10-Q 1 d02866e10vq.txt FORM 10-Q 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 ----------------- For Quarter Ended December 31, 2002 Commission File Number 1-5341 ----------------- ------ ELKCORP ---------------------------------------------------------------- (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 January 31, 2003, Registrant had outstanding 19,496,289 shares of Common Stock, par value $1 per share. ELKCORP AND SUBSIDIARIES FOR THE QUARTER ENDED DECEMBER 31, 2002 INDEX
Page ---- PART I. FINANCIAL INFORMATION (UNAUDITED) Item 1. Financial Statements Consolidated Statements of Operations for the Three Months and Six Months Ended December 31, 2002 and 2001 1 Consolidated Balance Sheets as of December 31, 2002 and June 30, 2002 2 Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2002 and 2001 3 Notes to Consolidated Financial Statements 4-10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11-18 Item 3. Quantitative and Qualitative Disclosures About Market Risk 19 Item 4. Controls and Procedures 19 PART II. OTHER INFORMATION Item 1. Legal Proceedings 20 Item 4. Submission of Matters to a Vote of Security Holders 21 Item 6. Exhibits and Reports on Form 8-K 22 SIGNATURES 23 CERTIFICATIONS 24-25
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 Six Months Ended December 31, December 31, ----------------------------- ---------------------------- 2002 2001 2002 2001 ----------- ----------- ----------- ----------- SALES $ 109,063 $ 113,128 $ 229,145 $ 256,347 ----------- ----------- ----------- ----------- COST AND EXPENSES Cost of sales 89,131 90,107 184,559 206,611 Selling, general and administrative 13,970 15,421 28,072 30,461 Noncash stock option compensation -- 4,040 (5,378) 5,477 ----------- ----------- ------------ ----------- INCOME FROM OPERATIONS 5,962 3,560 21,892 13,798 ----------- ----------- ----------- ----------- OTHER EXPENSE Interest expense, net 1,373 1,337 3,053 3,617 ----------- ----------- ----------- ----------- INCOME BEFORE INCOME TAXES 4,589 2,223 18,839 10,181 Provision for income taxes 1,773 960 7,027 4,018 ----------- ----------- ----------- ----------- NET INCOME $ 2,816 $ 1,263 $ 11,812 $ 6,163 =========== =========== =========== =========== NET INCOME PER SHARE-BASIC $ .14 $ .07 $ .61 $ .32 =========== =========== =========== =========== NET INCOME PER SHARE-DILUTED $ .14 $ .06 $ .60 $ .32 =========== =========== =========== =========== DIVIDENDS PER COMMON SHARE $ .05 $ .05 $ .10 $ .10 =========== =========== =========== =========== AVERAGE COMMON SHARES OUTSTANDING (000'S) Basic 19,484 19,244 19,473 19,238 =========== =========== =========== =========== Diluted 19,580 19,648 19,587 19,556 =========== =========== =========== ===========
See accompanying notes to consolidated financial statements. 1 ELKCORP AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited, $ in thousands, except share data)
December 31, June 30, 2002 2002 --------- --------- ASSETS CURRENT ASSETS Cash and cash equivalents $ 17,804 $ 12,436 Trade receivables, less allowance of $1,028 and $734 67,309 94,764 Inventories - Finished goods 52,091 36,888 Work-in-process 363 538 Raw materials 9,392 9,484 --------- --------- Total inventories 61,846 46,910 --------- --------- Prepaid expenses and other 9,537 9,474 Deferred income taxes 3,920 5,727 --------- --------- Total current assets 160,416 169,311 --------- --------- PROPERTY, PLANT AND EQUIPMENT, AT COST 341,034 320,695 Less - accumulated depreciation (123,186) (114,216) --------- --------- Property, plant and equipment, net 217,848 206,479 --------- --------- OTHER ASSETS 12,231 5,638 --------- --------- $ 390,495 $ 381,428 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 23,263 $ 27,418 Accrued liabilities 20,650 24,655 --------- --------- Total current liabilities 43,913 52,073 --------- --------- LONG-TERM DEBT 125,421 119,718 DEFERRED INCOME TAXES 35,096 33,545 SHAREHOLDERS' EQUITY - Common stock ($1 par, 19,988,074 shares issued) 19,988 19,988 Paid-in-capital 58,093 58,419 Unearned compensation (287) -- Accumulated other comprehensive income -- 31 Retained earnings 116,635 106,772 --------- --------- 194,429 185,210 Less-Treasury stock (493,949 and 527,076 shares, at cost) (8,364) (9,118) --------- --------- Total shareholders' equity 186,065 176,092 --------- --------- $ 390,495 $ 381,428 ========= =========
See accompanying notes to consolidated financial statements. 2 ELKCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited, $ in thousands)
Six Months Ended December 31, ------------------------- 2002 2001 ---------- --------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 11,812 $ 6,163 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 9,101 8,977 Deferred income taxes 3,358 4,256 Changes in assets and liabilities: Trade receivables 27,635 14,492 Inventories (14,708) 3,571 Prepaid expenses and other 16 (880) Accounts payable and accrued liabilities (8,160) 9,034 -------- -------- Net cash provided by operating activities 29,054 45,613 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Additions to property, plant and equipment (19,354) (4,989) Acquisition of business (2,224) -- Other (301) 287 -------- -------- Net cash used for investing activities (21,879) (4,702) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Repayments on Revolving Credit Facility, net -- (39,300) Dividends on common stock (1,948) (1,931) Treasury stock transactions and other, net 141 371 -------- -------- Net cash used for financing activities (1,807) (40,860) -------- -------- NET INCREASE IN CASH AND CASH EQUIVALENTS 5,368 51 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 12,436 128 -------- -------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 17,804 $ 179 ======== ========
