10-Q 1 sept03-10q.txt SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2003 ------------------ OR [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from __________ to _____________ Commission File Number: 000-25423 --------- EAGLE SUPPLY GROUP, INC. ----------------------------------------------------------------- (Exact Name of Registrant as Specified in Its Charter) Delaware 13-3889248 ----------------------------------------------------------------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 122 East 42nd Street, Suite 1618, New York, New York 10168 ----------------------------------------------------------------- (Address of Principal Executive Offices) (Zip Code) 212-986-6190 ----------------------------------------------------------------- (Registrant's Telephone Number, Including Area Code) 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 past 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 [ ] No [X] The number of shares outstanding of the Registrant's Common Stock, as of November 11, 2003, was 10,255,455 shares. EAGLE SUPPLY GROUP, INC. INDEX TO FORM 10-Q PAGE PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets as of September 30, 2003 (Unaudited) and June 30, 2003 3 Consolidated Statements of Operations (Unaudited) for the Three Months Ended September 30, 2003 and 2002 4-5 Consolidated Statement of Shareholders' Equity (Unaudited) for the Three Months Ended September 30, 2003 6 Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended September 30, 2003 and 2002 7 Notes to Unaudited Consolidated Financial Statements 8-12 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 22-23 Item 4. Controls and Procedures 23-24 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 25 SIGNATURES 26 CERTIFICATIONS 27-30 -2- EAGLE SUPPLY GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ---------------------------------------------------------------------------

See notes to unaudited consolidated financial statements. -3- EAGLE SUPPLY GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) THREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 ---------------------------------------------------------------------------

See notes to unaudited consolidated financial statements. -4- EAGLE SUPPLY GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) THREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 (Contd.) ---------------------------------------------------------------------------

See notes to unaudited consolidated financial statements. -5- EAGLE SUPPLY GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (UNAUDITED) THREE MONTHS ENDED SEPTEMBER 30, 2003 ---------------------------------------------------------------------------

See notes to unaudited consolidated financial statements. -6- EAGLE SUPPLY GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) THREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 ---------------------------------------------------------------------------

See notes to unaudited consolidated financial statements. -7- EAGLE SUPPLY GROUP, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS ---------------------------------------------------------------------- 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES The accompanying unaudited consolidated financial statements of Eagle Supply Group, Inc. and its subsidiaries and limited partnership (the "Company") have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in a manner consistent with that used in the preparation of the annual consolidated financial statements of the Company at June 30, 2003. In the opinion of management, the accompanying unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position and results of operations and cash flows for the periods presented. Operating results for the three months ended September 30, 2003 and 2002 are not necessarily indicative of the results that may be expected for a full year. In addition, the unaudited consolidated financial statements do not include all information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes thereto which are included in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2003 filed with the Securities and Exchange Commission. Business Description - The Company is a majority-owned ---------------------- subsidiary of TDA Industries, Inc. ("TDA") and was organized on May 1, 1996, as a Delaware corporation, to acquire, integrate and operate seasoned, privately-held companies which distribute products to or manufacture products for the building supplies/construction industry. Basis of Presentation - The Company operates in a single ----------------------- industry segment and all of its revenues are derived from sales to third party customers in the United States. Basic Net Income (Loss) Per Share - Basic net income (loss) per share was calculated by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the periods presented and excludes any potential dilution. Diluted net income (loss) per share was calculated similarly and includes potential dilution, unless anti- dilutive, from the exercise of common stock warrants. Comprehensive Income (Loss) - For the three months ended ----------------------------- September 30, 2003 and 2002, comprehensive income (loss) was equal to net income (loss). Shipping and Handling Fees and Costs - The Company includes -------------------------------------- shipping and handling charges billed to customers in revenues. The related costs associated with shipping and handling are included as a component of cost of sales. Advertising Costs - The Company expenses advertising costs as ----------------- incurred. The Company's advertising expenses are net of the portion of advertising costs shared with manufacturers. -8- Revenue Recognition - The Company recognizes revenues when -------------------- the earnings process is complete, title is transferred to the customer, and when collectability of the fixed sales price is reasonably assured. Title transfers to the customer upon delivery to the customer's job site or upon pick up by the customer at a Company distribution center. Stock-based Compensation - The Company applies Accounting ------------------------- Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its Stock Option Plan. Accordingly, no compensation expense has been recognized for the Company's Stock Option Plan, since the exercise price of the Company's stock option grants was the fair market value of the underlying stock on the dates of the grants. Had compensation costs for the Company's Stock Option Plan been determined based on the fair value at the grant dates consistent with the method of SFAS No. 123, Accounting for Stock-Based Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation -Transition and Disclosure, the Company's net income (loss) and basic and diluted net income (loss) per share for the three-month periods ended September 30, 2003 and 2002 would have been reduced to the proforma amounts indicated below:

The Company used the Black-Scholes model with the following assumptions in the calculation of fair value: risk-free interest rate of 5.5%, expected life of three years, expected volatility of 19.72% and a dividend yield of 0%. Reclassifications and Restatements - Certain reclassifications ----------------------------------- have been made in the prior period's financial statements in order to conform to the classifications in the current period. As reported in the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 2002, in January 2003, the Company sold its Birmingham, Alabama, distribution center and realized a loss of approximately $90,000 on the sale. The reported results of operations for the 2002 three-month period have been restated to reclassify the operations of this distribution center as discontinued. The consolidated statements of operations and cash flows of the Company for the three-month period ended September 30, 2002 have been restated for the change during the second quarter of fiscal 2003 in the adoption of Emerging Issues Task Force ("EITF") No. 02-16, effective July 1, 2002. In adopting the new guidance, the Company changed its previous method of accounting, which was consistent with generally -9- accepted accounting principles. Under the previous accounting method, vendor allowances were treated as a reduction of cost of sales when such allowances were earned. Under the new accounting guidance, vendor allowances are considered a reduction in inventory and a subsequent reduction in cost of goods sold when the related product is sold. The adoption of EITF 02-16, effective July 1, 2002, resulted, during the three-month period ended September 30, 2002, in a cumulative effect of accounting change of $413,000, net of $222,000 of income taxes, to reflect the deferral of certain allowances as a reduction of inventory cost. 2. ACCOUNTS AND NOTES RECEIVABLE - TRADE Accounts and notes receivable - trade are as follows:

During the fiscal year ended June 30, 2003, the Company reclassified approximately $2.8 million, net of allowance for doubtful accounts and notes receivable, from current accounts and notes receivable to long-term notes receivable. Management met with the Company's largest customers which were unable to make sufficient payments on their accounts when due or within a reasonable period of time after they became due to negotiate a formal payment schedule on terms that would enable the Company to begin collecting on past due accounts and notes receivable in amounts reasonably satisfactory to the Company. As a result, the Company accepted notes from these customers, with personal guarantees and additional collateral wherever possible. These notes bear interest at rates ranging from 6% to 18% with repayment periods ranging between 3 months and slightly less than 10 years as of September 30, 2003. Those notes receivable with maturity dates longer than 12 months were reclassified to long-term notes receivable. Given the uncertainty associated with these notes receivable, the Company is recognizing interest income on these notes on a cash basis. 3. NEW ACCOUNTING STANDARDS In January 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46, Consolidation of Variable Interest Entities - an Interpretation of ARB No. 51 ("FIN 46"). FIN 46 addresses consolidation by business enterprises of variable interest entities (formerly special purpose entities or SPEs). In general, a variable interest entity is a corporation, partnership, trust or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. The objective of FIN 46 is not to restrict the use of variable interest entities but to improve financial reporting by -10- companies involved with variable interest entities. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns or both. The consolidation requirements of FIN 46 apply to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. However, certain of the disclosure requirements apply to financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The Company does not have any variable interest entities as defined in FIN 46. Accordingly, this pronouncement currently is not applicable to the Company. In March 2003, the EITF issued final transition guidance regarding accounting for vendor allowances EITF No. 02-16. The EITF decision to allow retroactive application was made by the task force on March 20, 2003. As a result of the EITF change to its transition, the Company has adopted the new guidance on a retroactive basis to July 1, 2002, the beginning of its fiscal year ended June 30, 2003. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. The Company has not used derivative instruments and does not expect the adoption of this statement to have a material effect on the Company. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). It is effective at the beginning of the first interim period beginning after June 15, 2003. The effect of implementing this pronouncement did not have any impact on the Company's financial condition, results of operations or cash flows. 4. LONG-TERM DEBT In June 2000, and as subsequently amended, with the last amendment dated as of May 12, 2003, the Company's credit facilities were consolidated into an amended, restated and consolidated loan agreement with the Company's subsidiaries and limited partnership as borrowers. The loan agreement provides a credit facility of $44,975,000, including up to $8 million in borrowing available for acquisitions (subject to an adequate borrowing base and other conditions). The credit facility bears interest as follows (with the alternatives at the borrowers' election): * Equipment Term Note - Libor (as defined), plus two and one- half (2.5%) percent or the lender's Prime Rate (as defined), plus one-half of one (1/2%) percent. * Acquisition Term Note - Libor, plus two and three-fourths (2.75%) percent or the lender's Prime Rate, plus three-fourths of one (3/4%) percent. -11- * Revolving Credit Loans - Libor, plus two (2%) percent or the lender's Prime Rate. The credit facility is collateralized by substantially all of the tangible and