in average working capital
driven by improved collections, lower inventory levels due to lean enterprise
initiatives, and the receipt of more advance payments from customers.
Improved inventory utilization should further improve cash flow in 2003 as
the company continues to make process improvements in all of its groups as a
part of the company-wide lean enterprise initiative.
During the 1998-2002 period, the company utilized its strong cash flows
from operations and available debt capacity to: 1) fund in whole or in part
strategic acquisitions of companies operating in markets related to those
already served by the company; 2) purchase increasing amounts of equipment
principally to provide for further cost reductions and increased productive
capacity for the future as well as tooling for new products; 3) pay increasing
amounts in cash dividends to shareholders; and 4) repurchase a small percentage
of its outstanding common stock each year.
Cash flows for the five-year period ending December 31, 2002 are summarized
as follows (in millions):
<Table>
<Caption>
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Cash provided by (used for):
Operating activities $ 88.4 $ 95.1 $ 64.4 $ 57.7 $ 75.5
Investing activities (57.3) (59.2) (64.8) (105.1) (93.0)
Financing activities (38.1) (32.6) 5.2 40.9 22.2
</Table>
In order to show the distinct characteristics of the company's investment
in its manufacturing activities and its investment in its financial services
activities, the company has presented separately these investments and their
related liabilities. Different ratios of debt and equity support each of these
two types of activities.
At year-end, total manufacturing debt was $296 million, representing 44% of
capitalization; the ratio was unchanged from the prior year-end. The company
believes that its financial assets, due to their overall quality, are capable of
sustaining a leverage ratio of 87%. At both December 31, 2002 and 2001, the
company's debt-to-capitalization ratio for its financial services activities was
87% for its continuing operations.
As indicated earlier, management focuses substantial effort on improving
the utilization of the company's working capital. The company's current ratio
for its manufacturing operations was 1.8 at both December 31, 2002 and 2001. The
company anticipates that its financial resources and major sources of liquidity,
including cash flow from operations, will continue to be adequate to meet its
operating and capital needs in addition to its financial commitments.
During the fourth quarter of 2002, the company issued long-term debt of
$100 million at an average interest rate of 5.1%, at terms ranging from six to
ten years. The company issued the debt to replace $48 million of short-term debt
incurred to fund the refuse business acquisitions and to replace other existing
short-term debt.
MARKET RISK MANAGEMENT
The company is subject to risks associated with changes in interest rates
and foreign exchange rates. The company principally utilizes two types of
derivative financial instruments: 1) interest rate swaps and 2) foreign exchange
forward contracts to manage risks associated with sales and purchase commitments
denominated in foreign currencies. The company does not hold or issue derivative
financial instruments for trading or speculative purposes and is not a party to
leveraged derivatives.
Of the company's debt at December 31, 2002, 41% was used to support
financial services assets; the average remaining life of those assets is
typically under three years. The company is currently comfortable with a
sizeable
55
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
FINANCIAL REVIEW (CONTINUED)
portion of floating rate debt to support these financial services assets, since
a rise in borrowing rates would normally correspond with a rise in lending rates
within a reasonable period.
The company manages its exposure to interest rate movements by maintaining
a proportionate relationship between fixed-rate debt to total debt within
established percentages. The company uses funded fixed-rate borrowings as well
as interest rate swap agreements to balance its overall fixed/floating interest
rate mix.
At December 31, 2002 and 2001, the company was party to interest rate swap
agreements with aggregate notional amounts of $270,000,000 and $130,000,000,
respectively. See Note H to the consolidated financial statements for a
description of these agreements. All of the interest rate swap agreements
qualify for hedge accounting treatment.
