UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

þ    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2008

 

Commission File Number 1-6003

 

The Company’s telephone number, including area code

(630) 954-2000

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  o      No  þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes  o      No  þ

 

Indicate by check mark whether the Company (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Company was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  þ      No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the Company’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Indicate by check mark if the registrant is a shell company, in Rule 12b-2 of the Exchange Act.  Yes  o      No  þ

 

State the aggregate market value of voting stock held by nonaffiliates of the Company as of June 30, 2008: Common stock, $1.00 par value — $554,199,456

 

Indicate the number of shares outstanding of each of the Company’s classes of common stock, as of January 31, 2009: Common stock, $1.00 par value — 47,371,122 shares

 

Documents Incorporated By Reference

 

Portions of the definitive proxy statement for the 2009 Annual Meeting of Shareholders are incorporated by reference in Part III.

 

 

FEDERAL SIGNAL CORPORATION
Index to Form 10-K

 

This Form 10-K and other reports filed by Federal Signal Corporation and subsidiaries (“the Company”) with the Securities and Exchange Commission and comments made by management may contain the words such as “may,” “will,” “believe,” “expect,” “anticipate,” “intend,” “plan,” “project,” “estimate” and “objective” or the negative thereof or similar terminology concerning the Company’s future financial performance, business strategy, plans, goals and objectives. These expressions are intended to identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include information concerning the Company’s possible or assumed future performance or results of operations and are not guarantees. While these statements are based on assumptions and judgments that management has made in light of industry experience as well as perceptions of historical trends, current conditions, expected future developments and other factors believed to be appropriate under the circumstances, they are subject to risks, uncertainties and other factors that may cause the Company’s actual results, performance or achievements to be materially different.

 

These risks and uncertainties, some of which are beyond the Company’s control, include the cyclical nature of the Company’s industrial, municipal, government and commercial markets, availability of credit and third-party financing for customers, volatility in securities trading markets, economic downturns, risks associated with suppliers, dealer and other partner alliances, changes in cost competitiveness including those resulting from foreign currency movements, technological advances by competitors, increased warranty and product liability expenses, compliance with environmental and safety regulations, restrictive debt covenants, disruptions in the supply of parts or components from sole source suppliers and subcontractors, retention of key employees and general changes in the competitive environment. These risks and uncertainties include, but are not limited to, the risk factors described under Item 1A, “Risk Factors,” in this Form 10-K. These factors may not constitute all factors that could cause actual results to differ materially from those discussed in any forward-looking statement. The Company operates in a continually changing business environment and new factors emerge from time to time. The Company cannot predict such factors nor can it assess the impact, if any, of such factors on its financial position or results of operations. Accordingly, forward-looking statements should not be relied upon as a predictor of actual results. The Company disclaims any responsibility to update any forward-looking statement provided in this Form 10-K.

 

Environmental Solutions Group

 

The Environmental Solutions Group manufactures and markets worldwide a full range of street cleaning and vacuum loader vehicles and high-performance water blasting equipment. Products are also manufactured for the newer markets of hydro-excavation, glycol recovery and surface cleaning. Products are sold under the Elgin, RAVO, Vactor, Guzzler and Jetstream brand names. The group manufactures its vehicles and equipment in the United States and Europe.

 

Under the Elgin brand name, the Company sells the leading U.S. brand of street sweepers primarily designed for large-scale cleaning of curbed streets, parking lots and other paved surfaces utilizing mechanical sweeping, vacuum and recirculating air technology for cleaning. RAVO is a market leader in Europe for high-quality, compact and self-propelled sweepers that utilize vacuum technology for pick-up.

 

Vactor is a leading manufacturer of municipal combination catch basin/sewer cleaning vacuum trucks. Guzzler is a leader in industrial vacuum loaders that clean up industrial waste or recover and recycle valuable raw materials. Jetstream manufactures high pressure water blast equipment and accessories for commercial and industrial cleaning and maintenance operations. In addition to equipment sales, the group is increasingly engaged in the sale of parts and tooling, service and repair, equipment rentals and training as part of a complete offering to its customer base.

 

Tool Group

 

In 2008, the Company sold the remaining businesses within the Tool Group, referred to collectively as “Die and Mold Operations”. The results of the Die and Mold Operations are reported within discontinued operations for all periods presented.

 

Financial Services

 

The Company ceased entering into new financial services activities in 2008 and sold 92% of its municipal lease portfolio. The operations and gain upon sale are reported within discontinued operations. At December 31, 2008, the remaining leases and floor plan receivable balances, net of reserves, of $5.6 million were included on the balance sheet as Assets of Discontinued Operations.

 

Marketing and Distribution

 

The Safety and Security Systems Group companies sell to industrial customers through approximately 2,000 wholesalers/distributors who are supported by Company sales personnel and/or independent manufacturers’ representatives. Products are also sold to municipal and governmental customers through more than 900 active independent distributors as well as through original equipment manufacturers and direct sales. International sales are made through the group’s independent foreign distributors or on a direct basis. The Company also sells comprehensive integrated warning, interoperable communications and parking systems through a combination of a direct sales force and distributors.

 

Fire Rescue and Environmental Solutions use dealer networks and direct sales to service customers generally depending on the type and location of the customer. The Environmental Solutions direct sales channel concentrates on the industrial, utility and construction market segments while the dealer networks focus primarily on the municipal markets. The Company believes its national and global dealer networks for vehicles distinguishes it from its competitors. Dealer representatives demonstrate the vehicles’ functionality and capability to customers and service the vehicles on a timely basis.

 

Customers and Backlog

 

Approximately 29%, 25% and 46% of the Company’s total 2008 orders were to U.S. municipal and government customers, U.S. commercial and industrial customers, and non-U.S. customers, respectively. No single customer accounted for 10% or more of the Company’s business.

 

The Company’s U.S. municipal and government customers depend on tax revenues to support spending. A sluggish industrial economy, therefore, will eventually impact a municipality’s revenue base as tax receipts decline

due to higher levels of unemployment and declining profits. Additionally, a decline in housing prices may yield lower property tax receipts. During 2008, the Company’s U.S. municipal and government orders declined 12% from 2007, compared to a 5% increase in these orders in 2007 compared to 2006.

 

Orders to the U.S. commercial and industrial segment relate to the energy industries, principally oil and gas production and coal mining, to industrial contractors and rental companies and to parking operators.