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 December 31, 2002, and the results of their operations for the three and six month periods ended December 31, 2002 and 2001 and their cash flows for the six 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 is segregated and managed as two segments: Elk Premium Building Products (Building Products) and Elk Technologies (Other, Technologies). 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, advanced composite building products. Building Products accounted for 91% of consolidated sales in fiscal 2002 and 92% of consolidated sales during the six months ended December 31, 2002. The Other, Technologies segment consists of the operations that are not part of the Building Products segment. These dissimilar operations were combined into one segment beginning in fiscal 2002, as none individually met the materiality criteria for separate segment reporting. The businesses aggregated together as the Other, Technologies segment accounted for 9% of consolidated sales in fiscal 2002 and 8% of consolidated sales during the six months ended December 31, 2002. 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 4 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; 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. This business has not yet produced commercial sales. Financial information by company segment is summarized as follows:
(In thousands) (In thousands) Three Months Ended Six Months Ended December 31, December 31, ------------------------- ------------------------- 2002 2001 2002 2001 --------- --------- --------- --------- SALES Building Products $ 98,622 $ 96,964 $ 211,938 $ 227,989 Other, Technologies 10,441 16,164 17,207 28,358 --------- --------- --------- --------- $ 109,063 $ 113,128 $ 229,145 $ 256,347 ========= ========= ========= ========= OPERATING PROFIT (LOSS) Building Products $ 7,491 $ 9,672 $ 21,989 $ 24,297 Other, Technologies 1,189 1,073 100 1,166 Corporate and other, excluding noncash stock option compensation (2,718) (3,145) (5,575) (6,188) Noncash stock option compensation -- (4,040) 5,378 (5,477) --------- --------- --------- --------- 5,962 3,560 21,892 13,798 Interest expense, net (1,373) (1,337) (3,053) (3,617) --------- --------- --------- --------- Income before income taxes $ 4,589 $ 2,223 $ 18,839 $ 10,181 ========= ========= ========= ========= DEPRECIATION AND AMORTIZATION Building Products $ 3,413 $ 3,193 $ 6,828 $ 6,573 Other, Technologies 463 534 915 1,065 Corporate 675 670 1,358 1,339 --------- --------- --------- --------- $ 4,551 $ 4,397 $ 9,101 $ 8,977 ========= ========= ========= ========= CAPITAL EXPENDITURES Building Products $ 11,570 $ 1,649 $ 18,564 $ 3,942 Other, Technologies 54 462 200 920 Corporate 155 56 590 127 --------- --------- --------- --------- $ 11,779 $ 2,167 $ 19,354 $ 4,989 ========= ========= ========= =========
December 31, June 30, 2002 2002 --------------- -------------- IDENTIFIABLE ASSETS Building Products $ 315,048 $314,668 Other, Technologies 33,612 32,420 Corporate 41,835 34,340 --------------- -------------- $390,495 $381,428 =============== ==============
5 NOTE 3 - 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. The following table sets forth the computation of basic and diluted earnings per share:
(In thousands) (In thousands) Three Months Ended Six Months Ended December 31, December 31, -------------------- -------------------- 2002 2001 2002 2001 ------- ------- ------- ------- Net income $ 2,816 $ 1,263 $11,812 $ 6,163 ======= ======= ======= ======= Denominator for basic earnings per share - weighted average shares outstanding 19,484 19,244 19,473 19,238 Effect of dilutive securities: Employee stock options 96 404 114 318 ------- ------- ------- ------- Denominator for dilutive earnings per share - adjusted weighted average shares and assumed issuance of shares purchased under incentive stock option plan using the treasury stock method 19,580 19,648 19,587 19,556 ======= ======= ======= ======= Basic earnings per share $ .14 $ .07 $ .61 $ .32 ======= ======= ======= ======= Diluted earnings per share $ .14 $ .06 $ .60 $ .32 ======= ======= ======= =======
NOTE 4 - COMPREHENSIVE INCOME Total comprehensive income for the three-month and six-month periods ended December 31, 2002 and December 31, 2001 were as follows:
(In thousands) (In thousands) Three Months Ended Six Months Ended December 31, December 31, ----------------------- ----------------------- 2002 2001 2002 2001 -------- -------- -------- -------- Net income $ 2,816 $ 1,263 $ 11,812 $ 6,163 Derivative transactions (15) -- (31) -- -------- -------- -------- -------- Total comprehensive income $ 2,801 $ 1,263 $ 11,781 $ 6,163 ======== ======== ======== ========