intangible assets of the borrowers, is guaranteed by the Company and originally was to mature on October 21, 2003. The credit facility contains an evergreen provision which provides for an automatic one-year extension of the maturity date provided either the borrowers or the lender does not notify the other in writing of its intention not to renew within 180 days of the scheduled maturity date. Since neither the borrowers nor the lender provided the other with the required notice, the maturity date of the credit facility has been extended to October 21, 2004. The credit facility contained two specific financial covenants in addition to standard affirmative and negative covenants. The specific financial covenants required that the borrowers (a) maintain minimum Adjusted Tangible Net Worth, as defined, of not less than an amount equal to 80% of the actual Net Worth, as defined, as shown on the June 30, 1999 balance sheets of the borrowers; and (b) achieve Cash Flow, as defined, of not less than $300,000 for the trailing 12-month periods ending as of each calendar quarter. The borrowers were in compliance with the Minimum Adjusted Tangible Net Worth covenant but did not meet the Cash Flow requirement as of March 31, 2003. By an amendment to the loan agreement dated as of May 12, 2003, the borrowers received a waiver, and certain terms of the loan agreement were modified. The Cash Flow financial covenant was eliminated in its entirety and replaced with a Fixed Charge Coverage Ratio, as defined; the Applicable Inventory Sublimit, as defined, was increased to $22.5 million from $20 million through July 31, 2003; the amount of aggregate Rentals, as defined, for property and equipment under operating leases during any current or future consecutive twelve-month period was increased to $7 million from $6 million; and certain definitions were changed. The Company was in compliance with all such covenants at September 30, 2003. During the fiscal year ending June 30, 2004, management intends to attempt to refinance and extend the maturity date of the Company's existing asset based credit facility with the objective of increasing the size of the credit facility and extending the maturity date three to five years from the October 21, 2004 current maturity date. ***** -12- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ------------------------------------------------ This document contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934, and the Private Securities Litigation Reform Act of 1995, such as statements relating to our financial condition, results of operations, plans, objectives, future performance and business operations. These statements relate to expectations concerning matters that are not historical fact. Accordingly, statements that are based on management's projections, estimates, assumptions and judgments are forward- looking statements. These forward-looking statements are typically identified by words or phrases such as "believe," "expect," "anticipate," "plan," "estimate," "approximately," "intend," and other similar words and expressions, or future or conditional verbs such as "will," "should," "would," "could," and "may." In addition, the Company may from time to time make such written or oral forward-looking statements in future filings with the Securities and Exchange Commission (including exhibits thereto), in its reports to stockholders, and in other communications made by or with the approval of the Company. These forward-looking statements are based largely on our current expectations, assumptions, plans, estimates, judgments and projections about our business and our industry, and they involve inherent risks and uncertainties. Although we believe that these forward-looking statements are based upon reasonable estimates, judgments and assumptions, we can give no assurance that our expectations will in fact occur or that our estimates, judgments or assumptions will be correct, and we caution that actual results may differ materially and adversely from those in the forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties, contingencies and other factors that could cause our or our industry's actual results, level of activity, performance or achievement to differ materially from those discussed in or implied by any forward-looking statements made by or on behalf of us and could cause our financial condition, results of operations or cash flows to be materially adversely affected. Accordingly, investors and all others are cautioned not to place undue reliance on such forward-looking statements. Potential risks, uncertainties, and other factors which could cause the Company's financial performance or results of operations to differ materially from current expectations or such forward-looking statements include, but are not limited to: * general economic and market conditions, either nationally or in the markets where we conduct our business, may be less favorable than expected; * we may be unable to find adequate and suitable equity or debt financing when our current loan facilities mature or when otherwise needed on terms as favorable to us as our current financing or on terms that are commercially reasonable to us; * our costs of capital including interest rates and related fees and expenses may increase; * we may be unable to collect our accounts or notes receivables when due, within a reasonable period of time after they become due and payable, or at all; -13- * there may be significant increases in competitive pressures in our major market areas; * weather conditions in our market areas may adversely affect our business; * there may be interruptions or cancellations of sources of supply of products that we distribute, significant increases in the costs of such products, or changes in the terms of purchase that may be less favorable to us; * there may be changes in the cost or pricing of, or consumer demand for, our or our industry's distributed products that may adversely affect our ability to sell our products at certain levels of markup (gross profit margin); * there may be changes in the new housing market or the market for construction, renovation and repair relating to the product lines that we sell in various market areas that may adversely affect our business; * we may be adversely affected by changes in our costs of doing business including costs of fuel, labor and related benefits, occupancy, and the cost and availability of insurance; * we may be unable to locate suitable facilities or personnel to open or