 

Roughly 70% of orders to non-U.S. customers flow to municipalities and governments while 30% flow to industrial and commercial customers. The municipal and government segment is essentially similar to the U.S. in that it is largely dependent on tax revenues to support spending. Of the non-U.S. orders, the Company typically sells approximately 50% of its products into Europe, 15% into the Middle East and Africa, and less than 10% in any other particular region.

 

The Company’s backlog totaled $301 million at December 31, 2008, which averages to nearly four months of shipments overall. Backlogs vary by group due to the nature of the Company’s products and buying patterns of its customers. Safety and Security Systems typically maintains an average backlog of two months of shipments, Environmental Solutions three to four months of shipments and Fire Rescue normally six months of shipments.

 

Suppliers

 

The Company purchases a wide variety of raw materials from around the world for use in the manufacture of its products, although the majority of current purchases are from North American sources. To minimize availability, price and quality risk, the Company is party to numerous strategic supplier arrangements. Although certain materials are obtained from either a single-source supplier or a limited number of suppliers, the Company has identified alternative sources to minimize the interruption to its business in the event of supply problems.

 

Components critical to the production of the Company’s vehicles, such as engines and hydraulic systems, are purchased from a select number of suppliers. The Company also purchases raw and fabricated steel as well as commercial chassis with certain specifications from a few sources.

 

The Company believes it has adequate supplies or sources of availability of the raw materials and components necessary to meet its needs. However, there are risks and uncertainties with respect to the supply of certain of these raw materials that could impact their price, quality and availability in sufficient quantities.

 

Competition

 

Within specific product categories and domestic markets, the Safety and Security Systems Group companies are among the leaders with three to four strong competitors and several additional ancillary market participants. The group’s international market position varies from leader to ancillary participant depending on the geographic region and product line. Generally, competition is intense with all of the group’s products, and purchase decisions are made based on competitive bidding, price, reputation, performance and servicing.

 

Within the Fire Rescue Group, Bronto Skylift is established as the global leader for aerial platforms used in fire fighting, rescue and industrial markets. Competitor offerings can include trailer mounted articulated aerials and traditional fire trucks with ladders. Bronto competes on product performance where it holds technological advantages in its designs, materials and production processes.

 

Within the Environmental Solutions Group, Elgin is recognized as the market leader among several domestic sweeper competitors and differentiates itself primarily on product performance. RAVO, the Company’s Dutch compact sweeper manufacturer, also competes on product performance through its vacuum technology and successfully leads in market share for mid-sized sweepers among several regional European manufacturers. Vactor and Guzzler both maintain the leading domestic position in their respective marketplaces by enhancing product performance with leading technology and application flexibility. Jetstream is a market leader in the in-plant cleaning segment of the U.S. waterblast industry competing on product performance and rapid delivery.

Research and Development

 

The information concerning the Company’s research and development activities included in Note 15 of the Consolidated Financial Statements included under Item 8 of Part II of this Form 10-K is incorporated herein by reference.

 

Patents and Trademarks

 

The Company owns a number of patents and possesses rights under others to which it attaches importance, but does not believe that its business as a whole is materially dependent upon any such patents or rights. The Company also owns a number of trademarks that it believes are important in connection with the identification of its products and associated goodwill with customers, but no material part of the Company’s business is dependent on such trademarks.

 

Employees

 

The Company employed over 3,300 people in ongoing businesses at the close of 2008. Approximately 32% of the Company’s domestic hourly workers were unionized at December 31, 2008. The Company believes relations with its employees continue to be good.

 

Governmental Regulation of the Environment

 

The Company believes it substantially complies with federal, state and local provisions that have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment. Capital expenditures in 2008 attributable to compliance with such laws were not material. The Company believes that the overall impact of compliance with environmental regulations will not have a material effect on its future operations.

 

Seasonality

 

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, emergency signaling products and parking systems.

 

Additional Information

 

The Company makes its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, other reports and information filed with the SEC and amendments to those reports available, free of charge, through its Internet website (http://www.federalsignal.com) as soon as reasonably practical after it electronically files or furnishes such materials to the SEC. Additionally, the Company makes its proxy statement and its Annual Report to stockholders available at the same internet website (http://www.federalsignal.com) , free of charge, when sent to stockholders prior to the meeting date. All of the Company’s filings may be read or copied at the SEC’s Public Reference Room at 100 F. Street, N.E., Washington, DC 20549. Information on the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet website (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically.

 

results to differ from those contained in such forward-looking statements include, among other things, the risks described below.

 

The execution of our growth strategy is dependent upon the continued availability of credit and third-party financing arrangements for our customers.

 

The recent economic downturn has resulted in tighter credit markets, which could adversely affect our customers’ ability to secure the financing necessary to proceed or continue with purchases of our products and services. Our customers’ or potential customers’ inability to secure financing for projects could result in the delay, cancellation or down-sizing of new purchases or the suspension of purchases already under contract, which could cause a decline in the demand for our products and services and negatively impact our revenues and earnings.

 

We rely on access to financial markets to finance a portion of our working capital requirements and support our liquidity needs. Access to these markets may be adversely affected by factors beyond our control, including turmoil in the financial services industry, volatility in securities trading markets and general economic downturns.

 

We draw upon our revolving credit facility and our operating cash flow to fund working capital needs, capital expenditures, strategic acquisitions, pension contributions, debt repayments, share repurchases and dividends. Market disruptions such as those currently being experienced in the U.S. and abroad have materially impacted liquidity in the credit and debt markets, making financing terms for borrowers less attractive and in certain cases have resulted in the unavailability of certain types of financing. Continued uncertainty in the financial markets may negatively impact our ability to access additional financing or to refinance our existing credit facility or existing debt arrangements on favorable terms or at all, which could negatively affect our ability to fund current and future operations as well as future acquisitions and development. These disruptions may include turmoil in the financial services industry, unprecedented volatility in the markets where our outstanding securities trade, and general economic downturns in the areas where we do business. If we are unable to access monies at competitive rates, or if our short-term or long-term borrowings costs dramatically increase, our ability to finance our operations, meet our short-term obligations and implement our operating strategy could be adversely affected.

 

Our financial results are subject to considerable cyclicality.

