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SECURITIES AND EXCHANGE
COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
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For Quarter Ended March 31, 2003 Commission File Number 1-5341
ELKCORP
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(Exact name of Registrant as specified in its charter)
DELAWARE 75-1217920
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
14643 DALLAS PARKWAY
SUITE 1000, WELLINGTON CENTRE, DALLAS, TEXAS 75254-8890
- -------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (972) 851-0500
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X]. No [ ].
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [X]. No [ ].
As of close of business on April 30, 2003, Registrant had outstanding
19,529,389 shares of Common Stock, par value $1 per share.
ELKCORP AND SUBSIDIARIES
FOR THE QUARTER ENDED MARCH 31, 2003
INDEX
Page
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PART I. FINANCIAL INFORMATION (UNAUDITED)
Item 1. Financial Statements
Consolidated Statements of Operations for the Three Months and
Nine Months Ended March 31, 2003 and 2002 1
Consolidated Balance Sheets as of
March 31, 2003 and June 30, 2002 2
Consolidated Statements of Cash Flows for the Nine Months Ended
March 31, 2003 and 2002 3
Notes to Consolidated Financial Statements 4-12
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13-22
Item 3. Quantitative and Qualitative Disclosures About Market Risk 23
Item 4. Controls and Procedures 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURES 26
CERTIFICATIONS 27-28
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ELKCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, $ in thousands,
except per share data)
Three Months Ended Nine Months Ended
March 31, March 31,
----------------------------- ----------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
SALES $ 129,772 $ 119,175 $ 358,917 $ 375,522
----------- ----------- ----------- -----------
COST AND EXPENSES
Cost of sales 105,550 104,696 290,109 311,307
Selling, general and administrative 15,548 8,912 43,620 39,373
Noncash stock option compensation -- (3,381) (5,378) 2,096
----------- ----------- ----------- -----------
INCOME FROM OPERATIONS 8,674 8,948 30,566 22,746
----------- ----------- ----------- -----------
OTHER EXPENSE
Interest expense, net 1,469 856 4,522 4,473
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES 7,205 8,092 26,044 18,273
Provision for income taxes 2,743 2,965 9,770 6,983
----------- ----------- ----------- -----------
NET INCOME $ 4,462 $ 5,127 $ 16,274 $ 11,290
=========== =========== =========== ===========
NET INCOME PER SHARE-BASIC $ .23 $ .26 $ .84 $ .59
=========== =========== =========== ===========
NET INCOME PER SHARE-DILUTED $ .23 $ .26 $ .83 $ .58
=========== =========== =========== ===========
DIVIDENDS PER COMMON SHARE $ .05 $ .05 $ .15 $ .15
=========== =========== =========== ===========
AVERAGE COMMON SHARES OUTSTANDING (000's)
Basic 19,477 19,358 19,474 19,278
=========== =========== =========== ===========
Diluted 19,570 19,705 19,581 19,606
=========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
1
ELKCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited, $ in thousands, except share data)
March 31, June 30,
2003 2002
----------- -----------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 12,033 $ 12,436
Trade receivables, less allowance of $1,100 and $734 102,654 94,764
Inventories -
Finished goods 49,501 36,888
Work-in-process 532 538
Raw materials 9,410 9,484
----------- -----------
Total inventories 59,443 46,910
----------- -----------
Prepaid expenses and other 8,451 9,474
Deferred income taxes 3,841 5,727
----------- -----------
Total current assets 186,422 169,311
----------- -----------
PROPERTY, PLANT AND EQUIPMENT, AT COST 353,630 320,695
Less - accumulated depreciation (126,866) (114,216)
----------- -----------
Property, plant and equipment, net 226,764 206,479
----------- -----------
OTHER ASSETS 12,887 5,638
----------- -----------
$ 426,073 $ 381,428
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 30,584 $ 27,418
Accrued liabilities 19,127 24,655
----------- -----------
Total current liabilities 49,711 52,073
----------- -----------
LONG-TERM DEBT 151,131 119,718
DEFERRED INCOME TAXES 35,643 33,545
SHAREHOLDERS' EQUITY -
Common stock ($1 par, 19,988,074 shares issued) 19,988 19,988
Paid-in-capital 58,061 58,419
Unearned compensation - unvested restricted stock (297) --
Accumulated other comprehensive income -- 31
Retained earnings 120,122 106,772
----------- -----------
197,874 185,210
Less - Treasury stock (490,535 and 527,076 shares, at cost) (8,286) (9,118)
----------- -----------
Total shareholders' equity 189,588 176,092
----------- -----------
$ 426,073 $ 381,428
=========== ===========
See accompanying notes to consolidated financial statements.
2
ELKCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, $ in thousands)
Nine Months Ended
March 31,
----------------------------
2003 2002
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 16,274 $ 11,290
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization, including
$3,360 impairment in 2002 13,627 17,007
Deferred income taxes 3,984 4,350
Changes in assets and liabilities:
Trade receivables (7,710) (19,405)
Inventories (12,305) 8,915
Prepaid expenses and other 1,102 (936)
Accounts payable and accrued liabilities (2,362) 4,862
----------- -----------
Net cash provided by operating activities 12,610 26,083
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to property, plant and equipment (32,802) (8,250)
Acquisition of business (2,224) --
Other (222) 530
----------- -----------
Net cash used for investing activities (35,248) (7,720)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from sale of Senior Notes 25,000 --
Repayments on Revolving Credit Facility, net -- (17,300)
Dividends on common stock (2,923) (2,900)
Treasury stock transactions and other, net 158 1,744
----------- -----------
Net cash provided by (used for) financing activities 22,235 (18,456)
----------- -----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (403) (93)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 12,436 128
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 12,033 $ 35
=========== ===========
See accompanying notes to consolidated financial statements.
3
ELKCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - GENERAL
Effective September 1, 2002, the company changed its corporate name
from Elcor Corporation to ElkCorp to better identify itself with the Elk brand
name of its principal Building Products subsidiaries.
The attached condensed consolidated financial statements have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission. As a result, certain information and footnote disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted. The company believes that the disclosures included herein
are adequate to make the information presented not misleading. These condensed
consolidated financial statements should be read in conjunction with the
consolidated financial statements and related notes included in the company's
2002 Annual Report on Form 10-K. The unaudited financial information contained
herein has been prepared in conformity with accounting principles generally
accepted in the United States of America on a consistent basis and does reflect
all adjustments (consisting of normal recurring accruals) which are, in the
opinion of management, necessary for fair presentation of the financial position
of ElkCorp and subsidiaries (the company) at March 31, 2003, and the results of
their operations for the three-month and nine-month periods ended March 31, 2003
and 2002 and their cash flows for the nine-month periods then ended, but are,
however, subject to year-end audit by the company's independent auditors.
Because of seasonal, weather-related conditions in some of the company's market
areas, sales can vary at times, and results of any one quarter or other interim
reporting period should not necessarily be considered as indicative of results
for a full fiscal year.
NOTE 2 - COMPANY SEGMENTS
The company has one reportable segment: Elk Premium Building Products
(Building Products). The Building Products group consists of Elk Premium
Building Products, Inc. and its operating subsidiaries (collectively Elk). These
companies manufacture (1) premium laminated fiberglass asphalt shingles, (2)
coated and non-coated nonwoven fabrics used in asphalt shingles and other
applications in the building and construction, filtration, floor coverings and
other industries, and (3) beginning with an October 2002 business acquisition,
composite building products. Building Products accounted for 91% of consolidated
sales both in fiscal 2002 and for the nine months ended March 31, 2003.
The Other, Technologies grouping of companies consists of the
operations that are not part of the Building Products segment. These dissimilar
operations were combined beginning in fiscal 2002, as none individually met the
materiality criteria for separate segment reporting. The businesses aggregated
together as Other, Technologies accounted for 9% of consolidated sales in both
fiscal 2002 and for the nine months ended March 31, 2003.