maintain distribution center locations; * we may be unable to identify suitable acquisition candidates or, if identified, unable to consummate any such acquisitions and, if consummated, unable to obtain favorable results of operations from such acquisitions; * the number of shares of common stock that the Company has outstanding and the number of shares of common stock used to calculate our basic and diluted earnings per share may increase and adversely affect our earnings per share calculations; and * there may be changes in accounting policies and practice and in internal controls and requirements and disclosure controls and procedures and requirements that may be adopted by regulatory agencies as well as the Financial Accounting Standards Board that may adversely affect our costs and operations. Many of these factors are beyond our control, and you should read carefully the factors described in "Risk Factors" in the Company's filings (including its Forms 10-K and registration statements) with the Securities and Exchange Commission for a description of some, but not all, risks, uncertainties and contingencies. These forward-looking statements speak only as of the date of this document. We do not undertake any obligation to update or revise any of these forward-looking statements to reflect events or circumstances occurring after the date of this document or to reflect the occurrence of unanticipated events. -14- Critical Accounting Policies and Estimates The Company's discussion and analysis of financial condition and results of operations are based on the Company's consolidated financial statements which have been prepared in accordance with accounting principals generally accepted in the United States of America and which require the Company to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure and reported amounts of contingent assets and liabilities at the dates of the financial statements. Significant estimates which are reflected in these consolidated financial statements relate to, among other things, allowances for doubtful accounts and notes receivable, valuation of obsolete and slow-moving inventories, net realizable value of inventories, estimates of future cash flows associated with assets, asset impairments, and useful lives for depreciation and amortization. On an on-going basis, the Company evaluates its estimates, assumptions and judgments, including those related to allowances for doubtful accounts and notes receivable, inventories, intangible assets, investments, other receivables, expenses, income items, income taxes and contingencies. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets, liabilities, certain receivables, allowances, income items, expenses, and contingent assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, and there can be no assurance that estimates, assumptions and judgments that are made will prove to be valid in light of future conditions and developments. If such estimates, assumptions or judgments prove to be incorrect in the future, the Company's financial condition, results of operations and cash flows could be materially adversely affected. The Company believes the following critical accounting policies are based upon its more significant judgments and estimates used in the preparation of its consolidated financial statements: * We maintain allowances for doubtful accounts and notes receivable for estimated losses resulting from the failure of our customers to make payments when due or within a reasonable period of time thereafter. Although many factors can affect the failure of customers to make required payments when due, one of the most unpredictable is weather, which can have a positive as well as negative impact on the Company's customers. For example, severe or catastrophic weather conditions, such as hail storms or hurricanes, will generally increase the level of activity of our customers, thus enhancing their ability to make required payments. On the other hand, weather conditions such as heavy rain or snow or ice storms will generally preclude customers from installing the Company's products on job sites and collecting from their own customers, which conditions could result in the inability of the Company's customers to make payments when due. The allowance for doubtful accounts and notes receivable is intended to adjust the value of our accounts and notes receivable for possible credit losses as of the balance sheet date in accordance with generally accepted accounting principles. Calculating such allowances involves significant judgment. We estimate our allowance for doubtful accounts and notes receivable by applying estimated loss percentages against our aging -15- of accounts receivables and based on our estimate of the credit worthiness of the customers from which the notes are payable. Changes to such allowances may be required if the financial condition of our customers deteriorates or improves or if we adjust our credit standards, thereby resulting in reserve or write-off patterns that differ from historical experience. Misjudgments by the Company in estimating our allowance for doubtful accounts and notes receivable could have a material adverse affect on the Company's financial condition, results of operations, and cash flow. * We write down our inventories for estimated obsolete or slow-moving inventories equal to the difference between the cost of inventories and their estimated market value based upon assumed market conditions. If actual market conditions are less favorable than those assumed by management, additional inventory write-downs may be required. If inventory write-downs are required, the Company's financial condition, results of operations, and cash flows could be materially adversely affected. * We test for impairment of the carrying value of goodwill annually and when indicators of impairment occur. Indicators of impairment could include, among other things, a significant change in the business climate, including a significant sustained decline in an entity's market value, operating performance indicators, competition, sale or disposition of a significant portion of the business, legal or other factors. In connection with the annual test for impairment, management reviews various generally accepted valuation methodologies for valuing goodwill. Management reviewed the carrying value of the goodwill on its balance sheet as of June 30, 2003 in light of the fact that the Company's stock market capitalization of our outstanding equity securities as of