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, 2006

 

Commission File Number 1-6003

 

FEDERAL SIGNAL CORPORATION

(Exact name of the Company as specified in its charter)

 

The Company’s telephone number, including area code

(630) 954-2000

 

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

 

 

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 þ     No o

 

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 if the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b(2) of the Exchange Act. (Check one).

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

 

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, 2006: Common stock, $1.00 par value — $713,126,714.

 

Indicate the number of shares outstanding of each of the Company’s classes of common stock, as of January 31, 2007: Common stock, $1.00 par value — 47,649,076 shares.

 

Documents Incorporated By Reference

 

Portions of the proxy statement for the Annual Meeting of Shareholders to be held on April 24, 2007 are incorporated by reference in Part III.

 

 

FEDERAL SIGNAL CORPORATION
Index to Form 10-K

 

 

Federal Signal Corporation, founded in 1901, was reincorporated as a Delaware Corporation in 1969. The Company designs and manufactures a suite of products and integrated solutions for municipal, governmental, industrial and airport customers. Federal Signal’s portfolio of products includes interoperable communications platforms, safety and security systems, fire apparatus, aerial devices, street sweepers, industrial vacuums, waterblasters, sewer cleaners and consumable industrial tooling. Federal Signal Corporation and its subsidiaries (referred to collectively as “the Company” or “Company” herein, unless context otherwise indicates) operates manufacturing facilities in 33 plants in 13 countries around the world serving customers in approximately 100 countries in all regions of the world. The Company also provides customer and dealer financing to support the sale of its vehicles.

 

Narrative Description of Business

 

Products manufactured and services rendered by the Company are divided into four major operating groups: Safety and Security Systems, Fire Rescue, Environmental Solutions and Tool. The individual operating companies are organized as such because they share certain characteristics, including technology, marketing, distribution and product application, which create long-term synergies.

 

Financial information (net sales, foreign sales, export sales, operating income and identifiable assets) concerning the Company’s four operating segments as of, and for each of the three years in the period ended, December 31, 2006 included in Note 14 of the financial statements contained under Item 8 of this Form 10-K is incorporated herein by reference.

 

Safety and Security Systems Group

 

The Safety and Security Systems Group designs and manufactures emergency vehicle warning lights and sirens, industrial and outdoor signaling, warning, lighting and communication devices and integrated systems; and parking revenue and access control systems. Products are sold under the Federal Signal, Target Tech, VAMA, Pauluhn, Victor and Federal APD brand names. The group operates manufacturing facilities in North America, Europe and South Africa. Many of the group’s products are designed in accordance with various regulatory codes and standards, and meet agency approvals such as Underwriters Laboratory (UL), International Electrotechnical Commission (IEC) and American Bureau of Shipping (ABS).

 

Fire Rescue Group

 

The Fire Rescue Group manufactures a broad range of fire rescue apparatus in its facilities located in North America and Europe. The group sells vehicles under the following brand names: E-ONE, Superior, Saulsbury and Bronto Skylift.

 

E-ONE is a leading brand of aluminum and stainless steel, custom-made vehicles including pumpers and tankers, aerial ladders and platforms, rescues, quick attack units, command centers and airport rescue vehicles. Superior brand trucks are manufactured and distributed primarily for the Canadian market and US wildlands markets. Under the Bronto Skylift brand name, the Company manufactures vehicle-mounted aerial access platforms in Finland for sale globally.

 

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, Leach, Shanghai Federal Signal and Jetstream brand names. The group’s vehicles and equipment are manufactured in North America, Europe and Asia.

 

Under the Elgin brand name, the Company sells the leading US 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. Shanghai Federal Signal is a China-based joint venture manufacturer of refuse truck bodies for waste collection and disposal for Asian markets. Jetstream manufactures high pressure waterblast 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 in providing renting and used equipment resale services.

 

Segment results have been restated for all periods presented to exclude losses from the North American refuse business, which was reclassified as a discontinued operation in 2005. The Company substantially disposed of the assets of this business during 2006.

 

Tool Group

 

The Tool Group manufactures, and in some cases is a reseller of, a broad range of precision tooling, ejector pins, core pins, sleeves and accessories for the plastic injection mold industry; and precision tooling and die components for the metal stamping industry. Tooling products are marketed under the Dayton Progress and PCS brand names and manufactured in North America, Europe and Asia.

 

Segment results have been restated for all periods presented to exclude the impact from Manchester Tool Company, On Time Machining and ClappDico Corporation or “Cutting Tool Operations”; which was reclassified as a discontinued operation in 2006. The Company completed the sale of the Ohio based Cutting Tool Operations on January 31, 2007.

 

Restructurings

 

In June 2004, the Company announced the implementation of the first steps of a broad restructuring initiative aimed at enhancing the Company’s competitive profile. The measures announced addressed three key issues: improving the profitability of the Fire Rescue Group, divesting non-strategic business activities, and improving the Company’s manufacturing overhead cost structure.