The operations included as Other, Technologies are (1) the operating
subsidiaries of Cybershield, Inc. (collectively Cybershield), which apply
precise conductive metal coatings to plastic components utilized in electronics
enclosures to control the electromagnetic and radio frequency emissions of such
devices, and to create circuitry and antennae for digital wireless cellular
phones, consumer electronics equipment, and various other industries; (2)
Chromium Corporation (Chromium), which is a leading provider of hard chrome and
other surface finishes for the railroad, marine and various other industries;
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and (3) Ortloff Engineers, LTD (Ortloff), a leading supplier of proprietary
technologies and related engineering services to the natural gas processing
industry. A fourth operation, Elk Technologies, Inc., was incorporated to
develop and market fabrics featuring VersaShield(R) fire retardant coatings for
use outside of traditional building products applications, including mattresses,
furniture, curtains and bed clothing. Commercial sales relating to this business
have been immaterial to date.
Financial information by company segment is summarized as follows:
(In thousands) (In thousands)
Three Months Ended Nine Months Ended
March 31, March 31,
-------------------------------- ----------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
SALES
Building Products $ 116,981 $ 111,544 $ 328,919 $ 339,533
Other, Technologies 12,791 7,631 29,998 35,989
----------- ----------- ----------- -----------
$ 131,454 $ 119,175 $ 358,917 $ 375,522
=========== =========== =========== ===========
OPERATING PROFIT (LOSS)
Building Products(1) $ 8,081 $ 14,434 $ 30,070 $ 38,731
Other, Technologies(2) 3,088 (5,878) 3,188 (4,712)
Corporate and other, excluding
noncash stock option compensation (2,495) (2,989) (8,070) (9,177)
Noncash stock option compensation -- 3,381 5,378 (2,096)
----------- ----------- ----------- -----------
8,674 8,948 30,566 22,746
Interest expense, net (1,469) (856) (4,522) (4,473)
----------- ----------- ----------- -----------
Income before income taxes $ 7,205 $ 8,092 $ 26,044 $ 18,273
=========== =========== =========== ===========
DEPRECIATION AND AMORTIZATION
Building Products $ 3,409 $ 3,307 $ 10,237 $ 9,880
Other, Technologies(3) 479 4,053 1,394 5,118
Corporate 638 670 1,996 2,009
----------- ----------- ----------- -----------
$ 4,526 $ 8,030 $ 13,627 $ 17,007
=========== =========== =========== ===========
CAPITAL EXPENDITURES
Building Products $ 13,225 $ 2,663 $ 31,789 $ 6,605
Other, Technologies 79 413 279 1,333
Corporate 144 185 734 312
----------- ----------- ----------- -----------
$ 13,448 $ 3,261 $ 32,802 $ 8,250
=========== =========== =========== ===========
March 31, June 30,
2003 2002
----------- -----------
IDENTIFIABLE ASSETS
Building Products $ 352,890 $ 314,668
Other, Technologies 38,136 32,420
Corporate 35,047 34,340
----------- -----------
$ 426,073 $ 381,428
=========== ===========
Notes:
(1) Includes $5,625 nonrecurring income from a vendor settlement in the third
quarter of fiscal 2002.
(2) Includes $4,851 of plant closure costs in the third quarter of fiscal
2002.
(3) Includes $3,360 impairment in the third quarter of fiscal 2002.
5
NOTE 3 - ACCOUNTING FOR STOCK-BASED COMPENSATION
The company applies APB Opinion No. 25, "Accounting for Stock Issued to
Employees," and its related interpretations to measure compensation expense for
stock-based compensation plans. Refer to Note 6 - Noncash Stock Option
Compensation footnote on page 8 of this Form 10-Q for a detail description of
the company's application of APB No. 25. If compensation cost for stock-based
compensation plans had been determined under Financial Accounting Standards
Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 123, pro
forma net income, stock option compensation expense, and basic and diluted
earnings per common share for the three-month and nine-month periods ended March
31, 2003 and 2002, assuming all options granted in 1996 and thereafter were
valued using the Black-Scholes model, would have been as follows (in thousands,
except per share amounts):
Three Months Ended Nine Months Ended
March 31, March 31,
-------------------------- ----------------------------
2003 2002 2003 2002
--------- --------- ---------- ----------
Net income:
As reported $ 4,462 $ 5,127 $ 16,274 $ 11,290
Add: Stock-based employee compensation expense
(reversal) included in reported net
income, net of related tax effects -- (2,198) (3,496) 1,362
Deduct: Total stock-based compensation expense
determined under fair value based method
for all awards granted since January 1,
1996, net of related tax effects (550) (1,116) (1,717) (3,651)
--------- --------- ---------- ----------
Pro forma $ 3,912 $ 1,813 $ 11,061 $ 9,001
--------- --------- ---------- ----------
Earnings per common share:
Basic - as reported $ .23 $ .26 $ .84 $ .59
--------- --------- ---------- ----------
Basic - pro forma $ .20 $ .09 $ .57 $ .47
--------- --------- ---------- ----------
Diluted - as reported $ .23 $ .26 $ .83 $ .58
--------- --------- ---------- ----------
Diluted - pro forma $ .20 $ .09 $ .56 $ .46
--------- --------- ---------- ----------
6
NOTE 4 - EARNINGS PER SHARE
Basic earnings per share is computed based on the average number of
common shares outstanding. Diluted earnings per share includes outstanding stock
options and restricted shares. The following table sets forth the computation of
basic and diluted earnings per share:
(In thousands) (In thousands)
Three Months Ended Nine Months Ended
March 31, March 31,
--------------------------- --------------------------
2003 2002 2003 2002
---------- -------- ---------- --------
Net income $ 4,462 $ 5,127 $ 16,274 $ 11,290
========== ======== ========== ========
Denominator for basic earnings
per share - weighted average
shares outstanding 19,477 19,358 19,474 19,278
Effect of dilutive securities:
Restricted shares and
employee stock options 93 347 107 328
---------- -------- ---------- --------
Denominator for dilutive earnings
per share - adjusted weighted
average shares and assumed issuance
of shares purchased under incentive
stock option plan and vesting of
restricted shares using
the treasury stock method 19,570 19,705 19,581 19,606
========== ======== ========== ========
Basic earnings per share $ .23 $ .26 $ .84 $ .59
========== ======== ========== ========
Diluted earnings per share $ .23 $ .26 $ .83 $ .58
========== ======== ========== ========
NOTE 5 - COMPREHENSIVE INCOME
Total comprehensive income for the three-month and nine-month periods
ended March 31, 2003 and March 31, 2002 were as follows:
(In thousands) (In thousands)
Three Months Ended Nine Months Ended
March 31, March 31,
------------------------ --------------------------
2003 2002 2003 2002
---------- -------- ---------- --------
Net income $ 4,462 $ 5,127 $ 16,274 $ 11,290
Derivative transactions -- 102 -- (31)
---------- -------- ---------- --------
Total comprehensive income $ 4,462 $ 5,229 $ 16,274 $ 11,259
========== ======== ========== ========
At March 31, 2003, there are no derivative transactions in effect that
will cause net income to vary from total comprehensive income in future periods.
7
NOTE 6 - NONCASH STOCK OPTION COMPENSATION
Prior to fiscal 2002, the company followed the "fixed" method of
accounting for all employee stock options under APB No. 25, "Accounting for
Stock Issued to Employees," and related interpretations, and the disclosure-only
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation."
Accordingly, no compensation expense was recorded prior to fiscal 2002 with
respect to the company's stock option plan, as options were granted with an
exercise price equal to the stock's fair market value at date of grant.