At December 31, 2002, there are no remaining derivative transactions in effect that will cause net income to vary from total comprehensive income in future periods. 6 NOTE 5 - 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 six-month periods ended December 31, 2001, net income was previously reported as $3,889,000 ($.20 diluted earnings per share) and $9,723,000 ($.50 diluted earnings per share), respectively. The company recorded noncash stock option compensation of $4,040,000 ($2,626,000, net of tax, or $.14 per diluted share) and $5,477,000 ($3,560,000, net of tax, or $.18 per diluted share) for the three-month and six-month periods ended December 31, 2001, respectively. Accordingly, net income was restated as $1,263,000 ($.06 diluted earnings per share) and $6,163,000 ($.32 diluted earnings per share) for the three-month and six-month periods ended December 31, 2001, 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. 7 NOTE 6 - LONG-TERM DEBT In June 2002, the company issued $120,000,000 of Senior Notes (Notes). Of the Notes, $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, 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 December 31, 2002, letters of credit totaling $2,584,000 were outstanding. No borrowings were outstanding on the Facility at December 31, 2002. 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 December 31, 2002, the fair value of the derivative was $5,421,000 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:
December 31, June 30, (In thousands) 2002 2002 ------------ ---------- Senior Notes $ 120,000 $ 120,000 Fair value of interest rate swap 5,421 (282) Revolving Credit Facility -- -- ---------- ---------- $ 125,421 $ 119,718 ========== ==========
NOTE 7 - 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. 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 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. NOTE 8 - 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. 8 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, it is unable to estimate and provide reserves for remediation costs, which may or may not be material. 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 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, "Accounting for Contingencies," when appropriate. NOTE 9 - LEGAL PROCEEDINGS In February 2000, Wedgewood Knolls Condominium Association filed a purported class action in the United States District Court in Newark, New Jersey which, as amended, names two Elk subsidiaries. The purported nationwide class would include purchasers or current owners of buildings with certain Elk asphalt shingles installed between January 1, 1980 and present. The suit alleges, among other things, that the shingles were uniformly defective. It seeks various remedies including damages and reformation of the limited warranty applicable to the shingles on behalf of the plaintiff and the purported class. In late March 2002, the United States District Court for the District of New Jersey issued its opinion denying the plaintiff's motion for class certification in the Wedgewood Knolls lawsuit pending against Elk. In June 2000, an individual homeowner filed a purported class action, Lastih v. Elk Corporation of Alabama, in the Judicial District of Hartford, Connecticut. The Lastih suit involves similar class allegations and claims to those asserted in the Wedgewood Knolls suit described above. Elk denied the claims asserted in both actions, and vigorously defended them. Elk and the other parties are carrying out the terms of a settlement agreement with all plaintiffs represented by the law firm prosecuting the Wedgewood Knolls and Lastih cases, including without limitation Wedgewood Knolls Condominium Association, Lastih and several other individual plaintiffs. The settlement was not a class settlement and did not have a material adverse effect on the company's consolidated results of operations, financial condition or liquidity. 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, and seeks preliminary and permanent injunctive relief, damages and attorneys' 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 9 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 actions and claims, 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 consolidated financial statements. NOTE 10 - 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. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." This statement amends SFAS No. 123, "Accounting for Stock-Based Compensation," providing alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The company has adopted the disclosure-only provisions of SFAS No. 123. Therefore, SFAS No. 148 will not affect the company's results of operations. The new disclosure requirements will be effective for the company beginning in the quarter ending March 31, 2003. 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS CHANGES IN THE THREE-MONTH PERIOD ENDED DECEMBER 31, 2002 COMPARED TO THE THREE-MONTH PERIOD ENDED DECEMBER 31, 2001. OVERALL PERFORMANCE Sales of $109,063,000 during the three-month period ended December 31, 2002 were 3.6% lower than $113,128,000 in the same three-month period of fiscal 2002. During the quarter ended December 31, 2002, net income of $2,816,000 was 123% higher than $1,263,000 for the same period in the prior fiscal year. For the quarter ended December 31, 2001, net income was previously reported as $3,889,000. After recording noncash stock option compensation of $2,626,000, net of tax, net income was restated as $1,263,000 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 December 31, 2002 was not, and income in future quarters will not be, affected by changes in the company's share price. Consolidated operating income of $5,962,000 