 

The initiatives included the following restructuring plans and divestitures:

 

 

In the fourth quarter of 2006 the Company completed the closure of the Red Deer, Canada operation and consolidated the production of its fire rescue vehicles into the Ocala, Florida facility. In the fourth quarter of 2005, the Company completed the closure of operations in Federal APD do Brasil, LTDA, which produced parking

systems for the local market. In 2004, the Company divested Technical Tool, Inc., a small manufacturer of precision beverage can tooling, and Justrite Manufacturing Company, L.L.C., a leading manufacturer of products for the safe storage of flammable and hazardous materials.

 

Financial Services

 

The Company offers a variety of short- and long-term financing primarily to its Fire Rescue and Environmental Solutions independent dealers and customers. The Company provides financing, principally through sales-type leases, to (i) municipal customers to purchase vehicles and (ii) independent dealers to finance the purchase of vehicle inventory. Financings are secured by vehicles and primarily, in the case of the independent dealers, the dealer’s personal guarantee. In 2001, the Company decided to curtail new leasing to industrial customers, who generally have a higher credit risk; this portfolio continues to diminish over time as no new leases were extended to industrial customers in 2006. By December 31, 2006, the Company’s investment in leases to industrial customers had declined to 4% of its lease financing and other receivables.

 

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 manufacturer’s 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 complex, integrated warning, communications and parking systems through a combination of a direct sales force and distributors.

 

Fire Rescue and Environmental Solutions use both direct sales and dealer networks to service customers generally depending on the size of the customer as well as the technical complexity of the sale. The Company believes its national and global dealer networks for vehicles distinguishes it from its competitors. Dealer representatives are on-hand to demonstrate the vehicles’ functionality and capability to customers as well as service to the vehicles on a timely basis.

 

The Tool Group sells to die and mold builders, plastic molders, metal stampers and metal fabricators through distributors and a direct sales organization. Because of the consumable nature of most of the Tool Group’s products, volume depends mainly on repeat orders from thousands of customers and end users, driven primarily by their production levels and to a lesser extent by the volumes of new dies and molds being ordered for new products. Many of the Tool Group’s customers have some ability to produce certain products themselves, but at a cost disadvantage. Major market emphasis is placed on quality of product, delivery, level of service and price. Inventories for certain products, are maintained to assure prompt service to the customer, while other products are made to order. The average order for standard tools is filled in less than one week for domestic shipments and within two weeks for international shipments.

 

Customers and Backlog

 

Approximately 40%, 25% and 35% of the Company’s total 2006 orders were to US municipal and government customers, US commercial and industrial customers, and non-US customers, respectively. No single customer accounted for a material part of the Company’s business.

 

The Company’s US 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 jobs are lost and profits decline. Generally, a municipal slowdown lags far enough behind the industrial slowdown such that the industrial economy is growing again by the time municipalities reduce their spending. The US economic downturn from 2001 to 2003 lasted longer than expected, allowing spending cuts by municipalities to affect the Company during the same time period as weak industrial demand was experienced. During 2006, the Company saw municipal and governmental orders increase 3% from 2005, to add to the 10% increase in these orders in 2005 compared to 2004.

 

The Company’s backlog totaled $403 million and $386 million as of December 31, 2006 and 2005, respectively. The 4% increase is primarily attributed to strong orders for vacuum trucks, sewer cleaners and truck mounted aerial access platforms, partially offset by lower orders for other fire rescue vehicles. A substantial majority of the orders in backlog at December 31, 2006 are expected to be filled during 2007.

 

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 supplier strategic alliances. 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 in the production of the Company’s vehicles (such as engines, transmissions, drivetrains, axles and tires) are purchased from a select number of suppliers and may be specified by the customer. The Company also purchases raw and fabricated aluminum and 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 material 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 as to all of the group’s products and purchase decisions are made based on competitive bidding, price, reputation, performance and servicing.

 

E-ONE is a leading, single-source manufacturer of custom-built, stainless steel and aluminum-bodied fire apparatus and chassis in a market served by approximately ten key manufacturers and approximately 70 small, regional manufacturers. E-ONE occupies the number one or two position of the North American pumper and aerial market based on units. E-ONE is a leading command vehicle provider to the city, state and federal agencies for natural and man-made disaster response. In addition, E-ONE is a significant global provider of industrial pumpers and aerials serving the petrochemical and pharmaceutical industries. E-ONE also competes with six manufacturers worldwide in the production of airport rescue and firefighting vehicles. Bronto Skylift is established as the articulated aerial leader in the global fire fighting and rescue platform markets; the Company manufactures and distributes vehicle-mounted aerial access platforms globally.

 

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 US waterblast industry competing on product performance and rapid delivery.

 

The Tool Group companies compete with several hundred competitors worldwide. In North America, the Company holds a share position ranging from number one to number three depending on the product offering.

 

Research and Development

 

The information concerning the Company’s research and development activities included in Note 14 of the financial statements contained under Item 8 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 5,400 people in ongoing businesses at the close of 2006. Approximately 16% of the Company’s domestic hourly workers were unionized at December 31, 2006. 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 2006 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 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 Securities and Exchange Commission (“SEC”). All of the Company’s filings may be read or copied at the SEC’s Public Reference Room at 100 F Street, NE, 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.

 

The following are some of the risks that we face in our business. The list of risk factors is not exhaustive. There can be no assurance that we have correctly identified and appropriately assessed all factors affecting our business or that publicly available and other information with respect to these matters is complete and correct. Additional risks not presently known to us or that we currently believe to be immaterial also may adversely impact us. Should any risks and uncertainties develop into actual events, these developments could have material adverse effects on our business, financial condition and results of operations.