The company's 1998 Incentive Stock Option Plan (the 1998 Plan)
contained a cashless exercise provision that permitted an optionee to relinquish
vested options to the company in exchange for common shares having a current
market value equal to the net exercised market value of the relinquished
options. Under APB No. 25, the aforementioned cashless relinquishment feature
can cause options issued under the 1998 Plan to be considered stock appreciation
rights (SAR's) in substance, if not in form, unless past experience and economic
incentives indicate that optionees are more likely to exercise, rather than
relinquish, the options. Under APB No. 25, SAR's are accounted for using
"variable" accounting whereby income is charged (or credited) during each
accounting period to reflect any excess of the market value of shares underlying
vested SAR's, over the exercise price of vested SAR's.
It was never the company's intention to issue SAR's under the 1998
Plan. Prior to March 2002, no optionee ever utilized the cashless relinquishment
alternative, and a total of only three optionees, none being executive officers
of the company, utilized this exercise alternative. The company believed that
its prior use of "fixed" accounting for options outstanding under the 1998 Plan
was appropriate. However, in fiscal 2002 the company determined that options
granted under the 1998 Plan should have been accounted for using "variable"
option accounting. The impact of variable accounting on each year prior to
fiscal 2002 was not material. Net income as previously reported for each quarter
of fiscal 2002 has been restated for the change from the "fixed" method to the
"variable" method of stock option accounting. For the three-month and nine-month
periods ended March 31, 2002, net income was previously reported as $2,929,000
($.15 diluted earnings per share) and $12,652,000 ($.65 diluted earnings per
share), respectively. The company recorded a noncash stock option compensation
reversal of $3,381,000 ($2,198,000, net of tax, or $.11 per diluted share) and a
$2,096,000 expense ($1,362,000, net of tax, or $.07 per diluted share) for the
three-month and nine-month periods ended March 31, 2002, respectively.
Accordingly, net income was restated as $5,127,000 ($.26 diluted earnings per
share) and $11,290,000 ($.58 diluted earnings per share) for the three-month and
nine-month periods ended March 31, 2002, respectively.
In keeping with the company's original intent, effective August 13,
2002, the Compensation Committee of the Board of Directors terminated the
availability of the relinquishment alternative under the 1998 Plan, thereby
removing any question regarding the appropriateness of "fixed" accounting for
these employee stock options thereafter. Based on this action, together with a
decline in the company's share price subsequent to June 30, 2002, the company
recorded a reversal of fiscal 2002 noncash stock option compensation expense of
$5,378,000 ($3,496,000, net of tax, or $.18 per diluted share) in the first
quarter of fiscal 2003. Subsequent to August 13, 2002, the company is again
utilizing the "fixed" method of stock option accounting.
8
NOTE 7 - LONG-TERM DEBT
In June 2002, the company issued $120,000,000 of Senior Notes (Notes)
and in March 2003, issued an incremental $25,000,000 in Notes. Of the Notes,
$25,000,000 mature in fiscal 2008 and carry a coupon rate of 4.69%, $60,000,000
mature in fiscal 2009 and carry a coupon rate of 6.99%, and $60,000,000 mature
in fiscal 2012 and carry a coupon rate of 7.49%. In conjunction with the sale of
the Notes in June 2002, the company reduced its Revolving Credit Facility
(Facility) to $100,000,000 of primary credit, including up to a maximum of
$10,000,000 in letters of credit through November 30, 2005. At March 31, 2003,
letters of credit totaling $2,597,000 were outstanding. No borrowings were
outstanding on the Facility at March 31, 2003. In June 2002, the company entered
into an interest rate swap to effectively convert the interest rate from fixed
to floating on $60,000,000 of Notes through 2012. For this fair value hedge,
both the fair value of the derivative and the underlying hedged item are
reported in the balance sheet. At March 31, 2003, the fair value of the
derivative was $6,131,000 and this amount was included in other assets and as an
increase in the carrying value of long-term debt. Changes in the fair value of
the derivative and the underlying hedged item offset and are recorded each
period in other income or expense, as applicable. Long-term debt is summarized
as follows:
March 31, June 30,
(In thousands) 2003 2002
- -----------------------------------------------------------------------------------------------------
Senior Notes $145,000 $120,000
Fair value of interest rate swap 6,131 (282)
Revolving Credit Facility -- --
-------- --------
$151,131 $119,718
======== ========
NOTE 8 - ACQUISITION
On October 16, 2002, a newly formed wholly owned indirect subsidiary of
the company purchased substantially all of the assets of Advanced Composites
Technologies, L.L.C. (ACT), a start-up stage manufacturer of advanced composite
building products. The total purchase price was $2,224,000, plus contingent
future earn-out payments based upon the profitability above certain thresholds
of the newly formed subsidiary. For five years, the contingent earn-out amount
is unlimited in amount and is calculated using a defined formula. The company is
currently unable to estimate an amount for maximum potential payments in the
first five years. If in the first five years, the total contingent earn-out
payments are less than $12,725,000, the obligation continues indefinitely until
payments reach that amount. Existing cash resources were used to fund the
acquisition. Assets acquired included $180,000 in trade receivables, $228,000 in
inventory, $79,000 in other current assets, $1,123,000 in property and equipment
and $614,000 in patents and other intangibles. The operating results
attributable to the acquired assets have been included in the company's
consolidated financial statements since the date of acquisition. ACT's sales
were not significant in its most recent fiscal year prior to acquisition.
NOTE 9 - PRODUCT WARRANTIES
The company provides its customers limited warranties on certain
products. Limited warranties relating to products sold by the Building Products
segment generally range from 20 to 50 years. Warranties relating to the Other,
Technologies companies are not significant to their operations. Warranty
reserves are established based on known or probable claims, together with
historical experience factors. The company periodically assesses the adequacy of
its recorded
9
warranty liability and adjusts the amount as necessary. Changes in the company's
warranty liability during the current year period were as follows:
Warranty
(in thousands) Liability
- ---------------------------------------------------------------------------
Balance at June 30, 2002 $ 2,395
Amounts charged to expense 1,481
Warranty settlements (1,517)
---------
Balance at March 31, 2003 $ 2,359
=========
NOTE 10 - ENVIRONMENTAL RISK
Chromium has engaged in limited remediation activities at its former
plating operation, closed in 1999, at what is now Cybershield's Lufkin, Texas
manufacturing facility. Soil sampling results from a pre-closing environmental
evaluation of the site indicated the necessity of localized cleanup. Chromium
has entered the property into the Texas Voluntary Cleanup Program (VCP). Under
this program, the Texas Commission on Environmental Quality (TCEQ) reviews the
voluntary cleanup plan the applicant submits, and, when the work is complete,
issues a certificate of completion, evidencing cleanup to levels protective of
human health and the environment and releasing prospective purchasers and
lenders from liability to the state. Properties entered into the VCP are
protected from TCEQ enforcement actions.
Chromium submitted a work plan, which the TCEQ has approved, for a
supplemental groundwater and soil assessment at the facility. The plan was
designed to, among other things, further define the cleanup requirements at the
site. Chromium is preparing to implement that plan. Once the investigation is
complete, Chromium intends to clean up the site under the VCP to a site specific
risk-based cleanup standard as prescribed by the Texas Risk Reduction Program.
Until Chromium has the results from its supplemental assessment and TCEQ
approval of a cleanup plan, the range of costs to remediate the site are not
determinable, nor can the company determine at this point in time if it is
reasonably possible that it will incur material additional losses at the site.
If a plan similar to a plan successfully used at another Chromium plant is
approved by TCEQ, remediation costs will be immaterial to the company's
consolidated results of operations, financial position and liquidity. However,
other potential scenarios, none of which are reasonably expected at this time,
could potentially result in material costs to the company. By no later than
December 31, 2003 it is probable that a range of exposure can be determined.
Accordingly, the company currently believes sufficient information for
establishing a reserve for this environmental exposure in accordance with SFAS
No. 5, "Accounting for Contingencies," will be available no later than December
31, 2003, and further anticipates being in a position at that time to determine
if it is reasonably possible that the company will incur material additional
losses with regard to this site.