that date was below our total shareholders' equity (book value). Management concluded that the market price of the Company's common stock is not the best indication of the fair market value of the Company. Management believes that, with respect to the Company, the better indicator of fair market value results from the use of the discounted estimated future cash flow method, which includes an estimated terminal value component. This method is based on management's estimates, which will vary if the judgments and assumptions used to estimate the related business's future revenues, gross profit margins, operating expenses, interest rates, and other factors, prove to be inaccurate. If such judgments, assumptions and estimates prove to be incorrect, then the Company's carrying value of goodwill may be overstated on the Company's balance sheet, and the Company's results of operations may not reflect the impairment charge that would have resulted if such judgments, assumptions and estimates had been correct. Any failure to write down goodwill for impairment correctly during any period could have a material adverse effect on the Company's future financial condition and results of operations, as well as cause historical statements of operations, financial condition, and cash flows to have been incorrectly stated in light of the failure to take any such write downs correctly. -16- In conducting the required goodwill impairment test, we identified reporting units by determining the level at which separate financial statements are prepared and reviewed by management. The test was required by only one of our operating subsidiaries. As a result of the required test, we determined that no write down of our goodwill was required at June 30, 2003. While we do not use our stock market capitalization to determine the fair value of our reporting unit, we expect convergence between our stock market value capitalization and our discounted cash flow valuation to occur over time or from time to time. If this does not occur, it may signal the need for impairment charges. * We seek revenue and income growth by expanding our existing customer base, by opening new distribution centers, and by pursuing strategic acquisitions that meet our various criteria. If our evaluation of the prospects for opening a new distribution center or of acquiring a company misjudges our estimated future revenues or profitability, such a misjudgment could impair the carrying value of the investment and result in operating losses for the Company, which could materially adversely affect our results of operations, financial condition, and cash flows. * We file income tax returns in every jurisdiction in which we have reason to believe we are subject to tax. Historically, we have been subject to examination by various taxing jurisdictions. To date, none of these examinations has resulted in any material additional tax. Nonetheless, any tax jurisdiction may contend that a filing position claimed by us regarding one or more of our transactions is contrary to that jurisdiction's laws or regulations. In any such event, we may incur charges to our income statement which could materially adversely affect our net income and may incur liabilities for taxes and related charges which may materially adversely affect our financial condition and cash flows. The Company's discussion and analysis of financial condition and results of operations are based upon the Company's unaudited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. ***** -17- The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes thereto which are included in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2003 filed with the Securities and Exchange Commission. Results of Operations Three Months Ended September 30, 2003 Compared to the Three Months Ended September 30, 2002 ----------------------------------------------------- Revenues of the Company during the three-month period ended September 30, 2003 increased by approximately $12 million (19.9%) to approximately $72.4 million from approximately $60.4 million in the three-month period ended September 30, 2002. This increase may be attributed primarily to increases in revenues of approximately $12.8 million generated from "greenfield" distribution centers opened for more than one year and approximately $1.7 million from "storm" distribution centers opened during the current three-month period, offset by a decrease in revenues of approximately $2.5 million from a combination of distribution centers that were closed and those that have been opened for more than one year. As discussed in previous filings, all of the increase in revenues from greenfield distribution centers was from storm activity that occurred last spring in certain of the Company's existing market areas. The Company continues to believe that such storm activity will continue to have a positive impact on the Company's results of operations in the 2004 fiscal year. Cost of sales increased between the 2003 and 2002 three-month periods at a lesser rate than the increase in revenues between these three-month periods. Accordingly, cost of sales as a percentage of revenues decreased to 75.4% in the three-month period ended September 30, 2003 from 76.3% in the three-month period ended September 30, 2002, and gross profit as a percentage of revenues increased to 24.6% in the three- month period ended September 30, 2003 from 23.7% in the three- month period ended September 30, 2002. As stated in Note 3 to the unaudited consolidated financial statements, the Company adopted EITF 02-16, effective July 1, 2002. The impact of the accounting change resulting from the adoption of EITF 02-16 during the three-month period ended September 30, 2002 was a decrease of $115,000 in cost of sales. Operating expenses (including non-cash charges for depreciation and amortization) increased by approximately $1.1 million (7.9%) between the 2003 and 2002 three-month periods presented. Of this increase, approximately $445,000 may be attributed to an increase in the allowance for doubtful accounts and notes receivable and approximately $740,000 in increased payroll and related costs. Depreciation and amortization decreased by an aggregate of approximately $110,000 (32.4%) between the 2003 and 2002 three-month periods. Operating expenses (including depreciation and amortization) as a percentage of revenues were 20.8% in the three-month period ended September 30, 2003 compared to 23.1% in the three-month period ended September 30, 2002. Interest