 

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 correlation, usually lagged by one or two years, 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.

 

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 our Company 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 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 2006, approximately 35% of our sales were to customers outside the United States; with approximately 27% 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 US dollar costs for, or reduce our US dollar revenues from, our foreign operations. Any increased costs or reduced revenues as a result of foreign currency fluctuations could affect our profits.

 

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 claims are not covered by our product liability 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 that may hinder our ability to take advantage of attractive business opportunities. Our ability to meet these covenants may be affected by factors outside our control. Failure to meet one or more of these covenants may result in an event of default. Upon an event of default, some of our lenders may be entitled to declare all amounts outstanding as due and payable.

 

None.

 

As of December 31, 2006, the Company utilized 19 principal manufacturing plants located throughout North America, as well as 11 in Europe, 1 in South Africa and 2 in the Far East.

 

In total, the Company devoted approximately 1.3 million square feet to manufacturing and 0.9 million square feet to service, warehousing and office space as of December 31, 2006. Of the total square footage, approximately 39% is devoted to the Safety and Security Systems Group, 13% to the Tool Group, 23% to the Fire Rescue Group

and 25% to the Environmental Solutions Group. Approximately 71% of the total square footage is owned by the Company with the remaining 29% being leased.

 

All of the Company’s properties, as well as the related machinery and equipment, are considered to be well-maintained, suitable and adequate for their intended purposes. In the aggregate, these facilities are of sufficient capacity for the Company’s current business needs.

 

The information concerning the Company’s legal proceedings included in Note 13 of the financial statements contained under Item 8 of this Form 10-K is incorporated herein by reference.

 

No matters were submitted to a vote of security holders through the solicitation of proxies or otherwise during the three months ended December 31, 2006.

 

The following is a list of the Company’s executive officers, their ages, business experience and positions and offices as of February 1, 2007:

 

Paul D. Box, age 53, was appointed Vice President and Chief Procurement Officer in March 2006. Previously, Mr. Box was Vice President Global Purchasing at Newell Rubbermaid from 2002 to March 2006, and Director Corporate Procurement at Compaq Computer Corporation from 1996 to 2002.

 

Paul Brown, age 43, was appointed Vice President and Controller in March 2005. He served as Vice President-Internal Audit from April 2004. Previously, Mr. Brown was Vice President Finance-Flame Retardants, for Great Lakes Chemical Corporation from 2000 to April 2004.

 

Kimberly L. Dickens, age 45, was elected as Vice President Human Resources in April 2004. Previously, Ms. Dickens was appointed Vice President Human Resources for BorgWarner, Inc. from 2002 to March 2004, and Vice President Human Resources for BorgWarner Transmission Systems from 1999 to 2002.

 

Marc L. Gustafson, age 54, was appointed Group President, Fire Rescue Group effective October 7, 2004. Previously, Mr. Gustafson was President of American LaFrance from 2003 to 2004, Board Member (non-paid position) and laborer for Habitat for Humanity from 2001 to 2003 and President and CEO for Volvo Trucks NA from 1996 to 2001.

 

David E. Janek, age 43, was appointed Vice President and Treasurer in September 2006. Mr. Janek was Vice President Finance, Safety Products Group from June 2002. Previously, Mr. Janek was Vice President Finance and Administration at Zellweger Analytics, Inc. from 2001 to 2002.

 

Stephanie K. Kushner, age 51, was elected as Vice President and Chief Financial Officer in February 2002. Previously, Ms. Kushner was Vice President — Treasury and Corporate Development for FMC Technologies in 2001 and Vice President and Treasurer for FMC Corporation from 1999 to 2001.

 

David R. McConnaughey, age 50, was appointed President of Federal Signal’s Safety and Security Systems Group in March 2006. Previously, Mr. McConnaughey was President Maytag All Brand Service from 2005 to March 2006 and Vice President Maytag All Brand Service from 2004 to 2005. Previously, Mr. McConnaughey held several roles with Maytag Corporation including Vice President and G.M. Amana Brand 2003 to 2004, Vice President Supply Chain 2002 to 2003 and Vice President and G.M. Laundry Division 1998 to 2002.

 

Jennifer L. Sherman, age 42, was appointed Vice President, General Counsel and Secretary effective March 2004. Ms. Sherman was previously Deputy General Counsel and Assistant Secretary from 1998 to 2004.

 

Gregory A. Sink, age 48, was appointed Vice President Strategic Business Development in 2005. Previously, Mr. Sink was Vice President and General Manager of Federal Signal’s Communication System Division from 2000 to 2005.

 

Mark D. Weber, age 49, was appointed President of the Environmental Solutions Group in April 2003. Mr. Weber was Vice President Sweeper Products for the Environmental Solutions Group from 2002 to 2003, General Manager of Elgin Sweeper Company from 2001 to 2002.

 

Robert D. Welding, age 58, was elected President and Chief Executive Officer and elected to the Board of Directors in December 2003. Previously, Mr. Welding was Executive Vice President of BorgWarner, Inc. from 1999 to 2003, President of BorgWarner, Inc.’s Driveline Group from 2002 to 2003, President of BorgWarner Transmission Systems, Inc. from 1996 to 2003 and Vice President of BorgWarner, Inc. from 1996 to 1999.