The company's operations are subject to extensive federal, state and
local laws and regulations relating to environmental matters. Other than the
possible costs associated with the previously described Chromium matter, the
company does not believe it will be required to expend amounts which will have a
material adverse effect on the company's consolidated financial position or
results of operations by reason of environmental laws and regulations. Such laws
and regulations are frequently changed and could result in significantly
increased cost of compliance. Further, certain of the company's manufacturing
operations utilize hazardous materials in their production processes. As a
result, the company incurs costs for recycling or disposal of such materials and
may incur costs for
10
remediation activities at its facilities and off-site from time to time. The
company establishes and maintains reserves for such known remediation activities
in accordance with SFAS No. 5 when appropriate.
NOTE 11 - LEGAL PROCEEDINGS
On April 3, 2002, CertainTeed Corporation filed suit in the United
States District Court for the Eastern District of Pennsylvania, Philadelphia,
Pennsylvania for alleged patent infringement against the company and two of its
Elk affiliates. The suit, in essence, claims that Elk's Capstone shingle
infringes three CertainTeed patents. The complaint did not seek a specific
monetary amount of damages, but seeks preliminary and permanent injunctive
relief, unspecified damages and attorney's fees. Both parties have filed motions
for summary judgment in the case, which is in the late stages of discovery. The
company believes that it and its named affiliates have strong defenses to the
suit, and does not believe the suit will have a material adverse effect on its
consolidated results of operations, financial position or liquidity.
The company and its subsidiaries are involved in various other legal
proceedings, including claims arising in the ordinary course of business. Based
on advice from legal counsel, management believes such litigation and claims
will be resolved without material adverse effect on the company's consolidated
results of operations, financial position or liquidity.
NOTE 12 - NEW ACCOUNTING STANDARDS
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets." The company adopted SFAS No. 142, effective July 1, 2002.
Accordingly, goodwill must be tested for impairment annually and recorded
goodwill is not amortized. The adoption of SFAS No. 142 did not significantly
impact the company's financial position or results of operations.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." This statement is effective for the company in fiscal
2004. SFAS No. 143 requires legal obligations associated with the retirement of
long-lived assets to be recognized at their fair value at the time that the
obligations are incurred. Upon initial recognition of a liability, that cost is
capitalized as part of the related long-lived asset and allocated to expense
over the useful life of the asset. Based on current circumstances, the company
does not believe the adoption of SFAS No. 143 will have a material impact on the
company's financial position or results of operations.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment and Disposal of Long-Lived Assets." This statement supersedes SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of" and the accounting and reporting provision of
Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations
- - Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual, and Infrequently Occurring Events and Transactions."
SFAS No. 144 became effective for the company on July 1, 2002. The adoption of
SFAS No. 144 did not have a material impact on the company's financial position
or results of operations.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at a date of a commitment to an exit or disposal plan. SFAS
No. 146 is to be applied prospectively to exit or disposal activities after
December 31, 2002. The company has no currently anticipated exit or disposal
activities.
11
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" (FIN 45). FIN 45 addresses the disclosures
to be made by a guarantor in its interim and annual financial statements about
its obligations under guarantees. FIN 45 also clarifies the requirements related
to the recognition of a liability by a guarantor at the inception of a guarantee
for the guarantor's noncontingent obligations associated with such guarantee.
The disclosure requirements of this Interpretation are effective for financial
statements for periods ending after December 15, 2002 whereas the initial
recognition and measurement provisions are applicable on a prospective basis for
guarantees issued or modified after December 31, 2002. The initial adoption of
FIN 45 did not have a material impact on the company's financial condition,
results of operations or cash flows.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-based Compensation-Transition and Disclosure," an Amendment of FASB
Statement No. 123. This statement provides alternative methods of transition for
a voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, this statement amends the disclosure
provisions of SFAS No. 123 and APB Opinion No. 28, "Interim Financial
Reporting," to require disclosure in the summary of significant accounting
policies as to the effects of an entity's accounting policy with respect to
stock-based employee compensation on reported net income and earnings per share
in annual and interim financial statements. The company has not adopted the fair
value based method of accounting for stock-based compensation. Since the company
continues to use the intrinsic method of accounting for stock-based employee
compensation, the required interim disclosure is provided in Note 3 to this Form
10-Q.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities, an Interpretation of ARB No. 51" (FIN 46). FIN 46
requires certain variable interest entities to be consolidated by the primary
beneficiary of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. FIN 46 is effective for all
new variable interest entities created or acquired after January 31, 2003. For
variable interest entities created or acquired prior to February 1, 2003, the
provisions of FIN 46 must be applied for the first interim or annual period
beginning after June 15, 2003. The company has no current or planned variable
interest entities. Therefore, the adoption of FIN 46 had no impact on the
company's financial condition, results of operations or cash flows.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
CHANGES IN THE THREE-MONTH PERIOD ENDED MARCH 31, 2003 COMPARED TO THE
THREE-MONTH PERIOD ENDED MARCH 31, 2002.
OVERALL PERFORMANCE
Sales of $129,772,000 during the three-month period ended March 31, 2003
were 8.9% higher than $119,175,000 in the same three-month period of fiscal
2002. During the quarter ended March 31, 2003, net income of $4,462,000 was 13%
lower than $5,127,000 for the same period in the prior fiscal year. For the
quarter ended March 31, 2002, net income was previously reported as $2,929,000.
After recording a noncash stock option compensation reversal of $2,198,000, net
of tax, net income was restated as $5,127,000 for that period.
In fiscal 2002, the company changed its accounting for certain stock
options from fixed awards with no compensation expense to variable awards, which
generally results in periodic expense or income, as the company determined that
variable accounting is more appropriate for such stock options. Pursuant to
variable option accounting, income is charged or credited during each accounting
period to reflect any excess of the market value of shares underlying vested
options, over the exercise price of vested options. Based on a decline in the
company's share price subsequent to June 30, 2002 and actions taken by the Board
of Directors to terminate the feature of the 1998 Incentive Stock Option Plan
that caused certain stock options to be accounted for as variable awards, the
company recorded a reversal of the majority of fiscal 2002 noncash stock option
compensation in the first quarter of fiscal 2003. The company now has no options
subject to variable stock option accounting, and therefore, income in the
quarter ended March 31, 2003 was not, and income in future quarters will not be,
affected by changes in the company's share price.
Consolidated operating income of $8,674,000 in the quarter ended March 31,
2003 was 3.1% lower than $8,948,000 in the third quarter in the prior fiscal
year. Operating income for the previous year quarter was increased by a
$3,381,000 reversal for noncash stock option compensation associated with the
accounting change referred to above. Operating income in the prior year quarter
also included a favorable nonrecurring settlement with a vendor resulting in the
receipt of $5,625,000, and plant closure costs of $4,851,000. As a percentage of
sales, operating income was 6.7% in the seasonally slower third quarter of
fiscal 2003 compared to 7.5% during the third quarter in the prior year. Cost of
sales was 81.3% of sales for the three months ended March 31, 2003, compared to
87.9% for the same three-month period in the prior fiscal year. The prior year
percentage of cost of sales to sales was adversely affected by the
aforementioned plant closure costs. On a per unit basis, cost of sales in the
current year period was also adversely affected by much higher asphalt costs.
Selling, general and administrative (SG&A) costs in the three-month period ended
March 31, 2003 were $6,636,000 higher than in the three-month period ended March
31, 2002, primarily as a result of higher compensation expenses incurred in
connection with technology licensing and the aforementioned affect of the
nonrecurring settlement with a vendor which was accounted for as a reduction of
prior year, SG&A costs. As a percentage of sales, SG&A costs were 12.0% in the
third quarter of fiscal 2003, compared to 7.5% in the same quarter last year.
13
Due primarily to a higher level of long-term debt, interest expense was
$1,469,000 in the third quarter of fiscal 2003 compared to $856,000 in the same
prior year period. In the three months ended March 31, 2003, interest expense of
$273,000 was capitalized related to the expansion of the Tuscaloosa, Alabama
shingle plant and other significant capital projects. No interest cost was
capitalized in the same fiscal 2002 period.