income increased by approximately $104,000 (207.3%) between the 2003 and 2002 three-month periods presented. This increase is primarily attributable to the interest collected on notes receivable. -18- Interest expense decreased by approximately $116,000 (23%) between the 2003 and 2002 three-month periods presented. This decrease is due to lower rates of interest charged on borrowings under the Company's revolving credit facility. As reported in the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 2002, in January 2003, the Company sold its Birmingham, Alabama, distribution center and realized a loss of approximately $90,000 on the sale. The reported results of operations for the 2002 three-month period have been restated to reclassify the operations of this distribution center as discontinued. Liquidity and Capital Resources The Company's working capital was approximately $46,351,000 and $45,342,000 at September 30, 2003 and June 30, 2003, respectively. At September 30, 2003, the Company's current ratio was 2.3 to 1 compared to 2.13 to 1 at June 30, 2003. Net cash used in operating activities during the three-month period ended September 30, 2003 decreased by approximately $525,000 to approximately $100,000 from approximately $625,000 during the three-month period ended September 30, 2002. This decrease may be attributed principally to increases in net income of approximately $2.2 million, allowance for doubtful accounts of approximately $620,000 attributed to the deterioration in the aging of the Company's accounts and notes receivable and federal and state income taxes of approximately $1.3 million and decreases in inventories of $1.2 million, assets of discontinued operation of approximately $670,000 and accrued expenses and other current liabilities of approximately $410,000, offset by a decrease in depreciation and amortization of approximately $120,000 and increases in accounts and notes receivable of approximately $1.9 million and other current assets of approximately $200,000 and decreases in accounts payable of approximately $3.6 million and deferred income taxes of approximately $60,000. Net cash provided by (used in) investing activities during the three-month period ended September 30, 2003 increased by approximately $108,000 to approximately $11,000 from approximately ($97,000) during the three-month period ended September 30, 2002. This increase may be attributed to a decrease in capital expenditures of approximately $72,000 and an increase of approximately $36,000 from sales of fixed assets. Management of the Company presently anticipates capital expenditures in the next twelve months of not less than $400,000, of which approximately $100,000 is anticipated to be financed, for the purchase of trucks and forklifts for the Company's currently existing operations in anticipation of increased business and to upgrade its vehicles and upgrade and maintain its facilities to compete in its market areas, and $300,000 for leasehold improvements. Net cash used in financing activities during the three-month period ended September 30, 2003 decreased by approximately $100,000 to approximately $1 million from approximately $1.1 million during the three-month period ended September 30, 2002. This decrease may be attributed to a decrease in the net principal repayments of long-term debt of approximately $50,000 and a recovery of expenses of $50,000 relating to the May 2002 private placement of common stock and warrants. On February 6, 2003, the Company entered into a Securities Purchase Agreement ("Securities Purchase Agreement") with James E. Helzer, the President, Chief Operating Officer, and Vice Chairman of the Board of Directors of the Company, to sell in a private placement transaction (the "Helzer Transaction") for gross proceeds to the Company of $1 million -19- (a) 1,000,000 authorized but previously unissued shares of the Company's common stock, and (b) warrants to purchase up to an additional 1,000,000 authorized but previously unissued shares of the Company's common stock at an exercise price of $1.50 per share exercisable for 5 years from the date of issuance (the "Helzer Warrant"). Although the closing price for the Company's common stock at the close of business on the day before the Helzer Transaction closed was $0.81 and the Company received two separate fairness opinions indicating that the consideration received by the Company in the Helzer Transaction was fair, Mr. Helzer will be able to benefit from any appreciation in the market price of the Company's common stock. On September 30, 2003, the last reported sales price for the Company's common stock was $2.40 per share. During the fiscal year ending June 30, 2004, management intends to attempt to refinance and extend the maturity date of the Company's existing asset based credit facility with the objective of increasing the size of the credit facility and extending the maturity date three to five years from the October 21, 2004 current maturity date. There can be no assurance that the Company will be able refinance or extend the maturity of its credit facility or that it will be able to do so on terms that are satisfactory to the Company. The Company believes that its currently available sources of liquidity will be adequate to sustain its normal operations during the twelve-month period beginning July 1, 2003, assuming the Company is able to amend its credit facility to provide for limited over advances and overlines, if required, as it has in the past. Credit Facilities In June 2000, and as subsequently amended, with the last amendment dated as of May 12, 2003, the Company's credit facilities were consolidated into an amended, restated and consolidated loan agreement with the Company's subsidiaries and limited partnership as borrowers. The loan agreement provides a credit facility of $44,975,000, including up to $8 million in borrowing available for acquisitions (subject to an adequate borrowing base and other conditions). The credit facility bears interest as follows (with the alternatives at the borrowers' election): * Equipment Term Note - Libor (as defined), plus two and one-half (2.5%) percent or the lender's Prime Rate (as defined), plus one-half of one (1/2%) percent. * Acquisition Term Note - Libor, plus two and three- fourths (2.75%) percent or the lender's Prime Rate, plus three-fourths of one (3/4%) percent. * Revolving Credit Loans - Libor, plus two (2%) percent or the lender's Prime Rate. The credit facility is collateralized by substantially all of the