in the quarter ended December 31, 2002 was 67.5% higher than $3,560,000 in the second quarter in the prior fiscal year. Operating income for the previous year quarter was reduced by a $4,040,000 charge for noncash stock option compensation. Excluding the impact of noncash stock option compensation, operating income for the three months ended December 31, 2001 was $7,600,000. As a percentage of sales, operating income (excluding the impact of noncash stock option compensation), was 5.5% in the second quarter of fiscal 2003 compared to 6.7% for the same quarter in the prior fiscal year. Cost of sales was 81.7% of sales for the three months ended December 31, 2002, compared to 79.7% for the same three month period in the prior fiscal year. On a per unit basis, cost of sales in the current year period was adversely affected by much higher asphalt costs. Despite higher litigation costs, selling, general and administrative (SG&A) costs in the three-month period ended December 31, 2002 were significantly lower than in the second quarter of fiscal 2002, primarily as a result of lower promotional costs and lower SG&A costs realized from a restructuring at Cybershield in the third quarter of fiscal 2002. As a percentage of sales, SG&A costs were 12.8% in the second quarter of fiscal 2003, compared to 13.6% in the same quarter last year. Interest expense was $1,373,000 in the second quarter of fiscal 2003 compared to $1,337,000 in the same prior year period. In the three months ended December 31, 2002, interest expense of $201,000 was capitalized related to the construction 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 37.3% 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. 11 RESULTS OF BUSINESS SEGMENTS Sales in the Building Products segment increased 1.7% to $98,622,000 for the three months ended December 31, 2002 compared to $96,964,000 in the same prior year period. Higher sales in the current year period were reflective of a 10.4% increase in unit shingle shipments, partially offset by lower external nonwoven mat sales. Average shingle selling prices declined 2.6% in the second quarter of fiscal 2003 compared to the same quarter last year. Sales price per unit was also slightly lower in the current year quarter due to a lower sales mix (i.e. a relatively higher proportion of sales from lower-priced product categories). Total nonwoven mat sales, including internal sales, were comparable to the same quarter last year. However, a relatively higher proportion of nonwoven mat was consumed internally by Elk's roofing operations during the current year quarter. Internal nonwoven mat sales are eliminated in consolidation. Operating profit for the Building Products segment of $7,491,000 for the three-month period ended December 31, 2002 decreased 22.6% from $9,672,000 of operating profit achieved in the same period of fiscal 2002. This decrease in year-to-year operating profit was largely the result of significantly higher asphalt costs, which reduced operating profit by over $2,500,000 compared to the same quarter last year. In addition, higher litigation expenses and limited production of new "beta" shingle products combined to reduce operating profit by about $1,000,000. Elk was successful in the current year quarter in lowering controllable operating expenses through good cost control practices. Initial operations for Elk Composite Building Materials further reduced operating profit during the current year quarter by almost $500,000. During the December 2002 quarter, this acquisition was assimilated into Elk's operations and its product line for decking, transportation and other applications was expanded and improved. Management projects that by the end of March 2003, this new operation will be capable of generating in the range of $15,000,000 to $20,000,000 in annual sales and beginning to generate an operating profit. The Building Products segment experienced higher than expected demand during the month of December 2002 as a likely result of increased storm activity in some regions of the United States, combined with inventory purchases by distributors in advance of scheduled price increases, and to hedge against potential asphalt shortages. Demand was particularly strong in the Western United States, most likely the result of El Nino related storms containing heavy rain and strong winds that affected that region. Management expects continued strengthening in the roofing market during the spring and summer months of calendar year 2003. Management anticipates that the extended paralysis of Venezuela's oil industry will result in asphalt shortages to the roofing industry in the United States. Asphalt is believed to be in short supply in certain markets of the Eastern United States, and suppliers have begun to allocate available supplies to contractual customers based on historical usage. As a result of a strong inventory position, management does not currently anticipate any significant impairment of future sales related to an asphalt shortage. However, asphalt costs in the near term could increase by $30 - $40 per ton over December 2002 levels. Effective January 6, 2003, Elk implemented a 3% price increase intended to recover prior increases in asphalt costs. Another 5% price increase is scheduled for late February 2003 to recover the anticipated near term asphalt cost escalation. Management believes that current market