**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 
| **(Mark One)**                                                                                                                                                                         |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                   |   |   |
| **ý**                                                                                                                                                                             | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|                                                                                                                                                                                   |   |   |
| **For the  quarterly period ended July 2, 2005**                                                                                                                                  |
|                                                                                                                                                                                   |   |   |
| **OR**                                                                                                                                                                                 |
|                                                                                                                                                                                   |   |   |
| **o**                                                                                                                                                                                  | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
| ** **                                                                                                                                                                             | ** ** | ** ** |
| **For the  transition period  from            to            ** |

 

**CommissionFile number 1-3834**

 

**CONTINENTAL MATERIALS CORPORATION**

(Exact name of registrant asspecified in its charter)

 
| **Delaware**                                                     | ** ** | **36-2274391**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or  other jurisdiction of  incorporation or organization) |       | (I.R.S.  Employer Identification No.) |

 

**200 SouthWacker Drive, Suite 4000, Chicago, Illinois  60606**

(Address of principal executiveoffices)

(Zip Code)

 

**(312) 541-7200**

(Registrant’s telephone number, including area code)

 

 

(Former name, former addressand former fiscal

year, if changed since lastreport)

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the Registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 

Yes  ý   No  o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).

 

Yes  o   No  ý

 
| Number of common shares outstanding at  August 8, 2005   1,544,084 |
|----------------------------------------------------------------------------------------|

 

 

----

 

PART I – FINANCIALINFORMATION

 

**Item 1.  Financial Statements**

 

CONTINENTAL MATERIALSCORPORATION

CONDENSED CONSOLIDATED BALANCESHEETS

JULY 2, 2005 and JANUARY 1,2005

(000’s omitted except sharedata)

 
| ** **                                                                            | ** ** | **JULY 2, 2005** | ** ** | **JANUARY 1,  2005** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------|------------|---------------------------|------------|
| ** **                                                                            | ** ** | **(Unaudited)**       | ** ** | ** **                | ** ** |
| ***ASSETS***                                                                          | ** ** | ** **            | ** ** | ** **                | ** ** |
| Current assets:                                                                       |       |                  |       |                      |       |
| Cash and cash equivalents                                                             |       | $                     | 34         |                      | $          | 2,828 |   |
| Receivables, net                                                                      |       | 22,661                |       | 18,418                    |       |
| Receivable for insured losses                                                         |       | 1,552                 |       | 4,466                     |       |
| Inventories:                                                                          |       |                  |       |                      |       |
| Finished goods                                                                        |       | 7,923                 |       | 7,343                     |       |
| Work in process                                                                       |       | 1,616                 |       | 1,684                     |       |
| Raw materials and supplies                                                            |       | 9,166                 |       | 7,582                     |       |
| Prepaid expenses                                                                      |       | 3,493                 |       | 3,559                     |       |
| Total current assets                                                                  |       | 46,445                |       | 45,880                    |       |
|                                                                                  |       |                  |       |                      |       |
| Property, plant and equipment, net                                                    |       | 29,649                |       | 30,033                    |       |
|                                                                                  |       |                  |       |                      |       |
| Goodwill                                                                              |       | 7,374                 |       | 7,374                     |       |
| Non-compete agreements                                                                |       | 841                   |       | 953                       |       |
| Other assets                                                                          |       | 1,559                 |       | 1,643                     |       |
|                                                                                  |       |                  |       |                      |       |
|                                                                                  |       | $                     | 85,868     |                      | $          | 85,883 |   |
|                                                                                  |       |                  |       |                      |       |
| ***LIABILITIES***                                                                     |       |                  |       |                      |       |
| Current  liabilities:                                                                 |       |                  |       |                      |       |
| Bank loan payable                                                                     |       | $                     | 1,300      |                      | $          | — |   |
| Current portion of long-term debt                                                     |       | 2,000                 |       | 2,000                     |       |
| Accounts payable and accrued expenses                                                 |       | 15,057                |       | 14,239                    |       |
| Liability for unpaid claims covered by  insurance                                     |       | 1,552                 |       | 4,466                     |       |
| Income taxes                                                                          |       | 279                   |       | 767                       |       |
| Total current liabilities                                                             |       | 20,188                |       | 21,472                    |       |
|                                                                                  |       |                  |       |                      |       |
| Long-term debt                                                                        |       | 11,000                |       | 7,000                     |       |
| Deferred income taxes                                                                 |       | 3,796                 |       | 3,796                     |       |
| Other long-term liabilities                                                           |       | 2,439                 |       | 2,167                     |       |
|                                                                                  |       |                  |       |                      |       |
| ***SHAREHOLDERS’ EQUITY***                                                       |       |                  |       |                      |       |
| Common shares, $0.25 par value; authorized 3,000,000  shares; issued 2,574,264 shares |       | 643                   |       | 643                       |       |
| Capital in excess of par value                                                        |       | 1,982                 |       | 1,982                     |       |
| Retained earnings                                                                     |       | 63,230                |       | 62,573                    |       |
| Accumulated other comprehensive losses  (interest rate swap adjustments)              |       | (20                   | )          | (67                       | )          |
| Treasury shares, 1,030,180 and 923,850, at  cost                                      |       | (17,390               | )          | (13,683                   | )          |
|                                                                                  |       | 48,445                |       | 51,448                    |       |
|                                                                                  |       |                  |       |                      |       |
|                                                                                  |       | $                     | 85,868     |                      | $          | 85,883 |   |

 

See accompanying notes

 

2

----

 

CONTINENTAL MATERIALSCORPORATION

CONSOLIDATED STATEMENTS OFOPERATIONS AND RETAINED EARNINGS

FOR THE THREE MONTHS ENDED JULY 2,2005 AND JULY 3, 2004

(Unaudited)