The company currently projects its effective tax rate to be 37.8% for
fiscal 2003 compared to 39.0% for fiscal 2002. The difference between years
primarily relates to the impact of noncash stock option compensation on the
effective tax rate.
RESULTS OF BUSINESS SEGMENTS
Sales in the Building Products segment increased 4.9% to $116,981,000 for
the three months ended March 31, 2003 compared to $111,544,000 in the same prior
year period. Higher sales in the current year period reflected higher shingle
sales (approximately $8,600,000), together with new sales of composite lumber
products (approximately $200,000), partially offset by lower external nonwoven
fabric sales (approximately $3,300,000). Unit shingle shipments increased 6.8%
over the same quarter last year. A lower-value sales mix (i.e. a relatively
higher proportion of sales from lower priced product categories), combined with
a 4.0% increase in shingle selling prices, resulted in an overall 2.2% increase
in average sales per shingle unit. Sales mix stabilized near the current level
during the June 2002 quarter. Lower external nonwoven fabrics sales were
substantially offset by higher internal consumption of nonwoven production in
the manufacture of shingle products. Internal nonwoven sales are eliminated in
consolidation.
Shingle price increases of 3% and 4% were successfully implemented in early
January 2003 and late February 2003, respectively, in order to recover near
record high asphalt costs and increases in other energy related costs. Customer
purchases prior to the effective date of the announced price increases and
traditional industry-wide Spring sales promotions limited full realization of
revenues from these price increases during the quarter ended March 31, 2003. A
third price increase of 2% - 4% (depending upon product category) was
implemented in early April 2003. Management expects that operating margins in
the roofing business could improve during the remainder of fiscal 2003 due to
the benefit expected to be realized from the recent price increase and the
stabilization of (or decline in) asphalt prices.
Operating profit for the Building Products segment of $8,081,000 for the
three-month period ended March 31, 2003 decreased 44.0% from $14,434,000 of
operating profit achieved in the same period of fiscal 2002. However, operating
income in the prior year quarter included a $5,625,000 favorable nonrecurring
vendor settlement. The cash settlement primarily represented a reimbursement of
certain general and administrative costs previously incurred in the Building
Products segment.
The decrease in year-to-year recurring operating profit was largely the
result of significantly higher asphalt costs and start-up inefficiencies in
composite wood operations. Compared to the same prior year quarter, asphalt
costs increased by approximately $6,100,000. However, higher average sale prices
offset approximately $3,200,000 of higher asphalt costs. Higher production
volumes in roofing operations and the fixed cost nature of most manufacturing
expenses (other than raw materials and transportation costs) resulted in lower
unit production costs. In spite of higher fuel costs, unit transportation costs
declined. Segment SG&A expenses were slightly below comparable prior year
levels. Management was disappointed with the pace of progress made at the wood
composite business
14
during the quarter ended March 31, 2003. Delayed delivery of new production
equipment and production inefficiencies related to the start-up of newly
installed equipment for composite wood operations reduced operating profit
during the quarter by almost $1,000,000. Delivery and installation of the final
pieces of new production equipment is expected by May 2003. This delay, in
addition to inefficiencies during production start-up, is expected to result in
an operating loss for this new business in the June 2003 quarter, although
breakeven production rates by the end of that quarter are anticipated.
Management believes that demand for Cross Timber(TM) decking products currently
exceeds the company's ability to produce it and that profitable operations will
be achieved once anticipated production efficiency has been achieved.
Although concerned about the state of the United States economy, management
is generally optimistic about shingle demand and product pricing for the
remainder of fiscal 2003. Heavy Winter rains in the Western United States and
harsh Winter conditions in the Northeast region of the United States are
expected to create good roof replacement demand in the Summer months of calendar
2003. Further, the Dallas/Fort Worth, Texas area experienced widely spread
severe hail storms in early April 2003 that are expected to result in
significant roof replacement demand across that large metropolitan area. The
lingering effects of the Venezuelan oil industry strike are also expected to
keep asphalt shingles in tight supply. Management generally anticipates a supply
and demand environment that favors rational product pricing.
Sales for the Other, Technologies group of companies totaled $12,791,000
during the quarter ended March 31, 2003, compared to $7,631,000 in the same
prior year quarter. Significantly higher technology license revenues were earned
as Ortloff's proprietary gas processing technology was selected for use in
several key international projects during the current year quarter, including a
major new gas processing plant involving two different plant locations in Abu
Dhabi, United Arab Emirates. License revenues on this large project are the
result of the company's strategy of establishing cooperative marketing
arrangements with several key international suppliers of process technologies
that provides Ortloff with the opportunity to bid its technology packages on
large international projects that might not otherwise be available to it.
Licensing revenues can vary significantly between reporting periods since this
business is largely project driven. Therefore, Ortloff expects to return to
lower historical profitability levels in the June 2003 quarter. Chromium
reported lower sales in the current year quarter compared to the same quarter in
the prior fiscal year, but this reduction was more than offset by increased
sales at Cybershield.
The Other, Technologies group of companies reported $3,088,000 of operating
income in the quarter ended March 31, 2003 compared to a $5,878,000 operating
loss in the same quarter last year. The prior year operating loss included
$4,851,000 of expenses related to the closure of Cybershield's Georgia
manufacturing plant. The substantial year-to-year improvement was primarily the
result of the aforementioned higher Ortloff license revenues. Cybershield
reported a small operating profit for the quarter ended March 31, 2003 compared
to a significant operating loss in the same quarter last year. Although
Cybershield is attempting to diversify its revenue sources away from the
cellular handset market, certain handset models comprising a significant portion
of its recent sales have reached the end-of-life status and will be cancelled.
Next generation replacement handsets are currently scheduled to begin production
during the December 2003 quarter and management believes Cybershield will
provide content to these replacement units. However, there can be no assurance
as to the volume or profitably of these expected sales. Additionally, if
Cybershield is unable to generate replacement sales during the intervening
period, losses approximating $500,000 per fiscal quarter are possible for
Cybershield.
15
Elk Technologies, Inc., a new operation, has had immaterial commercial
sales and operating results to date. However, on February 24, 2003, the State of
California published proposed regulations (AB 603) requiring that all mattresses
sold to consumers in the state of California be protected against fires started
by open flames. The proposed testing protocol is currently in a forty-five day
comment period and the final standard will take effect January 1, 2004. A
related standard for products such as pillows and comforters is also being
developed. While there are numerous established fabric manufacturers competing
for this developing market, management believes that technical attributes of the
company's VersaShield(R) fire-barrier fabric position it as a very competitive
solution to the new mattress fire standards.
CHANGES IN THE NINE-MONTH PERIOD ENDED MARCH 31, 2003 COMPARED TO THE NINE-MONTH
PERIOD ENDED MARCH 31, 2002.
OVERALL PERFORMANCE
Sales of $358,917,000 during the nine-month period ended March 31, 2003
were 4.4% lower than $375,522,000 in the same period of fiscal 2002. During the
nine-month period ended March 31, 2003, net income of $16,274,000 was 44.2%
higher than $11,290,000 for the same period in the prior fiscal year. For the
nine months ended March 31, 2002, net income was previously reported as
$12,652,000. After recording noncash stock option compensation of $1,362,000,
net of tax, net income was restated as $11,290,000 for that period.