conditions are conducive to Elk's realization of both price increases. Sales for the Other, Technologies segment decreased 35.4% to $10,441,000 in the second quarter of fiscal 2003 compared to $16,164,000 in the same prior year quarter. Cybershield sales in the quarter ended December 31, 2002 were significantly below sales in same quarter last year, as cellular handset 12 production previously conducted in the United States and Latin America has largely shifted to Asia where the company has no significant operations. Chromium's sales were also lower in the second quarter of fiscal 2003 compared to the prior year quarter. However, Chromium continues to see momentum developing for its new wear plate and tile products to partially offset lower volumes as railroads continue to defer maintenance expenditures. Ortloff achieved higher revenues from license agreements in the current year quarter compared to the same quarter last year. The Other, Technologies segment reported $1,189,000 of operating profit in the second quarter of fiscal 2003 compared to a $1,073,000 operating profit in the second quarter of the prior fiscal year. Despite the significant change in Cybershield's market, this subsidiary experienced some benefit from a seasonal increase in cellular handset related sales and growing sales momentum in other product categories. These developments, combined with a much lower operating cost structure, allowed Cybershield to achieve an approximate $200,000 operating profit during the current year quarter compared to about $500,000 of operating profit in the same quarter last year. Management believes Cybershield is successfully positioned for sustained profitability. Chromium had an operating loss of approximately $100,000 during the current year quarter compared to a modest operating profit in the same period last year. Management expects Chromium's operating results to improve during the second half of fiscal 2003 as a result of projected increases in sales of new wear tile and abrasion plate products. Ortloff reported operating profit of $1,100,000 in the current year quarter, more than doubling its operating profit for the same quarter in fiscal 2002, due to higher revenues. Ortloff's activity backlog was strong at December 31, 2002 and this business is expected to generate good, to potentially excellent, results over the remainder of fiscal 2003. The company continues to be optimistic about the future market potential of its Versa Shield TB 129 fire-barrier fabric. California has not yet announced its definitive new fire standard for mattress products. Management expects a decision by the end of January 2003 or early February 2003, with compliance being required by January 2004. The company is hopeful that meaningful sales opportunities will begin to develop for this product during the second half of calendar 2003. CHANGES IN THE SIX-MONTH PERIOD ENDED DECEMBER 31, 2002 COMPARED TO THE SIX-MONTH PERIOD ENDED DECEMBER 31, 2001. OVERALL PERFORMANCE Sales of $229,145,000 during the six-month period ended December 31, 2002 were 10.6% lower than $256,347,000 in the same period of fiscal 2002. During the six-month period ended December 31, 2002, net income of $11,812,000 was 91.7% higher than $6,163,000 for the same period in the prior fiscal year. For the six months ended December 31, 2001, net income was previously reported as $9,723,000. After recording noncash stock option compensation of $3,560,000, net of tax, net income was restated as $6,163,000 for that period. Consolidated operating income of $21,892,000 in the first half of fiscal 2003 was 58.7% higher than $13,798,000 in the first half 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 $5,477,000 charge for this noncash item in the first half last year. Excluding the impact of noncash stock option compensation, operating income for the first six months of the current fiscal year was $16,514,000 compared to $19,275,000 for the same prior year period. As a percentage of sales, operating income (excluding the impact of noncash stock option compensation) was 7.2% in the first half of fiscal 2003 compared to 7.5% for the same period in the prior fiscal year. Cost of sales were 80.5% of sales for the six months ended December 31, 2002, compared to 80.6% for the same period in 13 fiscal 2002. 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. Despite much higher litigation costs, SG&A costs in the six-month period ended December 31, 2002 were lower than in the first half of fiscal 2002, primarily as a result of lower promotional costs and lower SG&A costs achieved from the consolidation of Cybershield's operations in the third quarter of fiscal 2002. As a percentage of sales, SG&A costs were 12.3% in the first half of fiscal 2003, compared to 11.9% in the same period last year. Interest expense was $3,053,000 in the first half of fiscal 2003 compared to $3,617,000 in the same prior year period. In the first half of fiscal 2003, interest expense of $248,000 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. The company currently projects its effective tax rate to be 37.3% 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 7.0% to $211,938,000 for the six months ended December 31, 2002 compared to $227,989,000 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. Average selling prices during the first half of fiscal 2003 were 0.4% lower than in the same six month period last year. Sales price per unit has also been lower in the current fiscal year due to a lower sales mix (i.e. a relatively higher proportion of sales from lower-priced product categories). Operating profit for the Building Products segment of $21,989,000 for the six-month period ended December 31, 2002 was 9.5% lower compared to $24,297,000 of operating profit achieved in the same period of fiscal 2002. Lower sales volumes and significantly higher asphalt costs have been 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 six months of fiscal 2003 were more than $5,000,000 higher than in the same period last year. 