tangible and intangible assets of the borrowers, is guaranteed by the Company and originally was to mature on October 21, 2003. The credit facility contains an evergreen provision which provides for an automatic one-year extension of the maturity date provided either the borrowers or the lender does not notify the other in writing of its intention not to renew within 180 days of the scheduled maturity date. Since neither the borrowers nor the lender provided the other -20- with the required notice, the maturity date of the credit facility has been extended to October 21, 2004. During the fiscal year ending June 30, 2004, management intends to attempt to refinance and extend the maturity date of the Company's existing asset based credit facility with the objective of increasing the size of the credit facility and extending the maturity date three to five years from the October 21, 2004 current maturity date. There can be no assurance that the Company will be able refinance or extend the maturity of its credit facility or that it will be able to do so on terms that are satisfactory to the Company. The credit facility originally contained two specific financial covenants in addition to standard affirmative and negative covenants. The specific financial covenants required that the borrowers (a) maintain minimum Adjusted Tangible Net Worth, as defined, of not less than an amount equal to 80% of the actual Net Worth, as defined, as shown on the June 30, 1999 balance sheets of the borrowers; and (b) achieve Cash Flow, as defined, of not less than $300,000 for the trailing 12-month periods ending as of each calendar quarter. The borrowers were in compliance with the Minimum Adjusted Tangible Net Worth covenant but did not meet the Cash Flow requirement as of March 31, 2003. By an amendment to the loan agreement dated as of May 12, 2003, the borrowers received a waiver, and certain terms of the loan agreement were modified. The Cash Flow financial covenant was eliminated in its entirety and replaced with a Fixed Charge Coverage Ratio, as defined; the Applicable Inventory Sublimit, as defined, was increased to $22.5 million from $20 million through July 31, 2003; the amount of aggregate Rentals, as defined, for property and equipment under operating leases during any current or future consecutive twelve-month period was increased to $7 million from $6 million; and certain definitions were changed. The Company was in compliance with all such covenants at September 30, 2003. Recent Developments Revenues for the month of October 2003, on a preliminary basis, increased by more than $5 million (25%) compared to the month of October 2002. This rate of growth should not be deemed to be indicative of the rate of growth that is likely to be achieved during the Company's current six-month or ensuing nine-month periods or fiscal year. Management believes that the current growth is due largely to increased revenues generated by the Company's distribution centers located in certain of the Company's existing market areas affected by storm activity that occurred last spring New Accounting Pronouncements In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities - an Interpretation of ARB No. 51 ("FIN 46"). FIN 46 addresses consolidation by business enterprises of variable interest entities (formerly special purpose entities or SPEs). In general, a variable interest entity is a corporation, partnership, trust or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. The objective of FIN 46 is not to restrict the use of variable interest entities but to improve financial reporting by companies involved with variable interest entities. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns or both. The -21- consolidation requirements of FIN 46 apply to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. However, certain of the disclosure requirements apply to financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The Company does not have any variable interest entities as defined in FIN 46. Accordingly, this pronouncement currently is not applicable to the Company. In March 2003, the EITF issued final transition guidance regarding accounting for vendor allowances EITF No. 02-16. The EITF decision to allow retroactive application was made by the task force on March 20, 2003. As a result of the EITF change to its transition, the Company has adopted the new guidance on a retroactive basis to July 1, 2002, the beginning of its fiscal year ended June 30, 2003. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. The Company has not used derivative instruments and does not expect the adoption of this statement to have a material effect on the Company. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). It is effective at the beginning of the first interim period beginning after June 15, 2003. The effect of implementing this pronouncement did not have any impact on the Company's financial condition, results of operations or cash flows. Item 3. Quantitative and Qualitative Disclosures about Market Risk The Company's carrying value of cash and cash equivalents, trade accounts and notes receivable, inventories, deferred tax asset, income taxes receivable, goodwill, accounts payable, accrued expenses, deferred tax liability and its existing line of credit facility are a reasonable approximation of their fair value. The Company has not entered into, and does not expect to enter into, financial instruments for trading or hedging purposes. The Company is currently exposed to material future earnings or cash flow fluctuations from changes in interest rates on long-term debt obligations since the majority of the Company's long-term debt obligations are at variable rates. Based on the amount outstanding as of September 30, 2003, a 100 basis point change in interest rates would result in an approximate $410,000 charge to the Company's annual interest expense. The Company does not currently anticipate entering into interest rate swaps and/or other similar instruments. -22- The Company's business is subject to certain risks, including, but not limited to, differing economic conditions, competition, loss of significant customers, customers' inability to make required payments, changes in political climate, differing tax structures, changes in accounting rules and requirements, and other governmental regulations and restrictions. The Company's future results could be materially and adversely impacted by changes in these or other factors. (See also "Risk Factors" in the Company's filings