 

Our ability to be profitable depends heavily on varying conditions in the United States government and municipal markets and the overall United States economy. The industrial markets in which we compete are subject to considerable cyclicality, and move in response to cycles in the overall business environment. Many of our customers are municipal governmental agencies, and as such, we are dependent on municipal government spending. Spending by our municipal customers can be affected by local political circumstances, budgetary constraints, and other factors. The United States government and municipalities depend heavily on tax revenues as a source of their spending and, accordingly, there is a historical correlation, of a one or two year lag between the overall strength of the United States economy and our sales to the United States government and municipalities. Therefore, downturns in the United States economy are likely to result in decreases in demand for our products. During previous economic downturns, we experienced decreases in sales and profitability, and we expect our business to remain subject to similar economic fluctuations in the future.

 

The inability to obtain raw materials, component parts, and/or finished goods in a timely and cost-effective manner from suppliers would adversely affect our ability to manufacture and market our products.

 

We purchase raw materials and component parts from suppliers to be used in the manufacturing of our products. In addition, we purchase certain finished goods from suppliers. Changes in our relationships with suppliers or increases in the costs of purchased raw materials, component parts or finished goods could result in manufacturing interruptions, delays, inefficiencies or our inability to market products. In addition, our profit margins would decrease if prices of purchased raw materials, component parts or finished goods increase and we are unable to pass on those increases to our customers.

We operate in highly competitive markets.

 

The markets in which we operate are highly competitive. The intensity of this competition, which is expected to continue, can result in price discounting and margin pressures throughout the industry and adversely affects our ability to increase or maintain prices for our products. In addition, certain of our competitors may have lower overall labor or material costs.

 

We have international operations that are subject to foreign economic and political uncertainties.

 

Our business is subject to fluctuations in demand and changing international economic and political conditions which are beyond our control. During 2008, approximately 43% of our sales were to customers outside the United States; with approximately 32% of sales being supplied from our overseas operations. We expect a significant and increasing portion of our revenues and profits to come from international sales for the foreseeable future. Operating in the international marketplace exposes us to a number of risks, including abrupt changes in foreign government policies and regulations and, in some cases, international hostilities. To the extent that our international operations are affected by unexpected and adverse foreign economic and political conditions, we may experience project disruptions and losses which could significantly reduce our revenues and profits.

 

Some of our contracts are denominated in foreign currencies, which result in additional risk of fluctuating currency values and exchange rates, hard currency shortages and controls on currency exchange. Although currency exposure is hedged in the short term, over the longer term changes in the value of foreign currencies could increase our U.S. dollar costs for, or reduce our U.S. dollar revenues from, our foreign operations. Any increased costs or reduced revenues as a result of foreign currency fluctuations could affect our profits.

 

Failure to keep pace with technological developments may adversely affect our operations.

 

We are engaged in an industry which will be affected by future technological developments. The introduction of products or processes utilizing new technologies could render our existing products or processes obsolete or unmarketable. Our success will depend upon our ability to develop and introduce on a timely and cost-effective basis new products, processes and applications that keep pace with technological developments and address increasingly sophisticated customer requirements. We may not be successful in identifying, developing and marketing new products, applications and processes and product or process enhancements. We may experience difficulties that could delay or prevent the successful development, introduction and marketing of product or process enhancements or new products, applications or processes. Our products, applications or processes may not adequately meet the requirements of the marketplace and achieve market acceptance. Our business, operating results and financial condition could be materially and adversely affected if we were to incur delays in developing new products, applications or processes or product or process enhancements or if our products do not gain market acceptance.

 

Our ability to operate effectively could be impaired if we fail to attract and retain key personnel.

 

Our ability to operate our businesses and implement our strategies depends, in part, on the efforts of our executive officers and other key employees. In addition, our future success will depend on, among other factors, our ability to attract and retain qualified personnel, including finance personnel, research professionals, technical sales professionals and engineers. The loss of the services of any key employee or the failure to attract or retain other qualified personnel could have a material adverse effect on our business or business prospects.

 

We may incur material losses and costs as a result of product liability, warranty, recall claims or other lawsuits or claims that may be brought against us.

 

We are exposed to product liability and warranty claims in the normal course of business in the event that our products actually or allegedly fail to perform as expected or the use of our products results, or is alleged to result, in bodily injury and/or property damage. Accordingly, we could experience material warranty or product liability costs in the future and incur significant costs to defend against these claims. We carry insurance and maintain reserves for product liability claims. However, we cannot be assured that our insurance coverage will be adequate if such claims do arise, and any liability not covered by insurance could have a material adverse impact on our results

of operations and financial position. A future claim could involve the imposition of punitive damages, the award of which, pursuant to state laws, may not be covered by insurance. In addition, warranty or other claims are not typically covered by insurance coverage. Any product liability or warranty issues may adversely impact our reputation as a manufacturer of high quality, safe products and may have a material adverse effect on our business.

 

The costs associated with complying with environmental and safety regulations could lower our margins.

 

We, like other manufacturers, continue to face heavy governmental regulation of our products, especially in the areas of the environment and employee health and safety. Complying with environmental and safety requirements has added and will continue to add to the cost of our products, and could increase the capital required. While we believe that we are in compliance in all material respects with these laws and regulations, we may be adversely impacted by costs, liabilities or claims with respect to our operations under existing laws or those that may be adopted. These requirements are complex, change frequently and have tended to become more stringent over time. Therefore, we could incur substantial costs, including cleanup costs, fines and civil or criminal sanctions as a result of violations, or liabilities under, environmental laws and safety regulations.

 

We are subject to a number of restrictive debt covenants.

 

Our credit facility and other debt instruments contain certain restrictive debt covenants and other customary events of default that may hinder our ability to continue operating or to take advantage of attractive business opportunities. These restrictive covenants include, among other things, an interest coverage ratio of 3.00:1 in all quarters effective with the first quarter of 2009 and a minimum net worth of $275.0 million at all times. Our ability to comply with these restrictive covenants may be affected by the other factors described in this “Risk Factors” section and other factors outside our control. Failure to comply with one or more of these restrictive covenants may result in an event of default. Upon an event of default, if not waived by our lenders, our lenders may declare all amounts outstanding as due and payable. If we are unable to comply with the restrictive covenants in the future, we would be required to obtain further modifications from our lenders or secure another source of financing. If our current lenders accelerate the maturity of our indebtedness, we may not have sufficient capital available at that time to pay the amounts due to our lenders on a timely basis. In addition, these restrictive covenants may prevent us from engaging in transactions that benefit us, including responding to changing business and economic conditions and taking advantage of attractive business opportunities.