 

Michael K. Wons, age 42, was appointed Vice President and Chief Information Officer in November 2006. Previously, Mr. Wons was Senior Technology Strategy Director at Microsoft Corporation from 2002 to November 2006 and Executive Vice President and CTO at National Transportation Exchange from 2001 to 2002.

 

These officers hold office until the next annual meeting of the Board of Directors following their election and until their successors have been elected and qualified.

 

There are no family relationships among any of the foregoing executive officers.

 

 

The Company’s common stock is listed and traded on the New York Stock Exchange (“NYSE”) under the symbol FSS. At December 31, 2006, there were no material restrictions on the Company’s ability to pay dividends. The information concerning the Company’s market price range data included in Note 18 of the financial statements contained under Item 8 of this Form 10-K is incorporated herein by reference.

 

As of January 31, 2007, there were 3,009 holders of record of the Company’s common stock.

The following graph matches the cumulative 5-year total return of shareholders on Federal Signal Corporation’s common stock relative to the cumulative total returns of the Russell 2000 index, the S & P Midcap 400 index and the S & P Industrials index. The graph tracks the performance of a $100 investment in the Company’s common stock and in each of the indices (with the reinvestment of all dividends) from December 31, 2001 to December 31, 2006.

 

Comparison of 5 Year Cumulative Total Return*

 

Among Federal Signal Corporation, The Russell 2000 Index,

The S & P Midcap 400 Index and the S & P Industrials Index

 

 

*$100 invested on December 31, 2001 in stock or index-including reinvestment of dividends. Fiscal year ending December 31.

 

Copyright^© 2007, Standard & Poor’s a division of The McGraw-Hill Companies, Inc. All rights reserved. www.researchdatagroup.com/S&P.htm

 

 

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 financial statements contained under Item 8 of this Form 10-K is incorporated herein by reference.

 

 

 

The program to repurchase 350,000 shares was approved by the Board of Directors’ on February 9, 2006. The Company disclosed this plan to repurchase shares to offset the dilution impact of stock based compensation in its Form 10-K filed on February 23, 2006. On July 18, 2006, the Board approved a supplemental share repurchase of up to 400,000 shares before December 31, 2006. This repurchase was completed during the quarter ended September 30, 2006.

 

 

The following table presents the selected financial information of the Company as of, and for each of the five years ended in the period December 31, 2006:

 

 

 

 

The 2005 and 2004 income (loss) before income taxes includes restructuring costs of $0.7 million and $7.0 million, respectively. These costs are further explained in Item 7 under Restructuring Charges and in Note 12 to the financial statements. The 2005 income before income taxes was impacted by a $6.7 million gain on the sale of two industrial lighting product lines. The 2004 loss before income taxes was impacted by a $10.6 million loss incurred on a large contract for fire apparatus in the Netherlands, as more completely described in Item 7 under Fire Rescue Operations.

 

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.

 

The Company designs and manufactures a suite of products and integrated solutions for municipal, governmental, industrial and airport customers. Federal Signal’s portfolio of products include aerial devices, street sweepers, fire apparatus, safety and security systems, industrial vacuums, waterblasters, sewer cleaners and consumable industrial tooling. Due to technology, marketing, distribution and product application synergies, the Company’s business units are organized and managed in four operating segments: Safety and Security Systems, Fire Rescue, Environmental Solutions and Tool. The Company also provides customer and dealer financing to support the sale of its vehicles. The information concerning the Company’s manufacturing businesses included in Item 1 of this Form 10-K and Note 14 of the financial statements contained under Item 8 of this Form 10-K are incorporated herein by reference.

 

This Form 10-K, 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 airport markets, technological advances by competitors, the Company’s ability to improve its operating performance in its fire rescue plants, increased warranty and product liability expenses, risks associated with supplier, dealer and other partner alliances, changes in cost competitiveness including those resulting from foreign currency movements, disruptions in the supply of parts or components from the 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.

 

Results of Operations

 

Operating results have been restated to exclude the results of the Cutting Tools operations, formerly a component of the Tool Group which has been presented as discontinued operations and also to reflect the exclusion of the Refuse business which was classified as a discontinued operation in 2005. The Company entered into an

agreement for the sale of the Cutting Tool operations in December, 2006. The transaction was completed on January 31, 2007. The assets of the Refuse business were substantially sold in 2006.

 

Orders and backlog

 

 

US municipal and government orders increased 3% in 2006 as a result of high demand for sweepers and sewer cleaners. US industrial and commercial orders increased on continued strength in industrial vacuum trucks and waterblasters. The substantial increase in non-US orders includes a large fire truck order for Montreal, Canada. Demand also increased for US exports in the Fire Rescue, Safety and Security Systems, and Environmental Solutions segments, and for products manufactured in Europe.

 

US municipal and government orders increased in 2005 primarily due to strong demand for fire apparatus and vacuum equipment. The decrease in 2005 US industrial and commercial orders was due to a $47 million parking system contract received in 2004. Excluding this contract, orders rose 10%, largely due to strength in industrial vacuum trucks and fire apparatus. The decrease in non-US orders in 2005 was primarily due to reduced sales of fire apparatus and a product line divestiture in the third quarter.