Consolidated operating income of $30,566,000 in the first nine months of
fiscal 2003 was 34.4% higher than $22,746,000 in the first nine months of the
prior fiscal year. Operating income for the current fiscal year period increased
$5,378,000 as a result of a credit for noncash stock option compensation,
compared to a $2,096,000 charge for this noncash item in the first nine months
last year. Operating income in the prior year period also included a favorable
settlement with a vendor resulting in the receipt of $5,625,000 and plant
closure costs of $4,851,000. As a percentage of sales, operating income was 8.5%
in the first nine months of fiscal 2003 compared to 6.1% for the same period in
the prior fiscal year. Cost of sales were 80.8% of sales for the nine months
ended March 31, 2003, compared to 82.9% for the same period in fiscal 2002. The
prior year percentage of cost of sales to sales was adversely affected by the
aforementioned plant closure costs. The impact of higher asphalt costs in the
current fiscal year were largely offset by, among other things, lower unit
manufacturing costs and strict management of controllable expenses at the
company's roofing plants. SG&A costs in the nine-month period ended March 31,
2003 were $4,247,000 higher than in the first nine months of fiscal 2002.
However, excluding the impact of a $5,625,000 reduction in SG&A costs as a
result of a vendor settlement in fiscal 2002, current year SG&A costs were
$1,378,000 lower than for the same period last year. As a percentage of sales,
SG&A costs were 12.2% in the first nine months of fiscal 2003, compared to 10.5%
in the same period last year.
Interest expense was $4,522,000 in the first nine months of fiscal 2003
compared to $4,473,000 in the same prior year period. In the first nine months
of fiscal 2003, interest expense of $521,000 was capitalized related to the
expansion of the Tuscaloosa, Alabama shingle plant and other significant capital
projects. No interest cost was capitalized in the comparable fiscal 2002 period.
16
The company currently projects its effective tax rate to be 37.8% for
fiscal 2003 compared to 39.0% for fiscal 2002. The difference between years
primarily relates to the impact of noncash stock option compensation on the
effective tax rate.
RESULTS OF BUSINESS SEGMENTS
Sales in the Building Products segment decreased 3.1% to $328,919,000 for
the nine months ended March 31, 2003 compared to $339,533,000 in the same prior
year period. Lower sales in the current year period were reflective of a general
slowing in the roofing market during the first quarter of the current fiscal
year and lower external nonwoven mat sales. During the first nine months of
fiscal 2003, unit shingle shipments increased 1.3% over the same nine-month
period last year. A lower value sales mix (i.e. a relatively higher proportion
of sales from lower-priced product categories), combined with a 1.1% increase in
shingle selling prices, resulted in an overall 1.1% decline in average sales per
shingle unit.
Operating profit for the Building Products segment of $30,070,000 for the
nine-month period ended March 31, 2003 was 22.4% lower compared to $38,731,000
of operating profit achieved in the same period of fiscal 2002. Prior year
operating income included the $5,625,000 favorable vendor settlement previously
discussed. Lower sales and significantly higher asphalt costs were partially
offset by lower freight costs, lower unit manufacturing costs and good expense
control at the company's roofing plants. Asphalt costs during the first nine
months of fiscal 2003 were more than $11,000,000 higher than in the same period
last year. Approximately $3,200,000 of these higher asphalt costs were offset by
higher average sales per shingle unit from price increases implemented in the
third quarter of fiscal 2003. Other factors that had a negative impact on
current year operating profit include higher litigation expenses, limited
production of new shingle products and initial losses at a newly acquired
subsidiary.
Sales for the Other, Technologies group of companies decreased 16.7% to
$29,998,000 in the first nine months of fiscal 2003 compared to $35,989,000 in
the same prior year period. Significantly reduced volumes of cellular handset
business in the first half of fiscal 2003 caused Cybershield's sales to decline
significantly in the current year. Cellular handset production previously in the
United States and Latin America has largely shifted to Asia where the company
has no significant operations. Commercialization of EXACT(TM), a proprietary
process for applying precise conductive metal patterns to plastics or other
components, together with other strategic moves including marketing partnerships
with key supply chain partners and utilizing a network of manufacturing
representatives to augment Cybershield's internal sales force, are key
strategies to diversify Cybershield's sales among a wider variety of consumer,
medical and military electronics applications. Chromium's sales were also lower
in the first nine months of fiscal 2003 compared to the prior year period as a
result of deferred maintenance expenditures by its railroad customers. For the
nine months ended March 31, 2003, Ortloff's licensing revenues were
significantly higher than in the same period last year, primarily as a result of
licensing revenues earned on several key international projects during the third
quarter of fiscal 2003, including a major new gas processing plant involving two
different plant locations in Abu Dhabi, United Arab Emirates.
Primarily as a result of higher technology licensing revenues, the Other,
Technologies group of companies reported a $3,188,000 operating profit for the
first nine months of fiscal 2003 compared to a $4,712,000 operating loss in the
same nine-month period last year. Chromium reported an approximate $60,000
operating loss during the current year period compared to approximately $400,000
of operating profit in the same period last year. Despite the significant
reduction in revenues at Cybershield, cost reductions allowed that subsidiary to
limit its operating loss in the current year period to approximately $350,000
17
compared to a $6,143,000 operating loss in the same period last year.
Cybershield's results in the prior fiscal year included $4,851,000 of plant
closure costs relating to closing its Canton, Georgia plant. Ortloff reported
operating profit of approximately $3,600,000 in the current year period compared
to approximately $1,000,000 in the same prior year period.
FINANCIAL CONDITION
Cash flows from operating activities are generally the result of net
income, deferred taxes, depreciation and amortization, and changes in working
capital. During the first nine months of fiscal 2003, the company generated cash
flows of $12,610,000 from operating activities compared to $26,083,000 for the
first nine months in the prior fiscal year. The decrease in cash flows generated
in the first nine months of fiscal 2003 was primarily the result of changing
dynamics in the significant components of working capital (trade receivables,
inventories, accounts payable and accrued liabilities).
Trade receivables from operating activities at March 31, 2003 were
$7,710,000 higher than at June 30, 2002. The majority of this increase relates
to receivables from technology licensing fees generated in the third quarter of
fiscal 2003. Additionally, in accordance with normal industry practices,
extended payment terms are granted to certain customers for roofing products
shipped during the late Winter and early Spring months, with payments generally
due during the Spring or early Summer.
At March 31, 2003, manufactured inventories were $12,305,000 higher than at
June 30, 2002 as production at the company's roofing plants continued at high
rates throughout much of the current year. The company believes that current
year inventories are at favorable levels, particularly with the potential for
industry product shortages resulting from the short supply of asphalt in certain
markets. In the prior year, extremely strong sales volumes had reduced roofing
product inventories to less than desired levels.
The $2,362,000 decrease in current liabilities at March 31, 2003 compared
to June 30, 2002 is primarily the result of the reversal of an accrual for
noncash stock option compensation during the current fiscal year, partially
offset by higher trade payables occurring from the normal timing of vendor
payments.
The current ratio was 3.7 to 1 at March 31, 2003 compared to 3.3 to 1 at
June 30, 2002. Historically, working capital requirements fluctuate during the
year because of seasonality in some market areas. Generally, working capital
requirements and related borrowings are higher in the Spring and Summer months,
and lower in the Fall and Winter months.
Cash flows from investing activities primarily reflect the company's
capital expenditure strategy. Approximately $20,800,000 of current year capital
expenditures relate to construction of a second shingle manufacturing line at
the Tuscaloosa, Alabama roofing plant. The company plans to invest approximately
$77,000,000 (including the aforementioned $20,800,000) over its two-year
construction period. This amount includes the installation of certain
infrastructure and material handling improvements designed to enhance the
overall efficiency of the expanded facility. Approximately $31,000,000 of the
planned investment is projected to be expended in fiscal 2003. In addition, the
company intends to invest approximately $11,000,000 in fiscal 2003 for
productivity enhancements at certain of its other roofing plants. During the
current fiscal year, the company utilized $2,224,000 of cash for a business
acquisition and subsequently invested $2,858,000 in incremental capital
expenditures for this new subsidiary to increase manufacturing capacity.