 

 

 

 

PART II

 

The following graph compares the cumulative 5-year total return provided to shareholders on the Company’s common stock relative to the cumulative total returns of the Russell 2000 index, the S&P Industrials index, and the S&P Midcap 400 index. An investment of $100 (with reinvestment of all dividends) is assumed to have been made in our common stock and in each index on December 31, 2003 and its relative performance is tracked through December 31, 2008.

 

Comparison of 5 Year Cumulative Total Return*

 

Federal Signal Corporation

 

 

*$100 invested on 12/31/03 in stock & index-including reinvestment of dividends. Fiscal year ending December 31.

 

Copyright ^© 2009 S&P, a division of The McGraw-Hill Companies Inc. All rights reserved.

 

 

The stock price performance included in this graph is not necessarily indicative of future stock price performance.

 

The information concerning the Company’s quarterly dividend per share data included in Note 18 of the Consolidated Financial Statements contained under Item 8 of Part II of this Form 10-K is incorporated herein by reference. The payment of future dividends is at the discretion of the Company’s Board of Directors and will depend, among other things, upon future earnings and cash flows, capital requirements, the Company’s general financial condition, general business conditions and other factors. Accordingly, the Company’s Board of Directors may at any time reduce or eliminate the Company’s quarterly dividend based on these factors.

 

The following table presents the selected financial information of the Company as of, and for each of the five years in the period ended December 31, 2008:

 

 

 

 

The 2008 and 2004 income before income taxes includes restructuring costs of $2.7 million and $0.4 million, respectively. The 2008 income before income taxes was impacted by a $6.9 million loss incurred to settle a dispute and write off assets associated with a large parking systems contract and a $13.0 million loss associated with ongoing operations as well as the Company’s decision to terminate funding of a joint venture in China (“China Joint Venture”). The 2005 loss before income taxes was impacted by a $6.7 million gain on the sale of two industrial lighting product lines.

 

The selected financial data set forth above should be read in conjunction with the Company’s consolidated financial statements, including the notes thereto, and Item 7 of this Form 10-K.

 

The information concerning the Company’s selected quarterly data included in Note 18 of the financial statements contained under Item 8 of this Form 10-K is incorporated herein by reference.

 

Consolidated results of operations

 

The following table summarizes the Company’s results of operations and selected operating metrics for each of the three years in the period ended December 31, 2008 ($ in millions, except per share amounts):

 

 

Year Ended December 31, 2008 vs. December 31, 2007

 

Net sales increased 3% over 2007 or 1% after removing the favorable effects of currency translation from a weaker U.S. dollar. Sales volume increases at Fire Rescue were largely offset by reductions at Environmental Solutions; while Safety and Security Systems were relatively flat (see segment discussions below). Gross profit margins fell slightly in 2008 to 26.3% from 26.6% due largely to the absence of a favorable $1.8 million excise tax settlement which occurred in 2007. Operating income decreased by 26% in 2008 as the gross profit increase of $3.5 million was more than offset by an increase of $20.5 million of operating expenses due to $9.9 million of higher legal costs associated with the Company’s ongoing firefighter hearing loss litigation, $6.2 million of increased charges to settle a dispute and write off assets associated with a contract to install revenue control equipment at the Dallas Fort Worth (DFW) airport, and $2.7 million of restructuring costs largely due to severance associated with streamlining the management structure.

 

Interest expense decreased 17% from 2007, primarily due to lower average borrowings in 2008 from a reduction in net debt of $30.7 million. The Company paid down debt using net proceeds of $3.4 million from the working capital reductions and sale of E-ONE, $59.9 million from the sale of its Tool Group businesses, and $35.8 million from the sale-leaseback of its Elgin and University Park, Illinois plants. For further discussion of the discontinued operations, see Note 12 of the financial statements contained under Item 8 of this Form 10-K.

 

Losses on the Company’s investment in a joint venture in China totaled $13.0 million in 2008. The Company’s share of operating losses was $2.6 million in 2008 versus $3.3 million in 2007. A charge of $10.4 million was taken in 2008 to reflect the Company’s contingent obligations to guaranty the debt of the joint venture and to guaranty the investment of one of its joint venture partners. A review of the market and forecasts of the joint venture’s cash flows indicated its bank debt was unlikely to be repaid and it was unlikely to provide a return to the joint venture partners. In February 2009, the Company decided to terminate funding to this venture. Significant uncertainties exist, however, including a requirement to obtain unanimous partner approval as well as Chinese government approval to liquidate the entity. The Company anticipates closure costs in 2009 in the range of $1.0 to $2.0 million.

Other expenses of $0.9 million include realized losses from foreign currency transactions and on derivatives contracts.

 

The 2008 effective tax rate on income from continuing operations decreased to (19.0)% from 25.9% in the prior year. The 2008 rate benefited from a capital loss utilization tax strategy on a sale/leaseback of real estate properties, the China Joint Venture shutdown tax benefits, and a higher mix of profits in lower taxed countries.

 

Income from continuing operations decreased 21% from 2007 primarily as a result of the aforementioned charges in operating expenses, loss on joint venture and offsetting tax benefits.

 

Net loss was $95.6 million in 2008 versus net income of $54.9 million in 2007. Losses from discontinued operations totaled $126.9 million in 2008 relating primarily to the impairment of assets and sale of the Company’s Die and Mold Operations and E-ONE. The Company also discontinued its financial services activities during 2008 which generated income of $0.3 million. A net gain of $15.2 million on discontinued operations in 2007 resulted primarily from the sale of the Cutting Tool Operations in that year. For further discussion of the discontinued operations, see Note 12 of the Consolidated Financial Statements contained under Item 8 of Part II of this Form 10-K.

 

Year Ended December 31, 2007 vs. December 31, 2006

 

Net sales increased 18% over 2006 or 15% without the favorable effects of currency translation from a weaker U.S. dollar. All groups experienced sizable sales volume increases, where Safety and Security Systems was up $62.7 million, Environmental Solutions was up $51.7 million and Fire Rescue was up $27.2 million. Gross profit margins fell to 26.6% in 2007 from 27.2% in 2006 due to costs associated with the launch and production of the new Elgin Pelican sweeper in the U.S. offset in part by a favorable $1.8 million excise tax settlement received in 2007.

 

Operating income rose 27% over 2006 primarily as a result of the leverage from higher sales volumes and a relative reduction in operating expenses, which as a percent of sales were 18.5% in 2007 down from 19.8% in 2006. Selling expenses were relatively lower and product development costs were relatively higher at Safety and Security Systems and at Environmental Solutions due largely to the mix of product shipments and a focus on new products.