(000’s omitted except per-shareamounts)

 
| ** **                                                              | ** ** | **JULY 2,  2005** | ** ** | **JULY 3,  2004** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
|                                                                    |       |                   |       |                   |       |
| Sales                                                                   |       | $                      | 38,273     |                   | $          | 34,577 |   |
|                                                                    |       |                   |       |                   |       |
| Costs and expenses:                                                     |       |                   |       |                   |       |
| Cost of sales (exclusive of depreciation, depletion  and amortization)  |       | 30,578                 |       | 27,688                 |       |
| Depreciation, depletion and amortization                                |       | 1,215                  |       | 1,251                  |       |
| Selling and administrative                                              |       | 5,226                  |       | 4,389                  |       |
|                                                                    |       |                   |       |                   |       |
| Gain (loss) on disposition of property and  equipment                   |       | 48                     |       | 217                    |       |
|                                                                    |       | 36,971                 |       | 33,111                 |       |
|                                                                    |       |                   |       |                   |       |
| Operating income                                                        |       | 1,302                  |       | 1,466                  |       |
|                                                                    |       |                   |       |                   |       |
| Interest                                                                |       | (159                   | )          | (155                   | )          |
| Other income, net                                                       |       | 24                     |       | —                 |       |
|                                                                    |       |                   |       |                   |       |
| Income before income taxes                                              |       | 1,167                  |       | 1,311                  |       |
|                                                                    |       |                   |       |                   |       |
| Provision for income taxes                                              |       | 222                    |       | 472                    |       |
|                                                                    |       |                   |       |                   |       |
| Net income                                                              |       | 945                    |       | 839                    |       |
|                                                                    |       |                   |       |                   |       |
| Retained earnings, beginning of period                                  |       | 62,285                 |       | 59,837                 |       |
| ** **                                                              | ** ** | ** **             | ** ** | ** **             | ** ** |
| Retained earnings, end of period                                        |       | $                      | 63,230     |                   | $          | 60,676 |   |
|                                                                    |       |                   |       |                   |       |
| Basic earnings per share                                                |       | $                      | .59        |                   | $          | .50 |   |
|                                                                    |       |                   |       |                   |       |
| Average shares outstanding                                              |       | 1,592                  |       | 1,695                  |       |
|                                                                    |       |                   |       |                   |       |
| Diluted earnings per share                                              |       | $                      | .58        |                   | $          | .48 |   |
|                                                                    |       |                   |       |                   |       |
| Average shares outstanding                                              |       | 1,633                  |       | 1,731                  |       |
|                                                                    |       |                   |       |                   |       |
| Comprehensive income:                                                   |       |                   |       |                   |       |
| Net income (loss)                                                       |       | $                      | 945        |                   | $          | 839 |   |
| Comprehensive income from interest rate  swap, net of tax of $2 and $65 |       | 4                      |       | 128                    |       |
|                                                                    |       | $                      | 949        |                   | $          | 967 |   |

 

See accompanying notes

 

3

----

 

CONTINENTAL MATERIALSCORPORATION

CONSOLIDATED STATEMENTS OFOPERATIONS AND RETAINED EARNINGS

FOR THE SIX MONTHS ENDED JULY 2,2005 AND JULY 3, 2004

(Unaudited)

(000’s omitted except per-shareamounts)

 
| ** **                                                               | ** ** | **JULY 2,  2005** | ** ** | **JULY 3,  2004** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
|                                                                     |       |                   |       |                   |       |
| Sales                                                                    |       | $                      | 68,030     |                   | $          | 61,824 |   |
|                                                                     |       |                   |       |                   |       |
| Costs and expenses:                                                      |       |                   |       |                   |       |
| Cost of sales (exclusive of depreciation, depletion  and amortization)   |       | 55,343                 |       | 49,859                 |       |
| Depreciation, depletion and amortization                                 |       | 2,431                  |       | 2,619                  |       |
| Selling and administrative                                               |       | 9,407                  |       | 8,513                  |       |
|                                                                     |       |                   |       |                   |       |
| Gain on disposition of property and  equipment                           |       | 115                    |       | 216                    |       |
|                                                                     |       | 67,066                 |       | 60,775                 |       |
|                                                                     |       |                   |       |                   |       |
| Operating income                                                         |       | 964                    |       | 1,049                  |       |
|                                                                     |       |                   |       |                   |       |
| Interest                                                                 |       | (290                   | )          | (311                   | )          |
| Other income, net                                                        |       | 70                     |       | 6                      |       |
|                                                                     |       |                   |       |                   |       |
| Income before income taxes                                               |       | 744                    |       | 744                    |       |
|                                                                     |       |                   |       |                   |       |
| Provision for income taxes                                               |       | 87                     |       | 268                    |       |
|                                                                     |       |                   |       |                   |       |
| Net income                                                               |       | 657                    |       | 476                    |       |
|                                                                     |       |                   |       |                   |       |
| Retained earnings, beginning of period                                   |       | 62,573                 |       | 60,200                 |       |
|                                                                     |       |                   |       |                   |       |
| Retained earnings, end of period                                         |       | $                      | 63,230     |                   | $          | 60,676 |   |
|                                                                     |       |                   |       |                   |       |
| Basic earnings per share                                                 |       | $                      | .41        |                   | $          | .28 |   |
|                                                                     |       |                   |       |                   |       |
| Average shares outstanding                                               |       | 1,620                  |       | 1,704                  |       |
|                                                                     |       |                   |       |                   |       |
| Diluted earnings per share                                               |       | $                      | .40        |                   | $          | .27 |   |
|                                                                     |       |                   |       |                   |       |
| Average shares outstanding                                               |       | 1,660                  |       | 1,740                  |       |
|                                                                     |       |                   |       |                   |       |
| Comprehensive income:                                                    | ** ** | ** **             | ** ** | ** **             | ** ** |
| Net income                                                               |       | $                      | 657        |                   | $          | 476 |   |
| Comprehensive income from interest rate  swap, net of tax of $28 and $50 |       | 47                     |       | 145                    |       |
|                                                                     |       | $                      | 704        |                   | $          | 621 |   |