18
Cash flows from financing activities generally reflect changes in the
company's borrowings during the period, together with dividends paid on common
stock, treasury stock transactions and exercises of stock options. Net cash
provided by financing activities was $22,235,000 in the first nine months of
fiscal 2003 compared to net cash used for financing operations of $18,456,000 in
the same period in fiscal 2002. In June 2002, the company sold $120,000,000 in
Senior Unsecured Notes in a private placement transaction with a group of
institutional investors. In March 2003 the company sold $25,000,000 in an
incremental note placement. The proceeds of the original note placement were
used to repay indebtedness outstanding under the company's existing Revolving
Credit Facility. The incremental note placement proceeds were primarily used in
the short-term to fund increased seasonal working capital needs. Longer term,
this debt will be used to fund the company's capital expansion plans. There was
no outstanding balance on the Revolving Credit Facility at March 31, 2003.
An additional $6,131,000 increase in long-term debt during the first nine
months of fiscal 2003 was the result of a noncash adjustment in the fair value
of long-term debt resulting from an interest rate swap to effectively convert
the interest rate from fixed to floating on $60,000,000 of long-term debt
through 2012. This fair market adjustment is offset by recording a corresponding
noncash amount in other assets for the value of the interest rate swap
instrument.
The changes in the company's debt structure were made to extend the
maturity structure of the company's debt on favorable terms, increase the
company's total committed borrowing availability and better diversify the
company's funding sources. At March 31, 2003, liquidity consisted of $12,033,000
of cash and cash equivalents and $97,403,000 of available borrowings under its
$100,000,000 committed Revolving Credit Facility. The debt to capital ratio
(after deducting cash and cash equivalents of $12,033,000 from $145,000,000 of
principal debt) was 41.1%. The company has no off-balance sheet arrangements or
transactions with unconsolidated, special purpose entities.
The company's Board of Directors has authorized the purchase of common
stock from time to time on the open market. As of March 31, 2003, the company
has repurchase authority of approximately $10,600,000 remaining.
See Note 10 on page 10 of this Form 10-Q for a summary of the company's
environmental risk and Note 12 on pages 11 and 12 for a discussion of new
accounting standards.
Management believes that current cash and cash equivalents, projected cash
flows from operations, and its existing debt capacity should be sufficient
during fiscal 2003 and for the foreseeable future to fund the Tuscaloosa,
Alabama plant expansion, other planned capital expenditures, working capital
needs, dividends, stock repurchases and other cash requirements.
USE OF NON-GAAP PERFORMANCE MEASURES
Operating results that exclude nonrecurring items of income and expense are
included in Management's Discussion and Analysis of Financial Condition and
Results of Operations in this Form 10-Q. These items represent non-GAAP
financial measures presented for informational purposes only. These non-GAAP
financial measures are not, and should not be considered as a substitute for
financial information presented in accordance with generally accepted accounting
principles, and may differ from non-GAAP financial measures used by other
companies. Management believes that the non-GAAP financial measures are useful
to investors because such information provides increased comparability between
reporting periods.
19
Noncash stock option compensation is the result of a change in accounting
made in fiscal 2002 from fixed awards with no compensation expense to variable
awards, which can result in periodic expense or income. The Board of Directors
terminated the feature that caused certain stock options to be accounted for as
variable awards on August 13, 2002. Subsequent to that date, the company again
began utilizing the fixed method of stock option accounting. Refer to Note 6 -
Noncash Stock Option Compensation on page 8 of this Form 10-Q for a more
detailed explanation of the accounting change.
The $5,625,000 nonrecurring pretax income item discussed herein represents
a one-time cash settlement resulting from a dispute with a vendor that was
recorded to income in the third quarter of fiscal 2002. The $4,851,000 of pretax
expenses discussed herein represents the costs of closing Cybershield's Canton,
Georgia manufacturing facility in the third quarter of fiscal 2002. Refer to the
Nonrecurring items footnote on page 47 in the company's Form 10-K for its fiscal
year ended June 30, 2002 for a more detailed explanation of these items.
CRITICAL ACCOUNTING POLICIES
The company's condensed consolidated financial statements were prepared in
conformity with accounting principles generally accepted in the United States of
America. As such, management is required to make certain estimates, judgments
and assumptions it believes are reasonable based on the information available.
The accounting policies which management believes are the most critical to fully
understanding and evaluating the company's reported financial results are
described in Management's Discussion and Analysis of Financial Condition and
Results of Operations on pages 22 and 23 in the company's Form 10-K for its
fiscal year ended June 30, 2002. There were no significant changes in critical
accounting policies during the nine-month period ended March 31, 2003.
FORWARD-LOOKING STATEMENTS
In an effort to give investors a well-rounded view of the company's
current condition and future opportunities, management's discussion and analysis
of financial condition and results of operations contain "forward-looking
statements" that involve risks and uncertainties about its prospects for the
future. The statements that are not historical facts are forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. These statements usually are accompanied by words such as "optimistic,"
"outlook," "believe," "estimate," "potential," "project," "expect,"
"anticipate," "plan," "predict," "could," "should," "may," "likely," or similar
words that convey the uncertainty of future events or outcomes.
These statements are based on judgments the company believes are
reasonable; however, actual results could differ materially from those discussed
here as a result of a number of factors, including the following:
1. The company's building products business is substantially
non-cyclical, but can be affected by weather, the availability of
financing, insurance claims paying practices, and general economic
conditions. In addition, the asphalt roofing products
manufacturing business is highly competitive. Actions of
competitors, including changes in pricing, or slowing demand for
asphalt roofing products due to general or industry economic
conditions or the amount of inclement weather could result in
decreased demand for the company's products, lower prices received
or reduced utilization of plant facilities. Further, changes in
building and insurance codes and other standards from time to time
can cause changes in demand, or increases in costs that may not be
passed through to customers.
20
2. In the building products business, the significant raw materials
are ceramic-coated granules, asphalt, glass fibers, resins and
mineral filler. Increased costs of raw materials can result in
reduced margins, as can higher energy, trucking and rail costs.
Historically, the company has been able to pass some of the higher
raw material, energy and transportation costs through to the
customer. Should the company be unable to recover higher raw
material, energy and/or transportation costs from price increases
of its products, operating results could be adversely affected
and/or lower than projected.
3. Temporary shortages or disruption in supply of raw materials or
transportation do result from time to time from a variety of
causes. The current Venezuelan oil workers strike has adversely
affected asphalt supplies in certain regions of the United States,
particularly the Eastern United States, and there can be no
assurance that such shortages will not be compounded in the
future. If the company experiences temporary shortages or
disruption of supply of raw materials from the Venezuelan
situation, war in Iraq, or other reasons, operating results could
be adversely affected and/or lower than projected.
4. The company has been involved in a significant expansion plan over
the past several years, including the construction of new
facilities and the expansion of existing facilities. Progress in
achieving anticipated operating efficiencies and financial results
is difficult to predict for new and expanded plant facilities. If
such progress is slower than anticipated, or if demand for
products produced at new or expanded plants does not meet current
expectations, operating results could be adversely affected.
5. Certain facilities of the company's subsidiaries must utilize
hazardous materials in their production process. As a result, the
company could incur costs for remediation activities at its
facilities or off-site, and other related exposures from time to
time in excess of established reserves for such activities.
6. The company's litigation is subject to inherent and case-specific
uncertainty. The outcome of such litigation depends on numerous
interrelated factors, many of which cannot be predicted.
7. Although the company currently anticipates that most of its needs
for new capital in the near future will be met with internally
generated funds or borrowings under its available credit
facilities, significant increases in interest rates could
substantially affect its borrowing costs or its cost of
alternative sources of capital.
8. Each of the company's businesses, especially Cybershield's
business, is subject to the risks of technological changes and
competition that is based on technology improvement or labor
savings. These factors could affect the demand for or the relative
cost of the company's technology, products and services, or the
method and profitability of the method of distribution or delivery
of such technology, products and services. In addition, the
company's businesses each could suffer significant setbacks in
revenues and operating income if it lost one or more of its
largest customers, or if its customers' plans and/or markets
should change significantly. Cybershield has lost substantial
business as a result of most cellular handset production moving to
Asia where Cybershield has no significant presence. Low labor
costs in Asia make other coating processes competitive with those
Cybershield would use. Cybershield's future viability may depend
on the successful
21
commercialization of the EXACT(TM)process, or other value added
services, which are unproven as yet on a large commercial scale.