 

Interest expense increased 9%, or $1.5 million from 2006, primarily due to an increase in borrowings to fund the PIPS Technologies acquisition in August 2007.

 

Loss on investment in joint venture rose 74% to $3.3 million in 2007 as additional costs were incurred to build the infrastructure of the operating entity.

 

The 2007 effective tax rate on income from continuing operations increased to 25.9% from 22.1% in the prior year. The 2007 rate benefited from the Company’s foreign tax planning strategies including dividend repatriation, foreign entity financing and a legal entity restructuring in Canada. The 2006 rate benefited from tax reserve reductions and a higher mix of profits in lower taxed foreign jurisdictions.

 

Income from continuing operations increased 27% in 2007 primarily as a result of the higher sales volumes and lower relative operating expenses offset by the higher effective tax rate.

 

Net income more than doubled to $54.9 million for the year ended December 31, 2007 versus $22.7 million in 2006. For 2007, after completion of the sale of the Cutting Tool Operations in the first quarter, substantial completion of the wind-down of the Refuse business, and the restated operating results for the operations discontinued in 2008, the Company realized a net after-tax gain on the sale of previously discontinued operations of $15.2 million, compared to a loss of $8.5 million in the prior year. For further discussion of the discontinued operations, see Note 12 of the financial statements contained under Item 8 of this Form 10-K.

 

Orders remained relatively flat in 2008 as compared to 2007. U.S. orders decreased 6% due to weak municipal spending and a relative softening in the industrial economy compared to 2007. For 2008, orders in the U.S. fell $12.3 million for police products, $6.1 million for parking systems, and $2.8 million for hazardous area lighting products. Partly offsetting these declines were an increase in orders of $2.1 million for outdoor warnings systems and $6.1 million for automated license plate recognition (“ALPR”) cameras made by PIPS Technologies, which was acquired in the third quarter of 2007. Non-U.S. orders in 2008 increased 9% over the prior year or 6% when excluding the favorable effects of currency translation due to strength in outdoor warning systems and the addition of PIPS Technologies acquired in 2007.

 

Net sales increased 1% in 2008. An increase in shipments of ALPR cameras during 2008 of $19.2 million and industrial communications systems of $2.4 million was offset by a $17.7 million decrease in global vehicular lighting and siren sales. Operating income in 2008 declined 19% and operating margins fell, primarily due to $6.2 million of increased charges to settle a dispute and write off assets associated with the DFW parking system contract, and $1.8 million of employee severance costs associated with restructuring initiatives, and $0.8 million associated with other cost reduction initiatives.

 

Orders improved 20% in 2007 over 2006 with strength across all market segments, except for outdoor warning systems which declined by $1.0 million. U.S. orders rose 17% due primarily to an increase of $9.1 million for police products, $6.3 million for hazardous area lighting products and $5.7 million of parking systems. Non-U.S. orders increased 25% in 2007 or 19% without the favorable effects of currency translation. The acquisition of PIPS Technologies in the third quarter of 2007 contributed $6.4 million. During 2007, the Company introduced a next generation and more reliable LED light bar technology which drove a $30.7 million increase in global orders for vehicular warning systems.

 

Net sales increased 21% and improved across most market segments with a $34.9 million increase in global vehicular warning systems and a $19.2 million increase in industrial communication and hazardous area products. The PIPS Technologies acquisition contributed $9.6 million for 2007. Operating income increased 20% in 2007 over 2006 and the operating margin remained at 13.5%. The leverage of higher sales volume was offset partly by increased costs associated with expanding the product portfolio and market reach.

 

Orders in 2008 decreased 7% from the prior year or 15% when excluding the favorable effects of currency translation. Bronto’s entire order decline existed within its industrial markets, primarily with weakness in Europe. Orders from the group’s former E-ONE business drove the increase in U.S. orders. Bronto’s fire rescue markets were flat overall during the year.

 

Net sales in 2008 increased 23% from the prior year or 19% when excluding the favorable effects of currency translation. Bronto’s unusually large backlog, which exceeded 12 months of shipments at the end of 2007, allowed for strong shipments in 2008 despite a reduction in orders during the year. Bronto completed a plant expansion in 2008, and with a backlog that remains at 12 months, the Company expects Bronto’s shipments will be strong next year despite a weak global economy.

 

Operating income rose 32% in 2008 and operating margins improved as a result of the increased sales volumes. Higher product costs for steel and other components and inefficiencies caused by the plant expansion offset some of the sales volume impact.

 

Orders in 2007 improved 51% over 2006 or 38% when excluding the favorable effects of currency translation. Bronto’s demand was strong across both of its primary market segments (industrial and fire rescue) and particularly in Europe and Asia. Net sales rose 30% in 2007 or 21% when excluding the favorable effects of currency translation. Shipments were higher due to the strong order intake, limited only by the company’s production capacity. Operating income rose 41% in 2007 and operating margins improved as a result of the leverage from higher sales volumes.

 

 

Orders of $411.0 million in 2008 were 10% below the prior year. U.S. orders decreased 14% in 2008 from the prior year as weak municipal and industrial markets drove a $28.9 million reduction in sweepers and a $28.1 million reduction in sewer cleaning and industrial vacuum trucks offset by an increase of $5.8 million in waterblasters. Non-U.S. orders increased 4% entirely by favorable foreign currency translation from a weaker U.S. dollar. Net sales in 2008 compared to 2007 decreased 2% as a decline in U.S sweeper shipments of $23.6 million more than offset a $13.6 million increase in global shipments of sewer cleaning and industrial vacuum trucks.

 

Operating income decreased 9% in 2008 due to lower sales volumes and the absence of a favorable $1.8 million excise tax settlement which occurred in 2007.

 

In 2007, orders increased 5% over the 2006 year. U.S. orders increased 5% due to solid demand for industrial vacuum trucks and the impact of higher priced chassis associated with new 2007 EPA standards. Non-U.S. orders increased 5% driven by stronger U.S. exports of sewer cleaners and industrial vacuum trucks primarily to the Middle East. Net sales compared to 2006 grew 13% on higher unit volumes of primarily vacuum trucks and overall higher pricing due in part to higher priced chassis.

 

Operating income in 2007 rose 10% over 2006, however, the operating margin in 2007 declined as the favorable benefits of higher pricing and sales volume were more than offset by increased chassis costs, temporarily high material costs, new product development, ERP implementation, product launches and initiatives to increase manufacturing efficiency.