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 segment decreased 39.3% to $17,207,000 in the first half of fiscal 2003 compared to $28,358,000 in the same prior year period. Significantly reduced volumes of cellular handset business 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 half of fiscal 2003 compared to the prior year period as a result of deferred maintenance expenditures by its railroad customers. For the six months ended December 31, 2002, Ortloff's licensing revenues were significantly lower than in the same period last year. 14 Primarily as a result of lower revenues, the Other, Technologies segment reported a $100,000 operating profit for the first half of fiscal 2003 compared to $1,166,000 operating profit in the same six month period last year. Chromium reported an approximate $150,000 operating loss during the current year period compared to approximately $300,000 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 $450,000 compared to a modest operating profit in the same period last year. Ortloff reported operating profit of approximately $700,000 in the current year period compared to about $800,000 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 six months of fiscal 2003, the company generated cash flows of $29,054,000 from operating activities compared to $45,613,000 for the first six months in the prior fiscal year. The decrease in cash flows generated in the first half 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 December 31, 2002 were $27,635,000 lower than at June 30, 2002, primarily due to the seasonal slowdown in sales volumes, together with collection of $8,608,000 of deferred trade receivables from promotional programs to certain customers in the current year period. In the prior year first half, receivables were $14,492,000 lower than at June 30, 2001. At December 31, 2002, manufactured inventories were $14,708,000 higher than at June 30, 2002 as production at the company's roofing plants continued at high rates throughout much of the current year while sales volumes declined. 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 $8,160,000 decrease in current liabilities at December 31, 2002 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, together with normal timing of vendor payments. In the prior year, cash flows were generated from an increase in trade payables that resulted from advantageous cash management strategies that were not beneficial in the current year due to the company's cash position. The current ratio was 3.7 to 1 at December 31, 2002 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 $11,500,000 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 over a two year period to construct this shingle manufacturing line and to install 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 second 15 quarter of fiscal 2003, the company utilized $2,224,000 of cash for a business acquisition and subsequently invested $2,234,000 in incremental capital expenditures for this new subsidiary to increase manufacturing capacity. 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 used for financing activities was $1,807,000 in the first half of fiscal 2003 compared to $40,860,000 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. The proceeds of the notes were used to repay indebtedness outstanding under the company's existing Revolving Credit Facility. There was no outstanding balance on the Revolving Credit Facility at December 31, 2002. The increase in long-term debt during the first half 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 December 31, 2002, liquidity consisted of $17,804,000 of cash and cash equivalents and $97,416,000 of available borrowings under its $100,000,000 committed Revolving Credit Facility. The debt to capital ratio (after deducting cash and cash equivalents from $120,000,000 of principal debt) was 35.4%. 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 December 31, 2002, the company has repurchase authority of approximately $10,600,000 remaining. See footnote 8 on page 8 on this Form 10-Q for a summary of the company's environmental risk and footnote 10 on page 10 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. 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 six-month period ended December 31, 2002. 16 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. 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, if not timely resolved, 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, 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. 17 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 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. 18 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 December 31, 2002. 