9. Although the company insures itself against physical loss to its
manufacturing facilities, including business interruption losses,
natural or other disasters and accidents, including but not
limited to fire, earthquake, damaging winds, and explosions,
operating results could be adversely affected if any of its
manufacturing facilities became inoperable for an extended period
of time due to such events.
10. Each of the company's businesses is actively involved in the
development of new products, processes and services which are
expected to contribute to the company's ongoing long-term growth
and earnings. Products using VersaShield fire retardant coatings
have not yet produced commercial sales. Its market potential may
be dependent on the stringency of federal and state regulatory
requirements, which are difficult to predict. If such development
activities are not successful, regulatory requirements are less
stringent than currently predicted, market demand is less than
expected, or the company cannot provide the requisite financial
and other resources to successfully commercialize such
developments, the growth of future sales and earnings may be
adversely affected.
Parties are cautioned not to rely on any such forward-looking beliefs or
judgments in making investment decisions.
22
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In addition to the risks inherent in its operations, the company is
exposed to financial, market, political and economic risks. The following
discussion provides additional detail regarding the company's exposure to the
risks of changing commodity prices and interest rates. The company has no
significant foreign exchange risk. Derivatives are held from time to time as
part of a formally documented risk management program. Derivatives are held to
mitigate uncertainty, volatility or to cover underlying exposures. No
derivatives are held for trading purposes. The company currently has entered
into derivative transactions related to interest rate risk.
The company is required to purchase natural gas for use in its
manufacturing facilities. These purchases expose the company to the risk of
higher natural gas prices. To hedge this risk, from time to time the company
enters into hedge transactions to fix the price on a portion of its projected
natural gas usage. There are no current hedge commitments on natural gas at
March 31, 2003. However, it is anticipated that hedging strategies will likely
be utilized in the future.
The company uses interest rate swaps to help maintain a reasonable
balance between fixed and floating rate debt. The company has entered into an
interest rate swap on $60,000,000 of the outstanding face amount of Senior Notes
at March 31, 2003. The fair value of this swap was a gain of $6,131,000 at March
31, 2003. Based on outstanding debt at March 31, 2003, the company's interest
costs would increase or decrease $600,000 for each theoretical 1% increase or
decrease in the floating interest rate.
ITEM 4. CONTROLS AND PROCEDURES
At a date within ninety days prior to the filing of this report, the
company completed an evaluation, under the supervision and with the
participation of management, including the Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of the
company's disclosure controls and procedures pursuant to Exchange Act Rules
13a-14 and 15d-14. Based upon that evaluation, the Chief Executive Officer and
the Chief Financial Officer concluded that the company's disclosure controls and
procedures are effective to timely alert them to any material information
relating to the company (including its consolidated subsidiaries) that must be
included in the company's periodic SEC filings. There have been no significant
changes in the company's internal controls or in other factors that could
significantly affect these controls subsequent to the date of the evaluation,
including any corrective actions with regard to significant deficiencies and
material weaknesses.
23
PART II. OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
On April 3, 2002, CertainTeed Corporation filed suit in the United
States District Court for the Eastern District of Pennsylvania, Philadelphia,
Pennsylvania for alleged patent infringement against the company and two of its
Elk affiliates. The suit, in essence, claims that Elk's Capstone shingle
infringes three CertainTeed patents. The complaint did not seek a specific
monetary amount of damages, but seeks preliminary and permanent injunctive
relief, unspecified damages and attorney's fees. Both parties have filed motions
for summary judgment in the case, which is in the late stages of discovery. The
company believes that it and its named affiliates have strong defenses to the
suit, and does not believe the suit will have a material adverse effect on its
consolidated results of operations, financial position or liquidity.
Other
The company and its subsidiaries are involved in various other legal
proceedings, including claims arising in the ordinary course of business. Based
on advice from legal counsel, management believes such litigation and claims
will be resolved without material adverse effect on the company's consolidated
results of operations, financial position or liquidity.
24
ITEM 6: EXHIBITS AND REPORTS OF FORM 8-K
(a) Exhibits:
4.16 Second Amendment to Credit Agreement dated as of June 5, 2002 among
Elcor Corporation, Bank One, N.A., as Documentation Agent, First Union
National Bank, as Syndication Agent, and Bank of America, N.A., as
Administrative Agent, Swing Line Lender and L/C Issuer.
4.17 Third Amendment to Credit Agreement dated as of February 20, 2003 among
ElkCorp (formerly known as Elcor Corporation), Bank One, N.A., as
Documentation Agent, Wachovia Bank, N.A., as Syndication Agent, and
Bank of America, N.A., as Administrative Agent, Swing Line Lender and
L/C Issuer.
4.18 Fourth Amendment to Credit Agreement dated as of March 7, 2003 among
ElkCorp (formerly known as Elcor Corporation), Bank One, N.A., as
Documentation Agent, and Bank of America, N.A., as Administrative
Agent, Swing Line Lender and L/C Issuer.
99.1 Certification of the Chief Executive Officer of ElkCorp
99.2 Certification of the Chief Financial Officer of ElkCorp
(b) The company filed two reports on Form 8-K during the quarter
ended March 31, 2003. The company filed a Form 8-K on January
17, 2003 relating to a press release reporting consolidated
operating results and other financial information for the
second quarter of fiscal 2003, and containing
"forward-looking" statements about its prospects for the
future, and certain other information concerning the company's
disclosures under Regulation FD, and the company filed a Form
8-K on March 20, 2003 relating to a press release containing
"forward-looking" statements about its prospects for the
future certain other information concerning the company's
disclosures under Regulation FD, and an exhibit for a Note
Purchase Agreement dated as of March 1, 2003 for the sale of
$25,000,000 Aggregate Principal Amount of Senior Notes.
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ElkCorp
DATE: May 15, 2003 /s/ Harold R. Beattie, Jr.
-------------------------------------
Harold R. Beattie, Jr.
Senior Vice President,
Chief Financial Officer and Treasurer
/s/ Leonard R. Harral
-------------------------------------
Leonard R. Harral
Vice President and Chief
Accounting Officer
26
CERTIFICATIONS
I, Thomas D. Karol, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ElkCorp;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 15, 2003 By /s/ Thomas D. Karol
-------------------------------
Thomas D. Karol
Principal Executive Officer
27
I, Harold R. Beattie, Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of ElkCorp;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 15, 2003 By /s/ Harold R. Beattie, Jr.
-------------------------------
Harold R. Beattie, Jr.
Principal Financial Officer
28
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
- ----------- -----------
4.16 Second Amendment to Credit Agreement dated as of June 5, 2002 among
Elcor Corporation, Bank One, N.A., as Documentation Agent, First Union
National Bank, as Syndication Agent, and Bank of America, N.A., as
Administrative Agent, Swing Line Lender and L/C Issuer.
4.17 Third Amendment to Credit Agreement dated as of February 20, 2003 among
ElkCorp (formerly known as Elcor Corporation), Bank One, N.A., as
Documentation Agent, Wachovia Bank, N.A., as Syndication Agent, and
Bank of America, N.A., as Administrative Agent, Swing Line Lender and
L/C Issuer.`
4.18 Fourth Amendment to Credit Agreement dated as of March 7, 2003 among
ElkCorp (formerly known as Elcor Corporation), Bank One, N.A., as
Documentation Agent, and Bank of America, N.A., as Administrative
Agent, Swing Line Lender and L/C Issuer.
99.1 Certification of the Chief Executive Officer of ElkCorp
99.2 Certification of the Chief Financial Officer of ElkCorp