Corporate Expense

 

Corporate expenses totaled $30.7 million in 2008, $21.1 million in 2007 and $23.0 million in 2006. The 45% increase in 2008 expense is primarily due to $9.9 million of higher legal costs associated with the Company’s ongoing firefighter hearing loss litigation and $1.5 million of costs associated with the hiring of a new chief executive officer and chief financial officer, reduced by lower bonus and stock-based compensation costs of $1.8 million.

 

The 8% reduction in 2007 expense was benefited by the receipt of $3.7 million in reimbursements from one of the Company’s insurers for certain out of pocket expenses related to the Company’s ongoing firefighter hearing loss litigation. The reimbursement essentially offset the legal expenses in 2007 associated with this litigation.

 

The hearing loss litigation has historically been managed by the Company’s legal staff resident at the corporate office and not by management at any reporting segment. In accordance with SFAS 131 which provides that segment reporting should follow the management of the item and that some expenses can be corporate expenses, these legal expenses (which are extremely unusual and not part of the normal operating activities of any of our operating segments), are reported and managed as corporate expenses. Only the Company, and no current or divested subsidiaries is a named party to these lawsuits.

 

Legal Matters

 

The Company has been sued by over 2,500 firefighters in numerous separate cases alleging that exposure to the Company’s sirens impaired their hearing. The Company contests the allegations. Over 100 cases have been dismissed in Cook County including 27 by way of verdict. The Company continues to aggressively defend the matter. For further details regarding this and other legal matters, refer to Note 14 in the financial statements included in Item 8 of this Form 10-K.

 

the year, the Company entered into a program agreement with Banc of America Public Capital Corp. to sell certain of its municipal leases by December 31, 2008. Approximately 92% of the Company’s municipal leases were sold under the program for net cash proceeds of approximately $94.0 million. The reduction in cash provided by continuing operations of $44.8 million was caused primarily by an increase in accounts receivable from the timing of shipments in 2008, a decrease in accounts payable and higher pension contributions in 2008.

 

Proceeds from the sale of properties, plant and equipment in 2008 are primarily the result of net cash proceeds of $35.8 million received from a sale-leaseback of the Company’s Elgin and University Park, Illinois plants.

 

Capital expenditures rose $8.4 million in 2008 from 2007 due primarily to the expansion of the Company’s plants in Pori, Finland and in Streator, Illinois. Capital expenditures increased in 2007 compared to 2006 as the Company’s ERP system design and implementation gained momentum during the year.

 

In 2007, the Company acquired three businesses, Codespear LLC in January for $17.4 million in cash, Riverchase Technologies in July for $6.7 million in cash, and PIPS Technologies in August for $126.3 million in cash. See Note 10 of the notes to the consolidated financial statements for additional information on these acquisitions. The Company funded the acquisitions through cash provided by operations, additional bank borrowings, and from proceeds received from the sale of the Cutting Tool Operations, included in discontinued operations in 2006, and sold in January, 2007 for $65.4 million in cash. See Note 12 of the notes to the consolidated financial statements for additional information on the sale of the Cutting Tool Operations.

 

In 2008, the Company divested its Die and Mold Operations and E-ONE business for net cash proceeds of $59.9 million and a payment of $0.6 million, respectively. Gross proceeds from the sale of E-ONE were $3.4 million, of which $0.5 million had been received at December 31, 2008.

 

The Company paid down a total of $151.7 million of debt during 2008, largely upon receipt of cash from the aforementioned sale of its municipal leasing portfolio which was included in discontinued operations and the aforementioned sale leaseback transactions. In 2007, the Company had an increase in net borrowings of $59.6 million due to the acquisition of PIPS Technologies in the second half of the year. In 2006, net borrowings were reduced by $50.7 million mainly as a result of excess cash that was used to pay down debt.

 

Payments for discontinued financing activities of $129.3 million in 2008 reflect the repayment of financial service borrowings as a result of the Company’s decision to exit the municipal lease financing business. Other year over year activity reflects the change in borrowings associated with the divested Die and Mold Tooling and E-ONE businesses.

 

In April, 2007, the Company amended its Revolving Credit Agreement. This Second Amended and Restated Credit Agreement (“Credit Agreement”) provides for borrowings of $250.0 million and matures April, 2012. It also allows the Company to borrow up to $35 million in an alternative currency under the swing line provision. As of December 31, 2007 €22.5 million, or $32.6 million, was drawn as alternative currency and $66.0 million was drawn on the Credit Agreement for a total of $98.6 million drawn under the Credit Agreement. The Company was in compliance with all debt covenants throughout 2007.

 

In December, 2007, the Company amended the Loan Agreement between E-ONE and Banc of America Leasing & Capital, LLC to allow borrowings against the leases of E-One Inc., E-One New York, Inc., Elgin Sweeper Company and Vactor Manufacturing, Inc. The outstanding balance on this agreement was $96.6 million as of December 31, 2007 and was paid off completely by August 2008.

 

In March 2008, the Company requested and was granted an amendment (the “Second Credit Amendment”) to the Credit Agreement. Affected items in the Second Credit Amendment included the definitions of Consolidated Net Worth and EBIT, reducing the Total Indebtedness to Capital ratio maximum to .50, reducing the minimum Interest Coverage Ratio requirement from 2:1 to 2.75:1 for the four quarters ending in 2008, and reducing the required minimum percentage of consolidated assets directly owned by the Credit Agreement’s borrower and guarantors to 50%. The amendment also allowed for the unencumbered sale of the E-ONE business. At December 31, 2008, a total of $97.0 million was drawn against the Credit Agreement. The Company was in compliance with all debt covenants throughout 2008.

At December 31, 2006, $21.8 million was drawn against the Company’s $125 million Amended Credit Agreement revolving credit line. This Amended Credit Agreement was increased from $75 million to $125 million during 2006. The Company borrowed $23.6 million in September, 2006 through the Banc of America Loan Agreement, the balance on this facility as of December 31, 2006 was $90.7 million. Also in 2006, a $65 million private placement note matured and was repaid using a combination of cash flow from operations and borrowings under the Amended Credit Agreement revolving credit line.

 

Cash dividends paid to shareholders in 2008, 2007 and 2006 were $11.5 million. The Company declared dividends of $0.24 per share in 2008, 2007 and 2006.

 

During 2006 and 2008, the Company completed repurchases totaling $12.1 million and $6.0 million, respectively, of stock under share repurchase programs approved by the Board of Directors. Treasury stock purchases reflect the Company’s policy to purchase shares to offset the dilutive effects of stock-based compensation.