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, or 50% of the outstanding face amount of Senior Notes at June 30, 2002. The fair value of this swap was a gain of $5,421,000 at December 31, 2002. Based on outstanding debt at December 31, 2002, 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 In January 2003, 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. 19 PART II. OTHER INFORMATION ITEM 1: LEGAL PROCEEDINGS In February 2000, Wedgewood Knolls Condominium Association filed a purported class action in the United States District Court in Newark, New Jersey which, as amended, names two Elk subsidiaries. The purported nationwide class would include purchasers or current owners of buildings with certain Elk asphalt shingles installed between January 1, 1980 and present. The suit alleges, among other things, that the shingles were uniformly defective. It seeks various remedies including damages and reformation of the limited warranty applicable to the shingles on behalf of the plaintiff and the purported class. In late March 2002, the United States District Court for the District of New Jersey issued its opinion denying the plaintiff's motion for class certification in the Wedgewood Knolls lawsuit pending against Elk. In June 2000, an individual homeowner filed a purported class action, Lastih v. Elk Corporation of Alabama, in the Judicial District of Hartford, Connecticut. The Lastih suit involves similar class allegations and claims to those asserted in the Wedgewood Knolls suit described above. Elk denied the claims asserted in both actions, and vigorously defended them. Elk and the other parties are carrying out the terms of a settlement agreement with all plaintiffs represented by the law firm prosecuting the Wedgewood Knolls and Lastih cases, including without limitation Wedgewood Knolls Condominium Association, Lastih and several other individual plaintiffs. The settlement was not a class settlement and did not have a material adverse effect on the company's consolidated results of operations, financial condition or liquidity. 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, and seeks preliminary and permanent injunctive relief, damages and attorneys' 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 actions and claims, 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 consolidated financial statements. 20 ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) The company's Annual Meeting of Shareholders was held on October 29, 2002 for the purpose of electing three directors, approving the 2002 ElkCorp Equity Incentive Compensation Plan, and ratifying the appointment of the company's independent auditors. (b) Directors Elected
NUMBER OF VOTES ------------------------------------------ FOR AGAINST WITHHELD --- ------- -------- Richard A. Nowak 16,272,938 64,202 286,960 David W. Quinn 15,947,042 390,098 286,960 Michael L. McMahan 15,949,461 387,679 286,960
(c) Other Directors Whose Term Continued After the Meeting: Thomas D. Karol Dale V. Kesler James E. Hall Harold K. Work (c) Other matters voted upon at the meeting and the number of affirmative votes, negative votes and abstentions.
NUMBER OF VOTES ---------------------------------------------------- BROKER AFFIRMATIVE AGAINST ABSTENTIONS NON-VOTES ----------- ------- ----------- --------- Approval of the 2002 ElkCorp Equity Incentive Compensation Plan 11,531,939 3,255,902 127,755 1,708,504 Ratification of PricewaterhouseCoopers as independent auditors of the company for the fiscal year ending June 30, 2003 16,055,947 337,696 230,457 0
21 ITEM 6: EXHIBITS AND REPORTS OF FORM 8-K (a) Exhibits: 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 December 31, 2002. The company filed a Form 8-K on October 17, 2002 relating to a press release reporting consolidating operating results and other financial information for the first 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 December 23, 2002 relating to a press release containing "forward-looking" statements about its prospects for the future and certain other information concerning the company's disclosures under Regulation FD. 22 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: February 3, 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 23 CERTIFICATIONS I, Thomas D. Karol, certify that: I have reviewed this quarterly report on Form 10-Q of ElkCorp; 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; 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; 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; The registrant's other certifying officer 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 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: February 3, 2003 By /s/ Thomas D. Karol ---------------------------- Thomas D. Karol Chief Executive Officer 24 I, Harold R. Beattie, Jr., certify that: I have reviewed this quarterly report on Form 10-Q of ElkCorp; 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; 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; 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; The registrant's other certifying officer 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 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: February 3, 2003 By /s/ Harold R. Beattie, Jr. ------------------------------ Harold R. Beattie, Jr. Chief Financial Officer 25 Exhibit Index 99.1 Certification of the Chief Executive Officer of ElkCorp 99.2 Certification of the Chief Financial Officer of ElkCorp