 

Consolidated results of operations

 

The following table summarizes the Company’s results of operations and operating metrics for each of the three years in the period ended December 31, 2006 ($ in millions, except per share amounts):

 

 

Year Ended December 31, 2006 vs. December 31, 2005

 

Net sales increased 8% over 2005 attributable to a higher volume of safety and environmental product shipments and increased pricing across all segments. Operating income increased 10% and operating margins

increased year over year, on a 13% gross profit increase. Pricing and volume gains overcame higher material and component costs to flow through to earnings. Offsetting the increase in gross profit, was an increase in operating expenses relating to higher sales commissions and selling-related expenses, an increase in stock-based compensation expense of $3.7 million and Economic Value based incentive achievement, at various levels throughout the Company, of $2.1 million. Additionally, a gain of $6.7 million from the sale of a product line reduced operating expenses in 2005.

 

Interest expense increased 8% from 2005, primarily as a result of higher interest rates and a greater mix of floating rate debt.

 

Other expenses include the Company’s share of losses relating to the start-up of the joint venture in China.

 

The 2006 effective tax rate relating to income from continuing operations increased to 19.4% from a tax benefit rate of 7.6%. The effective tax rate in 2005 reflected benefits associated with a reduction of reserves associated with the completion of a multi-year audit of the Company’s US tax returns in the amount of $6.0 million, a benefit associated with the reconciliation of deferred tax liabilities, the effect of tax-exempt municipal income, benefits associated with the repatriation of foreign earnings enabled under the American Jobs Creation Act, as well as the completion of other favorable tax reduction strategies. The 2006 rate benefited from the effect of tax-exempt municipal income and the completion of other favorable tax reduction strategies. Income from continuing operations decreased as a result of the less favorable tax rate in 2006.

 

Net income improved sixfold over the comparable 2005 period. Net income in 2006 includes an $11.7 million loss from discontinued operations versus a $48.5 million loss in 2005. Discontinued operations in 2006, includes the profitable Cutting Tool Operations of the Tool reporting segment, which were sold in January 2007. Also included in discontinued operations are the 2006 operations of the North American Refuse truck body business operating under the Leach brand name. Substantially all of the assets of the Leach business were sold during the second half of 2006.

 

Year Ended December 31, 2005 vs. December 31, 2004

 

Sales increased 9% in 2005 from 2004 as a result of strength in the fire rescue and vacuum truck businesses and deliveries against a large parking system contract. The Company’s operating income of $63.7 million in 2005 included restructuring charges of $0.7 million as the restructuring activities announced in 2004 were completed. The increase in income from continuing operations of $37.8 million compared to 2004 reflected the increase in sales across all groups and also lower operating costs in the fire rescue business and lower restructuring costs partially offset by higher corporate expense and interest expense.

 

Interest expense increased 12% to $23.1 million in 2005 compared to 2004. This increase was largely due to higher interest rates.

 

The Company’s 2005 effective tax rate on continuing operations of (7.6)% reflects a benefit of $6.0 million primarily due to a reduction in reserves in the second quarter associated with the completion of an audit of the Company’s US tax returns which encompassed the years 1999 — 2003, a $1.6 million benefit recorded to recognize the differences that existed between the recorded deferred tax liabilities and the amount that should have been recorded based on an analysis of timing differences between financial reporting and tax reporting, the effect of tax-exempt municipal income and a $2.5 million benefit in the fourth quarter of 2005 due to the repatriation of foreign cash balances associated with the American Jobs Creation Act; this benefit was realized because a portion of the repatriated earnings had previously been reserved at higher tax rates.

 

The net loss for 2005 of $4.6 million included $48.5 million of loss from discontinued operations. Discontinued operations in 2005 included the North American refuse truck body business, trading under the Leach brand name, which was classified as a business held for sale at December 31, 2005, and Federal APD do Brasil, LTDA, where operations were closed in the fourth quarter of 2005.

 

Restructuring Charges

 

The following table summarizes the Company’s restructuring charges by segment for each of the three years in the period ended December 31, 2006 ($ in millions):

 

 

In June 2004, the Company announced the implementation of the first steps of a broad restructuring initiative. The plan aimed at enhancing the Company’s competitive profile and creating a solid foundation for annual revenue growth in the high single digits. The measures included improving the profitability of the fire rescue and European tooling operations, divesting non-strategic business activities and improving the Company’s overhead cost structure.

 

The Company closed its 120,000 square foot production facilities in Preble, New York and consolidated US production of fire rescue vehicles into its Ocala, Florida operations as of December 31, 2004. The consolidation was possible because successful lean manufacturing initiatives reduced manufacturing space requirements in the Fire Rescue Group, and because of progress made to rationalize and restructure the broad array of vehicle offerings. The Fire Rescue Group incurred $5.4 million in restructuring charges for the year ended December 31, 2004 and a further $0.9 million in 2005 bringing the total to $6.3 million. This consisted of $2.5 million in real property and manufacturing equipment impairment, $3.5 million in employee severance and related costs and $0.3 million of other costs.