 

Total debt net of cash and short-term investments included in continuing operations was $245.5 million representing 46% of total capitalization at December 31, 2008 versus $276.2 million or 38% of total capitalization at December 31, 2007. The increase in the percentage of debt to total capitalization in 2008, despite the reduction in debt, was due to a reduction in equity of $160.8 million caused primarily by an increase in the net after tax losses associated with the divestitures of the Die and Mold Operations and E-ONE. In 2008, the Company’s aggregate borrowing capacity was maintained.

 

The Company anticipates that capital expenditures for 2009 will approximate $20 million and that its financial resources and major sources of liquidity, including cash flow from operations and borrowing capacity, will be adequate to meet its operating and capital needs in addition to its financial commitments.

 

 

 

 

The Company is party to various interest rate swap agreements in conjunction with the management of borrowing costs. As of December 31, 2008, the fair value of the Company’s net position would result in cash payments of $0.9 million. Future changes in the U.S. interest rate environment would correspondingly affect the fair value and ultimate settlement of the contracts.

 

The Company also enters into foreign currency forward contracts to protect against the variability in exchange rates on cash flows and intercompany transactions with its foreign subsidiaries. As of December 31, 2008, there is $0.7 million unrealized losses on the Company’s foreign exchange contracts. Volatility in the future exchange rates between the U.S. dollar and Euro and Canadian dollar will impact the final settlement of any of these contracts.

The following table presents a summary of the Company’s commercial commitments and the notional amount by expiration period ($ in millions):

 

 

Financial standby letters of credit largely relate to casualty insurance policies for the Company’s workers’ compensation, automobile, general liability and product liability policies. Performance standby letters of credit represent guarantees of performance by foreign subsidiaries that engage in cross-border transactions with foreign customers.

 

Purchase obligations relate to commercial chassis.

 

In limited circumstances, the Company guarantees the residual value on vehicles in order to facilitate a sale. The Company believes its risk of loss is low; no losses have been incurred to date. The inability of the Company to enter into these types of arrangements in the future due to unforeseen circumstances is not expected to have a material impact on its financial position, results of operations or cash flows.

 

As of December 31, 2008, the Company has a liability of approximately $5.9 million for unrecognized tax benefits (refer to Note 5). Due to the uncertainties related these tax matters, the Company cannot make a reasonably reliable estimate of the period of cash settlement for this liability.

 

Critical Accounting Policies and 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. 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.

 

Allowances for Doubtful Accounts

 

The Company performs ongoing credit evaluations of its customers. The Company’s policy is to establish, on a quarterly basis, allowances for doubtful accounts based on factors such as historical loss trends, credit quality of the present portfolio, collateral value and general economic conditions. If the historical loss trend increased or decreased 10% in 2008, the Company’s operating income would have decreased or increased by $0.1 million, respectively. Though management considers the valuation of the allowances proper and adequate, changes in the economy and/or deterioration of the financial condition of the Company’s customers could affect the reserve balances required.

 

Inventory Reserve

 

The Company performs ongoing evaluations to ensure that reserves for excess and obsolete inventory are properly identified and recorded. The reserve balance includes both specific and general reserves. Specific reserves at 100% are established based on the identification of separately identifiable obsolete products and materials. General reserves for materials are established based upon formulas which are established by reference to, among other things, the level of current inventory relative to recent usage, estimated scrap value and the level of estimated future usage. Historically, this reserve policy has given a close approximation of the Company’s experience with

excess and obsolete inventory. The Company does not foresee a need to revise its reserve policy in the future. However, from time to time unusual buying patterns or shifts in demand may cause large movements in the reserve balance.

 

Warranty Reserve

 

The Company’s products generally carry express warranties that provide repairs at no cost to the customer. The length of the warranty term depends on the product sold, but generally extends from six months to five years based on the terms that are generally accepted in the Company’s marketplaces. Certain components necessary to manufacture the Company’s vehicles (including chassis, engines and transmissions) are covered under an original manufacturers’ warranty. Such manufacturers’ warranties are extended directly to end customers.

 

The Company accrues its estimated exposure to warranty claims at the time of sale based upon historical warranty claim costs as a percentage of sales. Management reviews these estimates on a quarterly basis and adjusts the warranty provisions as actual experience differs from historical estimates. Infrequently, a material warranty issue can arise which is outside the norm of the Company’s historical experience; costs related to such issues, if any, are provided for when they become probable and estimable.

 

The Company’s warranty costs as a percentage of net sales totaled 1.0% in 2008, 0.9% in 2007 and 0.8% in 2006. The increase in the rate in 2008 is primarily due to increased costs in the Fire Rescue Group. Management believes the reserve recorded at December 31, 2008 is appropriate. A 10% increase or decrease in the estimated warranty costs in 2008 would have decreased or increased operating income by $0.9 million, respectively.

 

Workers’ Compensation and Product Liability Reserves

 

Due to the nature of the products manufactured, the Company is subject to product liability claims in the ordinary course of business. The Company is partially self-funded for workers’ compensation and product liability claims with various retention and excess coverage thresholds. After the claim is filed, an initial liability is estimated, if any is expected, to resolve the claim. This liability is periodically updated as more claim facts become known. The establishment and update of liabilities for unpaid claims, including claims incurred but not reported, is based on the assessment by the Company’s claim administrator of each claim, an independent actuarial valuation of the nature and severity of total claims and management’s estimate. The Company utilizes a third-party claims administrator to pay claims, track and evaluate actual claims experience and ensure consistency in the data used in the actuarial valuation. Management believes that the reserve established at December 31, 2008 appropriately reflects the Company’s risk exposure. The Company has not established a reserve for potential losses resulting from hearing loss litigation (see Note 14 to the Company’s Consolidated Financial Statements included in Item 8 of this Form 10-K); if the Company is not successful in its defense after exhausting all appellate options, it will record a charge for such claims, to the extent they exceed insurance recoveries, at the appropriate time.

 

Goodwill Impairment

 

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” the Company ceased amortization of goodwill and indefinite-lived intangible assets effective January 1, 2002. SFAS No. 142 also requires the Company to test these assets annually for impairment; the Company performs this test in the fourth quarter unless impairment indicators arise earlier. The Company continues to amortize definite-lived intangible assets over their useful life.