 

See accompanying notes

 

4

----

 

CONTINENTAL MATERIALSCORPORATION

CONSOLIDATED STATEMENTS OF CASHFLOWS

FOR THE SIX MONTHS ENDED JULY 2,2005 AND JULY 3, 2004

(Unaudited)

(000’s omitted)

 
| ** **                                    | ** ** | **JULY 2,  2005** | ** ** | **JULY 3,  2004** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                    | ** ** | ** **             | ** ** | ** **             | ** ** |
| Net cash used in operating activities         |       | $                      | (2,568     | )                      | $          | (3,576 | ) |
|                                          |       |                   |       |                   |       |
| Investing activities:                         |       |                   |       |                   |       |
| Capital expenditures                          |       | (1,946                 | )          | (2,347                 | )          |
| Proceeds from sale of property and  equipment |       | 127                    |       | 320                    |       |
| Net cash used in investing activities         |       | (1,819                 | )          | (2,027                 | )          |
|                                          |       |                   |       |                   |       |
| Financing activities:                         |       |                   |       |                   |       |
| Borrowings under revolving credit facility    |       | 1,300                  |       | 3,400                  |       |
| Long-term borrowings                          |       | 5,000                  |       | —                 |       |
| Repayment of long-term debt                   |       | (1,000                 | )          | (970                   | )          |
| Payment to acquire treasury stock             |       | (3,707                 | )          | (1,436                 | )          |
| Net cash provided by financing activities     |       | 1,593                  |       | 994                    |       |
|                                          |       |                   |       |                   |       |
| Net decrease in cash and cash equivalents     |       | (2,794                 | )          | (4,609                 | )          |
| Cash and cash equivalents:                    |       |                   |       |                   |       |
| Beginning of period                           |       | 2,828                  |       | 4,609                  |       |
|                                          |       |                   |       |                   |       |
| End of period                                 |       | $                      | 34         |                   | $          | — |   |
|                                          |       |                   |       |                   |       |
| Supplemental disclosures of cash flow items:  |       |                   |       |                   |       |
| Cash paid during the six months for:          |       |                   |       |                   |       |
| Interest                                      |       | $                      | 406        |                   | $          | 271 |   |
| Income taxes                                  |       | 575                    |       | 494                    |       |

 

See accompanying notes

 

5

----

 

CONTINENTAL MATERIALSCORPORATION

SECURITIES AND EXCHANGECOMMISSION FORM 10-Q

NOTES TO THE QUARTERLYCONSOLIDATED FINANCIAL STATEMENTS

QUARTER ENDED JULY 2, 2005

(Unaudited)

 

1.               Theunaudited interim consolidated financial statements included herein areprepared pursuant to the rules and regulations for reporting on Form 10-Q.Accordingly, certain information and footnote disclosures normally accompanyingthe annual financial statements have been omitted. The interim financialstatements and notes should be read in conjunction with the consolidatedfinancial statements and notes thereto included in the Company’s latest annualreport on Form 10-K including any amendments thereto. In the opinion ofmanagement, the consolidated financial statements include all adjustments (noneof which were other than normal recurring adjustments) necessary for a fairstatement of the results for the interim periods.

 

2.               The2005 provision for income taxes is based upon the estimated effective tax rateof 29% for the year which includes the estimated impact of the American JobsCreation Act of 2004. The tax rate for the quarter ended July 2, 2005 was19% reflecting the effect of the release of certain tax contingencies duringthe second quarter related to the closure of ongoing income tax audits.

 

3.               Operatingresults for the first six months of 2005 are not necessarily indicative ofperformance for the entire year. Historically, sales of construction materialsare higher in the second and third quarters. Overall, sales of heating and airconditioning products have not shown strong seasonal fluctuations in recentyears although product mix has historically yielded higher gross profit marginsin the fourth quarter. (See Note 10 of Notes to Consolidated FinancialStatements in the Company’s 2004 Annual Report on Form 10-K.)

 

4.               Thefollowing is a reconciliation of the calculation of basic and diluted earnings(loss) per share (EPS) for the three and six months ended July 2, 2005 andJuly 3, 2004 (amounts in thousands except per-share data).

 
| ** **                 | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|----------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                 | ** ** | **Income**             | ** ** | **Shares**           | ** ** | **Per-  share  earnings** | ** ** | **Income  (loss)** | ** ** | **Shares** | ** ** | **Per-share  earnings  (loss)** | ** ** |
| July 2, 2005          |       |                   |       |                 |       |   |   |   |   |   |   |   |   |
| Basic EPS                  |       | $                      | 945        |                 | 1,592      |   | $ | .59 |   | $ | 657 |   | 1,620 |   | $ | .41 |   |
| Effect of dilutive options |       | —                 |       | 41                   |       |   |   | — |   | 40 |   |   |   |
| Diluted EPS                |       | $                      | 945        |                 | 1,633      |   | $ | .58 |   | $ | 657 |   | 1,660 |   | $ | .40 |   |
|                       |       |                   |       |                 |       |   |   |   |   |   |   |   |   |
| July 3, 2004          |       |                   |       |                 |       |   |   |   |   |   |   |   |   |
| Basic EPS                  |       | $                      | 839        |                 | 1,695      |   | $ | .50 |   | $ | 476 |   | 1,704 |   | $ | .28 |   |
| Effect of dilutive options |       | —                 |       | 36                   |       |   |   | — |   | 36 |   |   |   |
| Diluted EPS                |       | $                      | 839        |                 | 1,731      |   | $ | .48 |   | $ | 476 |   | 1,740 |   | $ | .27 |   |

 

5.               On June 28,****2005,the Company entered into the Third Amendment (Amendment) to Revolving Creditand Term Loan Agreement (Loan Agreement) dated September 5, 2003, asamended as of May 29, 2004 and April 14, 2005. The Amendmentincreases the principal amount of the term loan portion of the Loan Agreementby $5 million. With the increase in the term loan amount, the total loancommitment is $23.5 million.