 

The Company also reduced the level of tooling production in France transferring some production to its Portugal facility, which began operations in 2003. The transfer was part of a broader plan to reduce fixed overhead and shift the manufacturing footprint to lower-cost locations. The Tool Group incurred $1.2 million in restructuring costs for the year ended December 31, 2004 and recorded a gain of $0.2 million against restructuring costs in 2005 due to a better than expected salvage value for manufacturing equipment. The total of $1.0 million consisted of severance for terminated employees.

 

The Company’s corporate office incurred $0.4 million in restructuring charges for the year ended December 31, 2004; these costs related to outside services directly attributable to the restructuring plan.

 

The 2004 restructuring plan was complete as of December 31, 2005.

 

Safety and Security Systems Operations

 

The following table presents the Safety and Security Systems Group’s results of operations for each of the three years in the period ended December 31, 2006 ($ in millions):

 

 

Orders improved 18% in 2006 over the comparable period in 2005 with strength across all major product lines, including industrial signaling and communications, hazardous area lighting, police products, warning systems, and

parking systems. Net sales increased 10% over 2005, on increased volumes across all product lines, with the exception of airport parking systems, and despite the absence of $8 million of revenue from two industrial lighting product lines which were divested in the third quarter of 2005.

 

The operating income decline of 9% and the lower reported operating margin resulted from the inclusion of a $6.7 million gain on the sale of the industrial lighting product lines in the prior year comparable period. Excluding the gain, and the operations of the disposed product lines, the operating margin increased slightly, on higher sales volume and improved pricing, offset by higher compensation-related charges.

 

Orders decreased 12% in 2005 largely due to a $47 million airport parking system order received in 2004. Excluding that order, an overall order increase of 5% was achieved due to strong demand in US industrial and commercial sectors. Full year revenues increased 12% in 2005 due to deliveries against the large airport parking system contract and strength in police products, electrical products and oil and mining related hazardous lighting products.

 

Operating income in 2005 included a $6.7 million gain on the sale of two industrial lighting product lines. The remainder of the income increase, compared with 2004, was largely due to the increased sales.

 

Fire Rescue Operations

 

The following table presents the Fire Rescue Group’s results of operations for each of the three years in the period ended December 31, 2006 ($ in millions):

 

 

Orders improved 3% over 2005, on strong aerial product demand in the Bronto articulated aerial apparatus business, particularly in the European and Asian markets as these platforms increasingly displace traditional ladders. The decline in US orders reflects effects of continuing changes in the Company’s dealer channel structure and policies. Sales increased 4% over the same period in 2005, on higher realized pricing across all product lines mainly due to pricing actions taken in 2005 to recover escalating material costs, and due to currency translation on non-USD orders. Partially offsetting these increases was the adverse impact of lower shipments from the Ocala production facility.

 

The operating income increase includes a $1.6 million benefit from the recovery of costs from certain suppliers relating to a large contract substantially completed in 2004. The benefit was partially offset by $1.0 million of costs incurred for the closure of a production facility in Red Deer, Alberta. The facility was sold in December, 2006. Excluding the effect of these events, operating income increased 170%, and operating margins improved to 1.6%.

 

Orders were essentially flat in 2005 compared to 2004. US municipal fire truck demand was strong throughout the year; however this increase was offset by lower international orders. Revenue rose 3% to $371.2 million and operating margin recovered to 0.6% due to performance improvements in the Ocala, Florida operation, lower restructuring charges and the realization of the benefits of the 2004 restructuring. Operating margin for 2004 of (6.6)% included the $10.6 million loss recorded on the multi-year contract for fire apparatus in the Netherlands. Results in 2005 also included $0.9 million in restructuring charges.

 

Environmental Solutions Operations

 

The following table presents the Environmental Solutions Group’s results of operations for each of the three years in the period ended December 31, 2006 ($ in millions):

 

 

Orders increased 21% over 2005, showing strength and improvement across all product lines, most notably in street sweepers and vacuum trucks. Sales increased 15% over the prior year on volume strength, higher pricing to offset increases in material and component costs and favorable currency movement.

 

Operating income increased 28% over the prior year. The operating margin benefited from the flow through of increased product demand and pricing and an improvement in production cost absorption, offset by elevated operating costs incurred from executing growth initiatives, including advancing the ERP system implementation, global expansion, and new product development.

 

In 2005, full year orders of $361.9 million increased 16% with increases at all operations. US vacuum truck and sewer cleaner orders were strong throughout the year. Higher sweeper volumes were the primary driver of the 21% increase in non-US orders. Revenue of $347.7 million was up 18% over 2004 primarily due to increased shipment volumes and higher pricing. Price increases were implemented in late-2004 and early-2005 to offset escalating raw material costs. Operating income increased primarily due to the increase in sales. The full year operating margin for 2005 declined to 8.3% from 8.6% in 2004 as a result of expenses related to a China joint venture initiated in the year and costs related to the progression of an enterprise business system implementation.

 

Tool Operations

 

The following table presents the Tool Group’s results of operations for each of the three years in the period ended December 31, 2006 ($ in millions):

 

 

Segment results have been restated to exclude the results of the Cutting Tools Operations, which have been presented as discontinued operations. The Company entered into an agreement for the sale of the Cutting Tool operations in December, 2006. The transaction was completed on January 31, 2007 for a gain of approximately $25 million.