 

A review for impairment requires judgment in estimated cash flows based upon estimates of future sales, operating income, working capital improvements and capital expenditures. Management utilizes a discounted cash flow approach to determine the fair value of the Company’s reporting units. If the sum of the expected discounted cash flows of the reporting unit is less than its carrying value, an impairment loss is required against the unit’s goodwill.

 

The annual testing conducted in 2008, 2007 and 2006 did not result in impairment.

Although management believes that the assumptions and estimates used were reasonable, a sensitivity analysis for each reporting unit is performed along with the impairment test. The analysis indicated that a 10% reduction to earnings before interest and taxes to all future years would not have resulted in a goodwill impairment in any group.

 

Postretirement Benefits

 

The Company sponsors domestic and foreign defined benefit pension and other postretirement plans. Major assumptions used in the accounting for these employee benefit plans include the discount rate, expected return on plan assets and rate of increase in employee compensation levels. A change in any of these assumptions would have an effect on net periodic pension and postretirement benefit costs.

 

The following table summarizes the impact that a change in these assumptions would have on the Company’s operating income:

 

 

The weighted-average discount rate used to measure pension liabilities and costs is set by reference to published high-quality bond indices. However, these indices give only an indication of the appropriate discount rate because the cash flows of the bonds comprising the indices do not match the projected benefit payment stream of the plan precisely. For this reason, we also consider the individual characteristics of the plan, such as projected cash flow patterns and payment durations, when setting the discount rate. The weighted-average discount rate used to measure U.S. pension liabilities increased from 6.0% in 2007 to 6.8% in 2008. See Note 6 to the Consolidated Financial Statements for further discussion.

 

Stock-Based Compensation Expense

 

The Company accounts for stock-based compensation in accordance with SFAS No. 123(R). SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options and restricted stock, to be recognized in the financial statements based on their respective grant date fair values. We use the Black-Scholes option pricing model to estimate the fair value of the stock option awards. The Black-Scholes model requires the use of highly subjective and complex assumptions, including the Company’s stock price, expected volatility, expected term, risk-free interest rate and expected dividend yield. For expected volatility, we base the assumption on the historical volatility of the Company’s common stock. The expected term of the awards is based on historical data regarding employees’ option exercise behaviors. The risk-free interest rate assumption is based on observed interest rates appropriate for the terms of the awards. The dividend yield assumption is based on the Company’s history and expectation of dividend payouts. In addition to the requirement for fair value estimates, SFAS No. 123(R) also requires the recording of expense that is net of an anticipated forfeiture rate. Therefore, only expenses associated with awards that are ultimately expected to vest are included in our financial statements. Our forfeiture rate is determined based on our historical option cancellation experience.

 

We evaluate the Black-Scholes assumptions that we use to value our awards on a quarterly basis. With respect to the forfeiture rate, we revise the rate if actual forfeitures differ from our estimates. If factors change and we employ different assumptions, stock-based compensation expense related to future stock-based payments may differ significantly from estimates recorded in prior periods.

 

Interest Rate Risk

 

The Company manages its exposure to interest rate movements by targeting a proportionate relationship between fixed-rate debt to total debt generally within established percentages of between 40% and 60%. The Company uses funded fixed-rate borrowings as well as interest rate swap agreements to balance its overall fixed/floating interest rate mix.

 

The following table presents the principal cash flows and weighted average interest rates by year of maturity for the Company’s total debt obligations held at December 31, 2008 ($ in millions):

 

 

The following table presents notional amounts and weighted average interest rates by expected (contractual) maturity date for the Company’s interest rate swap contracts held at December 31, 2008 ($ in millions). Notional amounts are used to calculate the contractual payments to be exchanged under the contract. Weighted average variable rates are based on implied forward rates in the yield curve at the reporting date.

 

 

See Note 7 to the consolidated financial statements in this Form 10-K for a description of these agreements. A 100 basis point increase or decrease in variable interest rates in 2008 would have increased or decreased interest expense by $1.3 million, respectively.

 

Foreign Exchange Rate Risk

 

Although the majority of our sales, expenses and cash flows are transaction in U.S. dollars, we have exposure to changes in foreign currency exchange rates, primarily the Euro and British Pound. If average annual foreign exchange rates collectively weakened against the U.S. dollar by 10%, our pre-tax earnings in 2008 would have decreased by $3.0 million from foreign currency translation.

 

The Company has foreign currency exposures related to buying and selling in currencies other than the local currency in which it operates. The Company utilizes foreign currency options and forward contracts to manage these risks.

The following table summarizes the Company’s foreign currency derivative instruments as of December 31, 2008. All are expected to settle in 2009 ($ in millions):

 

 

See Note 7 to the Consolidated Financial Statements in this Form 10-K for a description of these agreements.

 

Forward exchange contracts are recorded as a natural hedge when the hedged item is a recorded asset or liability that is revalued each accounting period, in accordance with SFAS No. 52, “Foreign Currency Translation”. For derivatives designated as natural hedges, changes in fair values are reported in the “Other income (expense)” line of the Consolidated Statements of Operations.

 

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 in each of the three years in the period ended December 31, 2008.

 

 

The information contained under the caption Financial Market Risk Management included in Item 7 of this Form 10-K is incorporated herein by reference.

 

FEDERAL SIGNAL CORPORATION

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

Board of Directors and Shareholders

of Federal Signal Corporation

 

We have audited the accompanying consolidated balance sheets of Federal Signal Corporation as of December 31, 2008 and 2007, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (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 at December 31, 2008 and 2007, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2008, in accordance with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

 

As discussed in Note 5 to the consolidated financial statements, on January 1, 2007, Federal Signal Corporation changed its method of accounting for uncertain tax positions to conform with Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes.” Additionally, as discussed in Note 1 to the consolidated financial statements, on December 31, 2006, Federal Signal Corporation changed its method of accounting for defined benefit pension and other postretirement benefit plans to conform with SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106 and 132(R).”

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Federal Signal Corporation’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2009, expressed an unqualified opinion thereon.

 

Ernst & Young LLP

 

Chicago, IL

February 27, 2009

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Shareholders

of Federal Signal Corporation

 

We have audited Federal Signal Corporation’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Federal Signal Corporation’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, Federal Signal Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the COSO criteria.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Federal Signal Corporation as of December 31, 2008 and 2007, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008 of Federal Signal Corporation and our report dated February 27, 2009 expressed an unqualified opinion thereon.

 

Ernst & Young LLP

 

Chicago, IL

February 27, 2009

 

See notes to consolidated financial statements.

 

See notes to consolidated financial statements.