Significant interest rate sensitive instruments at December 31, 2002 and
2001 were as follows (dollars in millions):
<Table>
<Caption>
2002 2001
--------------------------------------------------------------------- ---------------
FAIR FAIR
2003 2004 2005 2006 2007 THEREAFTER TOTAL VALUE TOTAL VALUE
---- ---- ---- ---- ---- ---------- ----- ----- ----- -----
Long-term debt
Fixed rate
Principal $ .2 $25.2 $17.2 $82.2 $27.1 $178.6 $330.5 $311.8 $239.3 $240.3
Average interest rate 5.8% 5.8% 5.7% 5.6% 5.6% 5.5% 5.7% 6.2%
Variable rate
Principal $ .5 $ .4 $ .4 $ .5 $ .5 $ 2.3 $ 4.6 $ 4.5 $ 2.2 $ 2.2
Average interest rate 5.8% 5.8% 5.8% 5.8% 5.8% 5.8% 5.8% 3.2%
Short-term debt--variable rate
Principal $152.8 $152.8 $152.8 $233.9 $233.9
Average interest rate 1.8% 1.8% 2.7%
Interest rate swaps (pay fixed,
receive variable)
Notional amount $20.0 $20.0 $ 25.0 $ 65.0 $ (2.4) $ 25.0 $ (1.4)
Average pay rate 4.2% 4.8% 5.1% 4.8% 5.1%
Average receive rate 1.4% 1.4% 1.4% 1.4% 2.0%
Interest rate swaps (receive
fixed, pay variable)
Notional amount $55.0 $10.0 $140.0 $205.0 $ 3.6 $105.0 $ (2.5)
Average pay rate 3.5% 4.0% 2.7% 3.0% 3.2%
Average receive rate 5.5% 6.8% 5.6% 5.6% 6.1%
</Table>
The company had $47,126,000 of foreign exchange forward contracts
outstanding at December 31, 2002. Most of these contracts were used to purchase
Canadian dollars and expire at various dates in 2003; the fair value of these
contracts was ($316,000) at December 31, 2002.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States 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. The
company considers the following policies to be the most critical in
understanding the judgments that are involved in the preparation of the
company's consolidated financial statements and the uncertainties that could
impact the company's financial condition, results of operations, and cash flows.
Allowance for doubtful accounts: The company maintains an allowance for
doubtful accounts for estimated losses resulting from the inability of its
customers to make required payments on the outstanding accounts receivable. The
allowance is maintained at a level considered appropriate based on historical
and other factors that affect collectibility. The factors include historical
trends of write-offs, recoveries and credit losses; the monitoring of portfolio
credit quality; and current and projected economic and market conditions. If the
financial condition of the company's customers were to deteriorate, resulting in
an impairment of the ability to make payments, additional allowances may be
required.
56
FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES
FINANCIAL REVIEW (CONTINUED)
Warranty: Sales of some of the company's products carry express warranties
based on the terms that are generally accepted in the company's marketplaces.
The company records provisions for estimated warranty at the time of sale based
on historical experience and periodically adjusts these provisions to reflect
actual experience. Infrequently, a material warranty issue can arise which is
beyond the scope of the company's historical experience. The company provides
for these issues as they become probable and estimable.
Product liability and worker's compensation: Due to the nature of the
company's products, the company is subject to claims for product liability and
worker's compensation in the normal course of business. The company is
self-insured for a portion of these claims. The company establishes a liability
using a third party actuary for any known outstanding matters, including a
reserve for claims incurred but not yet reported.
Goodwill Impairment: Under SFAS No. 142, "Goodwill and Other Intangible
Assets", the company is required to test its goodwill annually for impairment,
which is performed at the beginning of the fourth quarter. This review for
impairment requires judgment in estimating future sales, earnings and cash flows
to determine the fair value of the reporting units.
OTHER MATTERS
The company has a business conduct policy applicable to all employees and
regularly monitors compliance with that policy. The company has determined that
it had no significant related party transactions for the three-year period
ending December 31, 2002.
The company has reviewed its financial arrangements and has determined that
off-balance sheet arrangements, other than disclosed in the notes to the
financial statements, do not exceed $1 million.
57