 

US orders remained flat in 2006, and non-US orders contracted marginally. Sales were similarly impacted. All businesses continue to feel the impact of a weak automotive market and softness in the US housing market. Operating income declined 27% partially as a result of approximately $0.9 million of costs associated with a voluntary workforce reduction at the Dayton, Ohio plant in 2006. In addition, a business system conversion implementation error identified in 2006 resulted in approximately $1.5 million of incremental costs associated with lost productivity during the first half of 2006. These events affected the operating margin by 2.4 percentage points, and have since been satisfactorily resolved.

 

US orders increased 2% in 2005 due mainly to price increases. A stronger US industrial economy was offset by the weak automobile market. Sales were relatively flat in both US and non-US markets in 2005 compared to 2004. The operating income increase of $1.4 million in 2005 was primarily due to lower restructuring costs. The group incurred $1.2 million of restructuring charges in 2004 and recorded a $0.2 million gain in 2005.

 

Corporate Expense

 

Corporate expenses totaled $23.4 million in 2006 and $23.8 million in 2005 and $21.7 million in 2004. The 2% decrease in 2006 reflects lower expenses associated with firefighter hearing loss litigation and lower bad debt expenses relating to leasing activities, offset by higher compensation-related costs, particularly stock option expense of $1.3 million, as the Company began expensing stock options in 2006 as required under FASB Statement No. 123(R). In 2005, corporate expenses increased 10%, reflecting higher expenses associated with incentive compensation and salaries associated with improved earnings and an increased headcount. In 2005, incentive compensation included only bonuses and restricted stock awards.

 

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 has successfully defended itself in over 40 similar cases and contests the allegations. The Company continues to aggressively defend the matter. For further details regarding this and other legal matters, refer to Note 13 in the financial statements included in Item 8 of this Form 10-K.

 

Financial Services Activities

 

The Company maintained an investment of $158.9 million and $169.2 million at December 31, 2006 and 2005, respectively in lease financing and other receivables that are generated primarily by its Fire Rescue and Environmental Solutions customers. The decrease in leasing assets primarily resulted from early loan payoffs, and the continued runoff of the industrial leasing portfolio resulting from the Company’s decision in 2001 to no longer extend new leases to industrial customers. Financial services assets generally have repayment terms ranging from one to ten years. These assets are 94% leveraged as of December 31, 2006 and 2005, consistent with their overall quality; financial services debt was $149.0 million and $158.9 million at December 31, 2006 and 2005, respectively.

 

Financial revenues totaled $8.2 million, $9.6 million and $12.1 million in 2006, 2005 and 2004, respectively. The decline in 2006 and 2005 reflects the sale of a portion of the Company’s industrial leasing portfolio and lower financings of municipal product sales.

 

Financial Condition, Liquidity and Capital Resources

 

During each of the three years in the period ended December 31, 2006, the Company utilized its cash flows from operations to pay cash dividends to shareholders and to fund sustaining and cost reduction capital needs of its operations. Beyond these uses, remaining cash was used to pay down debt, to repurchase shares of common stock and to make voluntary pension contributions.

 

The Company’s cash and cash equivalents totaled $19.3 million, $91.9 million and $14.9 million as of December 31, 2006, 2005 and 2004, respectively. The following table summarizes the Company’s cash flows for each of the three years in the period ended December 31, 2006 ($ in millions):

 

 

Cash flow from operations decreased by $40.9 million in 2006 from 2005. The lower cash flow was driven by increases in working capital requirements to support high year-end sales; additional outsourcing to support higher sewer cleaner and aerial device production levels; and inventory pre-buying ahead of 2007 changes in US engine emission regulations; and an $11.5 million contribution to the Company’s pension plans compared to $7.7 million in 2005.

 

Operating cash flow increased by $18.1 million to $70.6 million in 2005 compared to 2004. Income from operations increased due to improved sales in Environmental Solutions and Safety and Security Systems, operational improvements in Fire Rescue and lower restructuring costs. Working capital improvements were the primary reason for the remaining increase.

 

During 2006, the Company repurchased $12.1 million of stock under a 750,000 stock buy-back program 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.

 

In 2006, the Company disposed of the production facility in Red Deer, Alberta for proceeds of $2.5 million. In 2005, the Company sold four former production facilities and two industrial lighting product lines for total cash proceeds of $22.0 million. In 2004, the Company disposed of Justrite Manufacturing Company, L.L.C. and Technical Tooling, Inc. for cash proceeds of $40.1 million and $6.5 million, respectively. In addition, the Company divested its 54% majority interest in Plastisol B.V. Holdings to the minority partner for $2.5 million in cash and a note receivable of $0.4 million. The divestitures in 2004 were in conjunction with the Company’s restructuring initiatives announced in June 2004 and the proceeds are included in the All Other, net line in the preceding table.

 

At December 31, 2006, $21.8 million was drawn against the Company’s $125 million Amended Credit Agreement revolving credit line. This credit agreement was amended and increased from $75 million to $125 million during 2006. The Company borrowed $23.6 million in September, 2006 through the Banc of America leasing facility, 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. The Company was in compliance with all debt covenants throughout 2006.