 

The Loan Agreement provides that, at the Company’soption, the term loan and revolving credit facility will bear interest at primeor a performance-based LIBOR rate. Based on the terms of the Amendment, theincrease in the term loan and the Company’s performance for the twelve monthsended July 2, 2005, the performance based rates would be LIBOR plus

 

6

----

 

1.50% for the term loan and LIBOR plus 1.25% forborrowings under the revolving credit facility.****Paymentof accrued interest is due and payable quarterly by the Company. Payments ofprincipal under the term loan are payable on a quarterly basis, ending on March 31,2011.

 

The proceeds of the term loan facility wereprimarily used to fund the purchase of the Company’s stock under the recentlycompleted modified Dutch auction tender offer and to pay related fees and expenses.The Amendment also reset the amount authorized for the repurchase of theCompany’s own stock to $1,438,000, separate from purchases made inconnection with the tender offer. Allother material terms of the Loan Agreement remain in force, except to theextent they have been modified by the Amendment.

 

6.               Thefollowing table presents information about the Company’s reported segments forthe six- and three-month periods ended July 2, 2005 and July 3, 2004(segment assets presented as of July 2, 2005 and July 3, 2004) alongwith the items necessary to reconcile the segment information to the totalsreported in the financial statements (amounts in thousands).

 
| ** **                       | ** ** | **Heating and Air  Conditioning** | ** ** | **Construction  Materials** | ** ** | **All Other** | ** ** | **Unallocated  Corporate** | ** ** | **Total** | ** ** |
|----------------------------------|------------|-----------------------------------|------------|-----------------------------|------------|---------------|------------|----------------------------|------------|-----------|------------|
| 2005                             |       |                              |       |                        |       |          |       |                       |       |      |       |
| Six Months                       |       |                              |       |                        |       |          |       |                       |       |      |       |
| Revenues from external customers |       | $                                 | 24,505     |                        | $          | 43,353        |       | $                          | 172        |      | $          | — |   | $ | 68,030 |   |
| Segment operating income (loss)  |       | 1,032                             |       | 1,731                       |       | 43            |       | (1,842                     | )          | 964       |       |
| Segment assets                   |       | 31,655                            |       | 52,113                      |       | 4             |       | 2,096                      |       | 85,868    |       |
| Three Months                     |       |                              |       |                        |       |          |       |                       |       |      |       |
| Revenues from external customers |       | 13,812                            |       | 24,375                      |       | 86            |       | —                     |       | 38,273    |       |
| Segment operating income (loss)  |       | 438                               |       | 1,867                       |       | 27            |       | (1,030                     | )          | 1,302     |       |
|                             |       |                              |       |                        |       |          |       |                       |       |      |       |
| 2004                             |       |                              |       |                        |       |          |       |                       |       |      |       |
| Six Months                       |       |                              |       |                        |       |          |       |                       |       |      |       |
| Revenues from external customers |       | $                                 | 24,112     |                        | $          | 37,538        |       | $                          | 172        |      | $          | 2 |   | $ | 61,824 |   |
| Segment operating (loss) income  |       | 1,557                             |       | 1,294                       |       | 39            |       | (1,841                     | )          | 1,049     |       |
| Segment assets                   |       | 30,257                            |       | 52,825                      |       | 264           |       | 1,941                      |       | 85,287    |       |
| Three Months                     |       |                              |       |                        |       |          |       |                       |       |      |       |
| Revenues from external customers |       | 12,443                            |       | 22,048                      |       | 86            |       | —                     |       | 34,577    |       |
| Segment operating income (loss)  |       | 449                               |       | 1,959                       |       | 27            |       | (969                       | )          | 1,466     |       |

 

Thereare no differences in the basis of segmentation or in the basis of measurementof segment profit or loss from the 2004 Annual Report.

 

7.               Theinterest rate swap agreement is reported consistent with SFAS No. 133, “Accountingfor Derivative Instruments and Hedging Activities,” and its related amendment,SFAS No. 138, “Accounting for Certain Derivative Instruments and CertainHedging Activities” which require recognition of derivatives as either assetsor liabilities and measurement at fair value. The change in accumulated othercomprehensive losses net of taxes from January 2, 2005 to July 2,2005 was as follows (amounts in thousands):

 

7

----

 
| Balance at January 2, 2005                                   |   | $   | (67    | ) |
|-------------------------------------------------------------------|--------|-----|--------|---|
| Comprehensive income from interest rate  swap, net of tax of $29  |   | 40  |   |
| Balance at April 2, 2005                                     |   | (27 | )      |
| Comprehensive income from interest rate  swap, net of tax of ($1) |   | 7   |   |
| Balance at July 2, 2005                                      |   | $   | (20    | ) |

 

**Item 2.**           Management’s Discussion and Analysis of Financial Conditionand Results of Operations

 

Company Overview

 

The Company operates primarily in two industrysegments, the heating and air conditioning segment and the constructionmaterials segment. The primary products manufactured by the heating and airconditioning segment are gas-fired wall furnaces, console heaters, evaporativecoolers and fan coils. Gas-fired wall furnaces, console heaters and fan coilproducts are manufactured at Williams Furnace Co., headquartered inColton, California. Evaporative coolers are manufactured at PhoenixManufacturing, Inc., based in Phoenix, Arizona. The primary products ofthe construction materials segment are ready mix concrete, constructionaggregates, building supplies and doors, which are offered by Transit MixConcrete Co. and Castle Concrete Company in Colorado Springs, Colorado andTransit Mix of Pueblo, Inc. and McKinney Door and Hardware, Inc. inPueblo, Colorado.  Currently, RockyMountain Ready Mix Concrete, Inc. of Denver, Colorado, only offers readymix concrete.

 

Financial Condition 

 

The Company’s heating and air conditioning businesses are seasonal andweather sensitive except for sales of fan coils. Revenues in the Company’sconstruction materials segment are influenced by weather conditions along theFront Range of Colorado. Historically, the Company has experienced operatinglosses during the first quarter except when the weather is mild along the FrontRange. Operating results typically improve in the second and third quartersreflecting more favorable weather conditions in Colorado and the seasonal salesof evaporative coolers. Fourth quarter results can vary based on weatherconditions in Colorado as well as in the principal markets for the Company’sheating equipment. The Company typically experiences operating cash flowdeficits during the first and second quarter of the year reflecting operatingresults, payments of the prior year’s accrued incentive bonuses and companyprofit-sharing contributions, and the use of sales dating programs (extendedpayment terms) related to the evaporative cooler product line. As a result, theCompany’s borrowings against its revolving credit facility tend to peak duringthe second quarter and then decline over the remainder of the year. This trendhas continued thus far in 2005.

 

Operationsfor the first six months of 2005 used $2,568,000 of cash compared to $3,576,000during the first six months of 2004. By segment, operating cash flow was asfollows (amounts in thousands):

 
| ** **                     | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|
| Construction materials segment |       | $        | 1,366      |     | $          | (666 | ) |
| Heating and air conditioning   |       | (2,101   | )          | (1,158   | )          |
| Corporate and Other            |       | (1,833   | )          | (1,752   | )          |
| Total                          |       | $        | (2,568     | )        | $          | (3,576 | ) |

 

8

----

 

Theimproved cash flow in the construction and materials segment was primarily theresult of a smaller increase in accounts receivable during the first six monthsof 2005 compared to the increase during the comparable 2004 period. Theconstruction materials segment closed the 2004 year with a high level ofreceivables reflecting the strong fourth quarter sales level.

 

Theincreased use of cash by the heating and air conditioning segment was primarilydue to a larger increase in accounts receivable during the first six months of2005 compared to the increase during the comparable 2004 period. Accountsreceivable increased during the second quarter of 2005 reflecting increasedsales at both Williams Furnace and Phoenix Manufacturing.

 

Theconstruction materials segment typically requires significant capitalinvestments, particularly when sales volume and demand are strong. Capitalexpenditures during the first six months of 2005 were primarily in theconstruction materials segment and included the completion of a batch plant inPueblo and a fines recovery system for the Colorado Springs’ sand operation.Expenditures during 2005 also included the capitalization of subsidizedleasehold improvements in the new office space leased for the Corporate office.

 

Asmore fully discussed in Note 5, the principal amount of the term loan wasincreased by $5 million. Approximately $3.5 million of the proceeds were usedto fund the purchase of the Company’s stock under the modified Dutch auctiontender offer and to pay related fees and expenses. The balance of theadditional term loan proceeds has been earmarked for potential capital projectsin the construction materials segment. Scheduled debt repayments were madeduring the first six months of both 2005 and 2004.

 

Asexpected, the Company continued to borrow against its revolving credit facilityduring the 2005 second quarter. During the first six months of 2005, thehighest amount of Company borrowings outstanding under the revolving creditagreement was $4,400,000 and the average amount outstanding was $1,413,000.

 

TheCompany believes that anticipated cash flow from operations, supplemented byseasonal borrowings against the revolving line of credit, (of which $1,300,000was outstanding at July 2, 2005) will be sufficient to cover expected cashneeds, including servicing debt and planned capital expenditures for at leastthe next twelve months.

 

Operations – Comparison of Quarter Ended July 2,2005 to Quarter Ended July 3, 2004

 

Historically,the Company has experienced improved operating results during the secondquarter as sales in the construction materials segment increase reflectingweather more conducive to construction activity. The 2005 operating results were consistent withthis trend. A summary of operatinginformation by segment for the quarters ended July 2, 2005 and July 3,2004 is as follows (amounts in thousands):

 

9

----

 
| ** **                             | ** ** | **Quarter ended  July 2, 2005** | ** ** | **Quarter ended  July 3, 2004** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|--------------------------------------|------------|
| Revenues from external customers       |       |                                 |       |                                 |       |
| Heating and air conditioning           |       | $                                    | 13,812     |                                 | $          | 12,443 |   |
| Construction materials                 |       | 24,375                               |       | 22,048                               |       |
|                                   |       |                                 |       |                                 |       |
| Operating income (loss)                |       |                                 |       |                                 |       |
| Heating and air conditioning           |       | 438                                  |       | 449                                  |       |
| Construction materials                 |       | 1,867                                |       | 1,959                                |       |
|                                   |       |                                 |       |                                 |       |
| Assets                                 |       |                                 |       |                                 |       |
| Heating and air conditioning           |       | 31,655                               |       | 30,144                               |       |
| Construction materials                 |       | 52,113                               |       | 51,677                               |       |
|                                   |       |                                 |       |                                 |       |
| Operating income as a percent of sales |       |                                 |       |                                 |       |
| Heating and air conditioning           |       | 3.2                                  | %          | 3.6                                  | %          |
| Construction materials                 |       | 7.7                                  |       | 8.9                                  |       |
|                                   |       |                                 |       |                                 |       |
| Return on assets                       |       |                                 |       |                                 |       |
| Heating and air conditioning           |       | 1.4                                  | %          | 1.5                                  | %          |
| Construction materials                 |       | 3.6                                  |       | 3.8                                  |       |
|                                        |            |                                      |            |                                      |            |  |  |

 

Theheating and air conditioning segment reported a $1,369,000 increase in sales,or 11%. The increased sales were reported for all three product lines;evaporative coolers, furnaces and fan coils. The increases represent increasedvolumes for wall furnaces and fan coils and price increases for all productsreflecting the pass through of increased steel costs. Cost of sales as apercentage of sales decreased slightly from 78.3% for the second quarter of2004 to 78% for the 2005 quarter. Within the segment the cost of salespercentage for the furnace line declined as 2005 pricing recovered theincreased steel costs compared to the 2004 quarter during which steel costsbegan to increase. Although fan coil volume was higher reflecting a slightimprovement in overall demand, pricing in the fan coil line was unable to fullyrecover the higher steel prices reflecting competitive pressures and the stillsoft market. Pricing in the evaporative cooler line encountered similarcompetitive pressures on selling prices. Depreciation remained relativelyconstant between the second quarter of 2004 and the second quarter of 2005.Selling and administrative costs during the second quarter of 2005 increased asa result of costs incurred related to the replacement of the general manager atWilliams Furnace Co., including severance pay. The slight decline in operatingincome was primarily the result of the narrower margins in the evaporativecooler line combined with the increased administrative costs discussed above.Operating income as a percent of sales was lower as a result of these factorswhile the return on assets showed less change.

 

Salesin the construction materials segment during the second quarter of 2005increased $2,327,000, or 10.6%. Sales improved due to higher volumes ofconcrete sold and price increases in response to higher cement and fuel costs.Pricing in the Denver metropolitan market has improved, however, the increasein concrete prices were substantially equal to the higher cost of cement,aggregates and fuel. The Denver ready mix concrete market remains verycompetitive. Volumes improved largely as a result of increased constructionactivity along the Front Range of Colorado. Sales at McKinney Door and Hardwaredeclined by $679,000 compared to the second quarter of 2004. The lower salesreflect the deferral of delivery by McKinney’s customers due to constructionschedules. McKinney’s sales order input has remained stable. Cost of sales inthe construction materials segment as a percentage of sales decreased slightlyfrom 81.2% for the second quarter of 2004 to 80.9% for the 2005 second quarterreflecting the competitive market conditions which prevented sales priceincreases in excess of the material and fuel cost increases. Depreciation,depletion and amortization declined slightly reflecting the effect of reduced

 

10

----

 

capitalspending in recent years. Selling and administrative costs increased inresponse to the improved sales. The gain on disposition of property andequipment decreased due to the inclusion of a $180,000 gain on the sale of awest Pueblo property during the quarter ended July 3, 2004. The reducedoperating profit during the second quarter of 2005 compared to 2004 was largelydue to the reduced profit at McKinney Door and Hardware resulting from thereduced sales. Operating income as a percent of sales declined as a result ofthese factors as did the return on assets, although to a lesser extent.

 

Net interest expense was about the same asthe effect of decreased average levels of debt was mostly offset by an increasein the average interest rate for the 2005 first quarter compared to the firstquarter of 2004.

 

The 2005 provision for income taxes is basedupon the estimated effective tax rate of 29% for the year which includes theestimated impact of the American Jobs Creation Act of 2004. The tax rate forthe quarter ended July 2, 2005 was 19% reflecting the effect of therelease of certain tax contingencies during the second quarter related to theclosure of ongoing income tax audits.

 

Operations - Comparison of Six Months Ended July 2,2005 to Six Months Ended July 3, 2004

 

Asummary of operating information by segment for the six month periods ended July 2,2005 and July 3, 2004 is as follows (amounts in thousands):

 
| ** **                             | ** ** | **Six Months ended  July 2, 2005** | ** ** | **Six Months ended  July 3, 2004** | ** ** |
|----------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| Revenues from external customers       |       |                                    |       |                                    |       |
| Heating and air conditioning           |       | $                                       | 24,505     |                                    | $          | 24,112 |   |
| Construction materials                 |       | 43,353                                  |       | 37,538                                  |       |
|                                   |       |                                    |       |                                    |       |
| Operating income                       |       |                                    |       |                                    |       |
| Heating and air conditioning           |       | 1,032                                   |       | 1,557                                   |       |
| Construction materials                 |       | 1,731                                   |       | 1,294                                   |       |
|                                   |       |                                    |       |                                    |       |
| Assets                                 |       |                                    |       |                                    |       |
| Heating and air conditioning           |       | 31,655                                  |       | 30,144                                  |       |
| Construction materials                 |       | 52,113                                  |       | 51,677                                  |       |
|                                   |       |                                    |       |                                    |       |
| Operating income as a percent of sales |       |                                    |       |                                    |       |
| Heating and air conditioning           |       | 4.2                                     | %          | 6.5                                     | %          |
| Construction materials                 |       | 4.0                                     |       | 3.4                                     |       |
|                                   |       |                                    |       |                                    |       |
| Return on assets                       |       |                                    |       |                                    |       |
| Heating and air conditioning           |       | 3.2                                     | %          | 5.2                                     | %          |
| Construction materials                 |       | 3.3                                     |       | 2.5                                     |       |
|                                        |            |                                         |            |                                         |            |  |  |

 

Consolidatedsales during the first half of 2005 were $68,030,000 yielding operating profitof $964,000. In the first half of 2004, sales were $61,824,000 with operatingincome of $1,049,000.

 

Theheating and air conditioning segment reported a modest $393,000 increase insales, or 1.6%. The sales increase reflects the improved sales of the secondquarter, noted above, more than offsetting the weak first quarter sales thatwere primarily the result of depressed evaporative cooler sales as a result ofrather cool weather in the markets served. Overall, for the six months, the fancoil product line reported a slight increase in sales while furnace and coolerrevenues were stable. For the six month periods, cost of

 

11

----

 

salesas a percentage of sales increased from 75.4% in 2004 to 77.4% for 2005reflecting a lower level of cooler production and the increase in steel costsdiscussed above. Depreciation remained relatively constant between the firstsix months of 2005 compared to the comparable 2004 period. Selling andadministrative costs increased slightly during the first six months of 2005 asreductions in office staff during the first quarter were offset by theadditional costs during the second quarter discussed above. The decline inoperating income was the result of the increased steel costs on evaporativecoolers and competitive conditions noted above. Operating income as a percentof sales and the return on assets were both lower as a result of these factors.

 

Salesin the construction materials segment during the first six months of 2005increased $5,815,000, or 15.5%. Sales improved due to the reasons noted aboveas well as milder weather in Colorado during the first quarter of 2005. Cost ofsales as a percentage of sales decreased from 84.2% for the first six months of2004 to 83.6% for the comparable 2005 period reflecting the competitive marketconditions which prevented sales price increases in excess of the material andfuel cost increases. Depreciation, depletion and amortization declinedreflecting the effect of reduced capital spending in recent years as notedabove. Selling and administrative costs increased in response to the improvedsales. The gain on disposition of property and equipment decreased due to thesale of property during the second quarter of 2004 noted above. The increase inoperating income was primarily due to the improved volumes. Operating income asa percent of sales and the return on assets both improved as a result of thesefactors.

 

Net interest expense declined slightly as theeffect of decreased average levels of debt exceeded the effect of an increasein the average interest rate for the first six months of 2005 compared to thecomparable period of 2004.

 

Thetax rate for the six months ended July 2, 2005 was 12% primarilyreflecting the release of certain tax contingencies during the second quarteras noted above.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

The condensed and consolidated financial statements have been preparedin accordance with accounting principles generally accepted in the UnitedStates which require the Company to make estimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities as of July 2,2005 and January 1, 2005 and affect the reported amounts of revenues andexpenses for the periods reported. Actual results could differ from thoseestimates.

 

Informationwith respect to the Company’s critical accounting policies which the Companybelieves could have the most significant effect on the Company’s reportedresults and require subjective or complex judgments by management is containedon pages 13 and 14 in Item 7, Management’s Discussion and Analysis ofFinancial Condition and Results of Operations, of the Company’s Annual Reporton Form 10-K for the fiscal year ended January 1, 2005. In addition,the following information is provided:

 

TheCompany maintained insurance policies since March 31, 2005 with thefollowing per incident deductibles and policy limits:

 
| ** **                    | ** ** | **Deductible** | ** ** | **Policy Limits** | ** ** |
|-------------------------------|------------|----------------|------------|-------------------|------------|
| Product and general liability |       | $              | 250,000    |              | $          | 5,000,000 |   |
| Workers’ compensation    |       | 350,000        |       | 1,000,000         |       |
| Auto and truck liability      |       | 100,000        |       | 2,000,000         |       |
|                               |            |                |            |                   |            |  |  |

 

Should the aggregated out-of-pocket payments for thethree policies exceed $3,400,000 during a policy year, deductibles on futureclaims are waived and the policies pay all amounts up to the policy limits.Should any, or all policy limits be exceeded, an umbrella policy is maintainedwhich covers the next $25,000,000 of claims.

 

12

----

 

Revenues received for shipping and handling areclassified as sales. Costs associated with shipping and handling are classifiedas costs of sales.

 

The Company annually assesses goodwill for potentialimpairment as of the last day of its fiscal year.

 

OUTLOOK

 

The level of construction in the Denvermarket appears to have stabilized, however, concrete prices, though improved in2005 compared to the first half of 2004, are depressed and expected to remainvery competitive. The construction markets in Colorado Springs and Pueblo arerelatively strong and stable. Increases in interest rates, particularlymortgage interest rates, could slow the level of construction in all markets.

 

The demand for fan coil products has shownsome improvement this year from the rather depressed levels of the past threeyears. Sales of furnaces and evaporative coolers are not expected to grow significantlyand will remain weather sensitive.

 

RECENTLY ISSUED ACCOUNTING STANDARDS

 

TheCompany discusses recently issued accounting standards and tax law changes inthe Critical Accounting Policies section under Item 7 and in Note 1 toConsolidated Financial Statements in Item 8 of the Company’s 2004 Annual Reporton Form 10-K. Other than as discussed in those sections, the Company doesnot currently have any transactions or circumstances that have been addressedby recently issued accounting pronouncements. Therefore, adoption of any ofthese statements or pronouncements would not have a material impact on theCompany’s results of operations, financial position or liquidity. The Companyhas determined that it qualifies for certain deductions that the American JobsCreation Act of 2004 provides for income from qualified domestic productionactivities. Although the effect of the deduction is not expected to have amaterial effect on the tax provision for 2005, a preliminary estimate of thededuction was included in the determination of the tax provision.

 

FORWARD-LOOKING STATEMENTS

 

The foregoing discussion contains forward-lookingstatements within the meaning of Section 27A of the Securities Act of1933, as amended. Such forward-looking statements are based on the beliefs ofthe Company’s management as well as on assumptions made by and informationavailable to the Company at the time such statements were made.  When used in this Report, words such as “anticipates,”“believes,” “contemplates,” “estimates,” “expects,” “plans,” “projects,” andsimilar expressions are intended to identify forward-looking statements. Actualresults could differ materially from those projected in the forward-lookingstatements as a result of factors including but not limited to: weather,interest rates, availability of raw materials and their related costs, nationaland local economic conditions and competitive forces. Some of these factors arediscussed in more detail in the Company’s 2004 Annual Report on Form 10-K.Changes in accounting pronouncements could also alter projected results.Forward-looking statements speak only as of the date they were made, and theCompany undertakes no obligation to publicly update them.

 

**Item 3****              QuantitativeAnd Qualitative Disclosures About Market Risk**

 

There have been no material changes in the marketrisks that the Company is exposed to since those discussed in the Company’s2004 Annual Report on Form 10-K. At July 2, 2005, the amount subjectto the interest rate swap agreement was $6,000,000. Also see Note 7 to thequarterly financial statements above.

 

13

----

 

**Item 4.    Controls and Procedures**

 

(a)                       Disclosure Controls and Procedures.

 

The Company’s chief executive officer and chieffinancial officer, with the participation of management, have evaluated theeffectiveness of the Company’s “disclosure controls and procedures” (as definedin Rules 13a-15(e) and 15d-15(e) under the Securities ExchangeAct of 1934, as amended) as of the end of the period covering this report.Based on their evaluation, they have concluded that the Company’s disclosurecontrols and procedures were effective and were reasonably designed to ensurethat all material information relating to the Company (including itssubsidiaries) required to be disclosed in this quarterly report is recorded,processed, summarized and reported within the time periods specified in the rules andforms of the Securities and Exchange Commission.

 

(b)                      Changes in Internal Controls Over FinancialReporting.

 

There were no significant changes in the Company’sinternal control over financial reporting identified in connection with theevaluation of such internal control that occurred during the last fiscalquarter that have materially affected, or are reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

PART II – OtherInformation

 
| Item 2. | Unregistered Sales of Equity Securities and  Use of Proceeds |
|---------|--------------------------------------------------------------|

 

The following table presents information withrespect to purchases made by the Company of its common stock to become treasurystock for the period April 3 through July 2, 2005.

 

Issuer Purchases of EquitySecurities

 
| **Period**                              | ** ** | **(a) Total  Number of  Shares  Purchased** | ** ** | **(b) Average  Price Paid  per Share** | ** ** | **(c) Total Number of  Shares Purchased as Part  of Publicly Announced  Plans or Programs** | ** ** | **(d) Maximum Dollar  Value of shares that  May Yet Be Purchased  Under the Plans or  Programs** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------|------------|
| April 2 – April 30, 2005 |       | —                                           |       | —                                      |       | —                                                                                           |       | $                                                                                                          | 1,437,360  |   |
| May 1 – May 28, 2005     |       | —                                           |       | —                                      |       | —                                                                                           |       | 1,437,360                                                                                                  |       |
| May 29 – July 2, 2005    |       | 103,830                                          |       | $                                           | 35.04      |                                                                                             | 103,830    |                                                                                                       | 1,437,360  |   |
| Total                                   |       | 103,830                                          |       | $                                           | 35.04      |                                                                                             | 103,830    |                                                                                                       | $          | 1,437,360 |   |

 

On January 19, 1999, the Companyinitiated purchases under the current open-ended program to repurchase itscommon stock. Purchases are made on the open market or in block trades at thediscretion of management. The dollar amount authorized for the program has beenperiodically increased by the Board of Directors and approved by the Company’stwo banks as required by the Company’s Revolving Credit and Term LoanAgreement. Effective May 29, 2003, the Board increased the permittedamount to a total not to exceed $2,750,000 for purchases on or after May 29,2004, separate from purchases made in connection with the tender offer. Allshares purchased during fiscal June were under the tender offer. The pricepaid was $30.50 per share. The $35.04 average price noted in the above tableincludes approximately $471,000, or $4.04 per share, of related expenses.

 

14

----

 
| Item 4. |   | Submission of Matters to a Vote of Security  Holders                                                                                                               |
|---------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                                                                               |   |
|    | (a)    | The 2005 Annual Meeting of the Stockholders  of the Company was held on May 25, 2005.                                                                         |
|    |   |                                                                                                                                                               |
|    | (b)    | At that meeting, three individuals, all of  whom are current directors, were nominated and elected to serve until the  2008 Annual Meeting by the following votes: |

 
| **Director**         | ** ** | **Shares For** | ** ** | **Shares Against** | ** ** | **Shares Withheld** | ** ** |
|----------------------|------------|----------------|------------|--------------------|------------|---------------------|------------|
| Ralph W. Gidwitz     |       | 1,572,741      |       | —             |       | 22,674              |       |
| Theodore R. Tetzlaff |       | 1,452,264      |       | —             |       | 143,151             |       |
| Peter E. Thieriot    |       | 1,576,615      |       | —             |       | 18,800              |       |

 
|   |   | There were no broker non-votes.                                                                                                   |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                              |
|   |   | The following directors’ terms of office  continued after the 2005 Meeting until the Annual Meetings of the years as  noted: |

 
| **Directors**      | ** ** | **Expiration of Term** | ** ** |
|--------------------|------------|------------------------|------------|
| Thomas H. Carmody  |       | 2006                   |       |
| Ronald J. Gidwitz  |       | 2006                   |       |
| Darrell M. Trent   |       | 2006                   |       |
| William D. Andrews |       | 2007                   |       |
| Betsy R. Gidwitz   |       | 2007                   |       |
| James G. Gidwitz   |       | 2007                   |       |

 
|   | (c) | In addition to the above election, the  appointment of the independent auditing firm of PricewaterhouseCoopers LLP  was ratified by the following vote: |
|--------|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------|

 
| **For**   | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|-----------|------------|-------------|------------|-------------|------------|
| 1,590,675 |       | 3,600       |       | 1,140       |       |

 
|   |   | There were no broker non-votes. |
|--------|--------|---------------------------------|
|   |   |                            |
|   | (d)    | Not applicable.                 |

 
| Item 6.    | Exhibits             |       |                                                                                                                                                                                                     |
|------------|----------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                 |       |                                                                                                                                                                                                     |
|       | Exhibits             |       |                                                                                                                                                                                                     |
|       |                 |       |                                                                                                                                                                                                     |
| ** ** | **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                          |
|       |                 |       |                                                                                                                                                                                                     |
|       | 31.1                 |       | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted  pursuant to Section 302 of the Sarbanes – Oxley Act of 2002 |
|       |                 |       |                                                                                                                                                                                                     |
|       | 31.2                 |       | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted  pursuant to Section 302 of the Sarbanes – Oxley Act of 2002 |
|       |                 |       |                                                                                                                                                                                                     |
|       | 32                   |       | Certification of Chief Executive Officer and Chief Financial Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes – Oxley Act of 2002         |

 

15

----

 

SIGNATURE

 

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 theundersigned thereunto duly authorized.

 

 
|   |                 | CONTINENTAL MATERIALS CORPORATION |
|--------|----------------------|-----------------------------------|
|   |                 |                              |   |
|   |                 |                              |   |
| Date:  | August 16, 2005 |                              | By: |   /S/ Joseph J. Sum |   |
|   |                 |                              |   Joseph J. Sum, Vice President |
|   |                 |                              |   and Chief Financial Officer |
|        |                      |                                   |  |  |  |

 

----