with the Securities and Exchange Commission (including its Forms 10-K and registration statements) for a description of some, but not all, risks, uncertainties and contingencies.) There have been no material changes in the Company's market risk since June 30, 2003. For information regarding the Company's market risk, please refer to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2003. Item 4. Controls and Procedures In seeking to meet our responsibility for the reliability of our financial statements, the Company maintains a system of internal controls. This system is designed to provide management with reasonable assurance that assets are safeguarded and transactions are executed in accordance with the appropriate corporate authorization and recorded properly to permit the preparation of the financial statements in accordance with accounting principles generally accepted in the United States of America. The concept of reasonable assurance recognizes that the design, monitoring and revision of internal accounting and other controls involve, among other considerations, management's judgments with respect to the relative costs and expected benefits of specific control measures. An effective system of internal controls, no matter how well designed, has inherent limitations and may not prevent or detect a material misstatement in published financial statements. Nevertheless, management believes that its system of internal controls provides reasonable assurance with respect to the reliability of its consolidated financial statements. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as of the end of the period covered by this Form 10-Q. The Company's management, including its Chief Executive Officer and Chief Financial Officer, does not expect that its disclosure controls and procedures will prevent all error and all fraud. A disclosure control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the disclosure control system's objectives will be met. Further, the design of a disclosure control system must reflect the fact that there are resource constraints, and the benefits of disclosure controls must be considered relative to their costs. Because of the inherent limitations in all disclosure control systems, no evaluation of controls can provide absolute assurance that all disclosure control issues, errors, and instances of fraud, if any, within the Company have been or will be detected. The inherent limitations include, among other things, the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Disclosure controls and procedures also can be circumvented by the individual acts of some persons, by collision of two or more people, or by management or employee override of disclosure controls and procedures. The design of any system -23- of disclosure controls and procedures is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, disclosure controls and procedures may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost- effective disclosure control system, misstatements due to error or fraud may occur and not be detected. If and when management learns that any disclosure control or procedure is not being properly implemented or has become inadequate, management (a) immediately reviews our disclosure controls and procedures to determine whether they are appropriate to accomplish the control objective and, if necessary, modifies and improves our disclosure controls and procedures to assure compliance with our control objectives(b) takes immediate action to cause our disclosure controls and procedures to be strictly adhered to, (c) immediately informs all relevant managers of the requirement to adhere to such disclosure controls, as well as all relevant personnel throughout our organization, and (d) implements in our training program specific emphasis on such disclosure controls and procedures to assure compliance with such disclosure controls and procedures. The development, modification, improvement, implementation and evaluation of our systems of disclosure controls and procedures is a continuous project that requires changes and modifications to them to remedy deficiencies, to improve training, and to improve implementation in order to assure the achievement of our overall control objectives. Based upon the evaluation of our disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer have concluded that, subject to the limitations noted above, the Company's disclosure controls and procedures were effective to ensure that material information relating to the Company and the Company's consolidated subsidiaries is made known to them by others within those entities to allow timely decisions regarding required disclosures. There have been no significant changes in our internal controls, or in other factors that could significantly affect internal controls, subsequent to the date the Chief Executive Officer and the Chief Financial Officer completed their evaluation, including any significant corrective actions with regard to significant deficiencies and material weaknesses. ***** -24- PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) The following exhibits are being filed with this Report: Exhibit Description ------- ----------- 31.1 Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rule 13a-14(a)). 31.2 Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rule 13a-14(a)). 32.1 Certificate of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Rule 13a-14(b)). 32.2 Certificate of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Rule 13a-14(b)). (b) Reports on Form 8-K: During the quarterly period covered by this Report, the Registrant filed the following Report on Form 8-K: On August 11, 2003, the Company filed a Current Report on Form 8-K under Item 9 to provide information regarding the Company's preliminary unaudited fiscal 2003 fourth quarter results and anticipated projected revenues, net income, and basic earnings per share for the 2004 fiscal year ending June 30, 2004. -25- SIGNATURES In accordance with 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. EAGLE SUPPLY GROUP, INC. Dated: November 13, 2003 By:/s/ Douglas P. Fields --------------------------- Douglas P. Fields, Chairman of the Board of Directors, Chief Executive Officer and a Director (Principal Executive Officer) Dated: November 13, 2003 By:/s/ Frederick M. Friedman --------------------------- Frederick M. Friedman, Executive Vice President, Treasurer, Secretary and a Director (Principal Financial and Accounting Officer) -26-

EAGLE SUPPLY GROUP INC 10-Q