 

In March 2005, the Company entered into a loan agreement secured by certain leases of the E-One business. For more detail on this loan agreement refer to Note 5 — Debt, contained in this Form 10-K. As of December 31, 2005 the balance on this facility was $91.4 million. At December 31, 2005 there was no balance drawn under the Company’s revolving credit facility.

 

In 2004, the Company repaid $62.4 million of debt by utilizing the proceeds from the sale of the three aforementioned businesses as well as the positive cash flow from operations. In 2004, the Company voluntarily reduced the size of its revolving credit facility from $250 million to $200 million.

 

Total manufacturing debt, net of cash, totaled $205.7 million at December 31, 2006, or 35% of total capitalization, up from 34% in 2005. At December 31, 2005, total manufacturing debt net of cash was $184.4 million. The Company believes that its municipal financial services assets, due to their high overall

quality, are capable of sustaining a leverage ratio of 95% at December 31, 2006. The Company’s debt-to-capitalization ratio for its financial services activities was 94% at both December 31, 2006 and 2005. In 2006, the Company’s aggregate borrowing capacity was maintained.

 

Cash dividends decreased to $11.5 million in 2006 from $13.5 million in 2005. The Company declared dividends of $0.24 per share in 2006 and 2005.

 

The Company anticipates 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.

 

Contractual Obligations and Commercial Commitments

 

The following table presents a summary of the Company’s contractual obligations and payments due by period as of December 31, 2006 ($ in millions):

 

 

The Company is party to various interest rate swap agreements in conjunction with the management of borrowing costs. As of December 31, 2006, the fair value of the Company’s net position would result in cash payments of $5.6 million. Future changes in the US 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 of its foreign subsidiaries. As of December 31, 2006, there is no unrealized gain or loss on the Company’s foreign exchange contracts. Volatility in the future exchange rates between the US dollar and Euro and Canadian dollar will impact final settlement.

 

The following table presents a summary of the Company’s commercial commitments and the notional amount expiration by 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.

 

In limited circumstances, the Company guarantees the residual value on vehicles in order to facilitate a sale. The Company also guaranteed the debt of an independent dealer that sells the Company’s vehicles. 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.

 

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 2006, 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 or the issuance of credit. 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 cost as a percentage of net sales totaled 1.0% in 2006, 1.1% in 2005 and 1.3% in 2004. The decrease in the rate in 2006 is primarily due to operational improvements in the Fire Rescue business. Management believes the reserve recorded at December 31, 2006 is appropriate. A 10% increase or decrease in the estimated warranty costs in 2006 would have decreased or increased operating income by $1.3 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. When a claim is filed, an initial liability is estimated, if any is expected, to settle 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, 2006 appropriately reflects the Company’s risk exposure. The Company has not established a reserve for potential losses resulting from hearing loss litigation (see Note 13); if the Company is not successful in its defense, it will record a charge for such claims, to the extent they exceed insurance recoveries, at the time a judgment or settlement is made.

 

Goodwill Impairment

 

In accordance with 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 2006 and 2005 did not result in any 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 5% change in the operating margin assumption would not have resulted in a goodwill impairment in any group.

 

Financial Market Risk Management

 

The Company is subject to market risk associated with changes in interest rates and foreign exchange rates. To mitigate this risk, the Company utilizes interest rate swaps and foreign currency options and forward contracts. The Company does not hold or issue derivative financial instruments for trading or speculative purposes and is not party to leveraged derivatives contracts.

 

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.

 

Of the Company’s debt at December 31, 2006, 40% was used to support financial services assets; the weighted average remaining life of those assets is typically under three years and the debt is substantially match-funded to the financing assets.

 

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, 2006 ($ 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, 2006 ($ 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 8 to the consolidated financial statements in this Form 10-K for a description of these agreements.

 

Foreign Exchange Rate Risk

 

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, 2006. All are expected to settle in 2007. ($ in millions):

 

 

See Note 8 to the consolidated financial statements for a description of these agreements. All of these derivative instruments qualify for hedge accounting treatment.

 

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, 2006.

 

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

 

 

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, 2006 and 2005, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2006. 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 and subsidiaries at December 31, 2006 and 2005, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with US 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 1 to the consolidated financial statements, effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” and, effective for the fiscal year ended December 31, 2006, the Company adopted certain provisions of Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Federal Signal Corporation’s internal control over financial reporting as of December 31, 2006, 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 20, 2007 expressed an unqualified opinion thereon.

 

 

Chicago, Illinois

February 20, 2007

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Shareholders and Board of Directors

of Federal Signal Corporation

 

We have audited management’s assessment, included in Item 9A(b) of the accompanying Form 10-K, that Federal Signal Corporation maintained effective internal control over financial reporting as of December 31, 2006, 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. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of 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, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, 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, management’s assessment that Federal Signal Corporation maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Federal Signal Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, 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 as of December 31, 2006 and 2005, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2006 of Federal Signal Corporation and our report dated February 20, 2007, expressed an unqualified opinion thereon.

 

 

Chicago, Illinois

February 20, 2007

FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

 

See notes to consolidated financial statements.

FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

See notes to consolidated financial statements.

FEDERAL SIGNAL CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY