** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, 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 April 1, 2006**                                                  |
| ** **     | ** **                                                                                              |
| ** **     | **OR**                                                                                                  |
| ** **     | ** **                                                                                              |
| **o**          | **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 1-3834**

**CONTINENTAL MATERIALS CORPORATION**(Exact name of registrant as specified in its charter)

 

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

 

| **200 South Wacker Drive, Suite 4000, Chicago, Illinois** |   | **60606**  |
|----------------------------------------------------------------|--------|------------|
| (Address of  principal executive offices)                      |   | (Zip Code) |

 

**(312) 541-7200**(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed sincelast report)

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes  o  No  x

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act). o  No  x

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2or the Exchange Act). o  No  x
| Number of common shares  outstanding at July 7, 2006 |   | 1,605,461 |
|-----------------------------------------------------------|--------|-----------|

 

 

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PART I - FINANCIAL INFORMATION

## **Item1.  Financial Statements**

CONTINENTAL MATERIALS CORPORATIONCONDENSED CONSOLIDATED BALANCE SHEETSAPRIL 1, 2006 AND DECEMBER 31, 2005(Unaudited) (000’s omitted except share data)

 
| ** **                                                                                      | ** **   | **APRIL 1,** | ** **   | **DECEMBER 31,** | ** **   |
|-------------------------------------------------------------------------------------------------|--------------|-------------------|--------------|-----------------------|--------------|
| ***ASSETS***                                                                                    | ** **   | **2006**          | ** **   | **2005**              | ** **   |
| Current assets:                                                                                 |         |              |         |                  |         |
| Cash and cash  equivalents                                                                      |         | $                 | —       |                  | $            | 6,829 |   |
| Receivables, net                                                                                |         | 22,163            |         | 17,678                |         |
| Receivable for  insured losses                                                                  |         | 1,681             |         | 1,718                 |         |
| Inventories:                                                                                    |         |              |         |                  |         |
| Finished goods                                                                                  |         | 8,394             |         | 7,650                 |         |
| Work in process                                                                                 |         | 1,655             |         | 1,907                 |         |
| Raw materials  and supplies                                                                     |         | 8,991             |         | 7,898                 |         |
| Prepaid expenses                                                                                |         | 3,401             |         | 3,910                 |         |
| Total current  assets                                                                           |         | 46,285            |         | 47,590                |         |
|                                                                                            |         |              |         |                  |         |
| Property, plant and  equipment, net                                                             |         | 29,132            |         | 28,844                |         |
|                                                                                            |         |              |         |                  |         |
| Goodwill                                                                                        |         | 7,474             |         | 7,374                 |         |
| Non-compete agreements                                                                          |         | 766               |         | 728                   |         |
| Other assets                                                                                    |         | 2,428             |         | 2,524                 |         |
|                                                                                            |         |              |         |                  |         |
|                                                                                            |         | $                 | 86,085       |                  | $            | 87,060 |   |
| ***LIABILITIES***                                                                               | *** *** | *** ***      | *** *** | *** ***          | *** *** |
| Current liabilities:                                                                            |         |              |         |                  |         |
| Bank loan  payable                                                                              |         | $                 | 1,000        |                  | $            | — |   |
| Current portion  of long-term debt                                                              |         | 2,000             |         | 2,000                 |         |
| Accounts payable  and accrued expenses                                                          |         | 15,698            |         | 15,748                |         |
| Liability for  unpaid claims covered by insurance                                               |         | 1,681             |         | 1,718                 |         |
| Income taxes                                                                                    |         | —            |         | 342                   |         |
| Total current  liabilities                                                                      |         | 20,379            |         | 19,808                |         |
|                                                                                            |         |              |         |                  |         |
| Long-term debt                                                                                  |         | 9,500             |         | 10,000                |         |
| Deferred income taxes                                                                           |         | 3,680             |         | 3,681                 |         |
| Other long-term  liabilities                                                                    |         | 1,517             |         | 2,264                 |         |
|                                                                                            |         |              |         |                  |         |
| ***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                                                                 |         | 1,830             |         | 1,830                 |         |
| Retained earnings                                                                               |         | 65,030            |         | 65,331                |         |
| Accumulated other  comprehensive gains net of tax of $4 and $3 (interest rate swap adjustments) |         | 9                 |         | 6                     |         |
| Treasury shares,  968,803, at cost                                                              |         | (16,503           | )            | (16,503               |         |
|                                                                                            |         | 51,009            |         | 51,307                |         |
|                                                                                            |         |              |         |                  |         |
|                                                                                            |         | $                 | 86,085       |                  | $            | 87,060 |   |

 

See accompanying notes

2

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CONTINENTAL MATERIALSCORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS, RETAINED EARNINGSAND COMPREHENSIVE INCOME (LOSS)FOR THE THREE MONTHS ENDED APRIL 1, 2006 AND APRIL 2, 2005(Unaudited)(000’s omitted except per-share amounts)

 
| ** **                                                              | ** ** | **APRIL 1, 2006** | ** ** | **APRIL 2, 2005** | ** ** |
|-------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
|                                                                    |       |                        |       |                        |       |
| Sales                                                                   |       | $                           | 33,684     |                        | $          | 29,757 |   |
|                                                                    |       |                        |       |                        |       |
| Costs and  expenses:                                                    |       |                        |       |                        |       |
| Cost of sales (exclusive of depreciation,                               |       |                        |       |                        |       |
| depletion and amortization)                                             |       | 27,981                      |       | 24,765                      |       |
| Depreciation, depletion and amortization                                |       | 1,190                       |       | 1,216                       |       |
| Selling and administrative                                              |       | 5,007                       |       | 4,181                       |       |
|                                                                    |       |                        |       |                        |       |
| Gain on  disposition of property and equipment                          |       | 74                          |       | 67                          |       |
|                                                                    |       | 34,104                      |       | 30,095                      |       |
|                                                                    |       |                        |       |                        |       |
| Operating loss                                                          |       | (420                        | )          | (338                        | )          |
|                                                                    |       |                        |       |                        |       |
| Interest                                                                |       | (96                         | )          | (131                        | )          |
| Other income,  net                                                      |       | 61                          |       | 46                          |       |
|                                                                    |       |                        |       |                        |       |
| Loss before  income taxes                                               |       | (455                        | )          | (423                        | )          |
|                                                                    |       |                        |       |                        |       |
| Benefit from  income taxes                                              |       | (154                        | )          | (135                        | )          |
|                                                                    |       |                        |       |                        |       |
| Net loss                                                                |       | (301                        | )          | (288                        | )          |
|                                                                    |       |                        |       |                        |       |
| Retained  earnings, beginning of period                                 |       | 65,331                      |       | 62,573                      |       |
|                                                                    | ** ** | ** **                  |       | ** **                  | ** ** |
| Retained  earnings, end of period                                       |       | $                           | 65,030     |                        | $          | 62,285 |   |
|                                                                    |       |                        |       |                        |       |
| Basic loss per  share                                                   |       | $                           | (.19       | )                           | $          | (.17 | ) |
|                                                                    |       |                        |       |                        |       |
| Average shares outstanding                                              |       | 1,605                       | ** ** | 1,648                       |       |
|                                                                    |       |                        |       |                        |       |
| Diluted loss per  share                                                 |       | $                           | (.19       | )                           | $          | (.17 | ) |
|                                                                    |       |                        |       |                        |       |
| Average shares outstanding                                              |       | 1,605                       | ** ** | 1,648                       |       |
|                                                                    |       |                        |       |                        |       |
| Comprehensive  (loss) income:                                           |       |                        |       |                        |       |
| Net loss                                                                |       | $                           | (301       | )                           | $          | (288 | ) |
| Comprehensive  income from interest rate swap, net of tax of $1 and $29 |       | 3                           |       | 40                          |       |
|                                                                    |       | $                           | (298       | )                           | $          | (248 | ) |

 

See accompanying notes

3

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CONTINENTAL MATERIALS CORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWSFOR THE THREE MONTHS ENDED APRIL 1, 2006 AND APRIL 2, 2005(Unaudited)(000’s omitted)

 

 
| ** **                                    | ** ** | **APRIL 1, 2006** | ** ** | **APRIL 2, 2005** | ** ** |
|-----------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
|                                          |       |                        |       |                        |       |
| Net cash used in  operating activities        |       | $                           | (5,684     | )                           | $          | (1,745 | ) |
|                                          |       |                        |       |                        |       |
| Investing  activities:                        |       |                        |       |                        |       |
| Purchase of CSSL                              |       | (352                        | )          | —                      |       |
| Capital expenditures                          |       | (1,411                      | )          | (1,374                      | )          |
| Proceeds from sale of property and equipment  |       | 118                         |       | 67                          |       |
| Net cash used in  investing activities        |       | (1,645                      | )          | (1,307                      | )          |
|                                          |       |                        |       |                        |       |
| Financing  activities:                        |       |                        |       |                        |       |
| Borrowings under revolving credit facility    |       | 1,000                       |       | 800                         |       |
| Repayment of long term debt                   |       | (500                        | )          | (500                        | )          |
| Payment to acquire treasury stock             |       | —                      |       | (76                         | )          |
| Net cash  provided by financing activities    |       | 500                         |       | 224                         |       |
|                                          |       |                        |       |                        |       |
| Net decrease in  cash and cash equivalents    |       | (6,829                      | )          | (2,828                      | )          |
| Cash and cash  equivalents:                   |       |                        |       |                        |       |
| Beginning of period                           |       | 6,829                       |       | 2,828                       |       |
|                                          |       |                        |       |                        |       |
| End of period                                 | ** ** | **$**                       | **—** | ** **                  | **$**      | **—** | ** ** |
| ** **                                    | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| ** **                                    | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| Supplemental  disclosures of cash flow items: |       |                        |       |                        |       |
| Cash paid during  the three months for:       |       |                        |       |                        |       |
| Interest                                      |       | $                           | 18         |                        | $          | 222 |   |
| Income taxes                                  |       | 215                         |       | 287                         |       |

 

See accompanying notes

 

4

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CONTINENTAL MATERIALSCORPORATIONSECURITIES AND EXCHANGE COMMISSION FORM 10-QNOTES TO THE QUARTERLY CONDENSED CONSOLIDATED FINANCIAL STATEMENTSQUARTER ENDED APRIL 1, 2006(Unaudited)

1.               Theunaudited interim condensed consolidated financial statements included hereinare prepared pursuant to the rules and regulations for reporting on Form 10-Q.Accordingly, certain information and footnote disclosures normally accompanyingthe annual consolidated financial statements have been omitted. The interimcondensed consolidated financial statements and notes should be read inconjunction with the consolidated financial statements and notes theretoincluded in the Company’s latest annual report on Form 10-Kincluding any amendments thereto. For reasons more fully discussed in Note 5,the segment information for the first quarter of 2005 has been restated. In theopinion of management, the condensed consolidated financial statements includeall adjustments (none of which were other than normal recurring adjustments)necessary for a fair statement of the results for the interim periods.

2.               Theprovision for income taxes for the quarter ended April 1, 2006 of 34% isthe same as the estimated effective tax rate of 34% for the year.

3.               Operatingresults for the first three months of 2006 are not necessarily indicative ofperformance for the entire year. Historically, sales of the Evaporative Coolingsegment are higher in the first and second quarters, sales of the Concrete,Aggregates and Construction Supplies segment are higher in the second and thirdquarters and sales of the Heating and Cooling segment are higher in the thirdand fourth quarters. The sales of the Door segment have not shown strongseasonal fluctuations in recent years.

4.               Thefollowing is a reconciliation of the calculation of basic and diluted earningsper share (EPS) for the three months ended April 1, 2006 and April 2,2005 (amounts in thousands, except per-share amounts):

 

|                             | ** ** | **Income  (Loss)** | ** ** | **Shares** | ** ** | **Per-share (loss)  earnings** | ** ** |
|-----------------------------|------------|--------------------|------------|------------|------------|-------------------------------------|------------|
| April 1, 2006          |       |               |       |       |       |                                |       |
| Basic EPS                   |       | $                  | (301       | )          | 1,605      |                                | $          | (.19 | ) |
| Effect of dilutive  options |       | —             |       | —     |       |                                |       |
| Diluted EPS                 |       | $                  | (301       | )          | 1,605      |                                | $          | (.19 | ) |
|                        |       |               |       |       |       |                                |       |
| April 2, 2005          |       |               |       |       |       |                                |       |
| Basic EPS                   |       | $                  | (288       | )          | 1,648      |                                | $          | (.17 | ) |
| Effect of dilutive  options |       | —             |       | —     |       |                                |       |
| Diluted EPS                 |       | $                  | (288       | )          | 1,648      |                                | $          | (.17 | ) |

 

5.               The Companyoperates primarily in two industry groups, HVAC and Construction Products.Prior to the 2005 fiscal year, the Company reported its financial results intwo reportable segments, essentially along the lines of these two industrygroups. The reporting segments were titled the Heating and Air Conditioningsegment and the Construction Materials segment. Prior to filing the annualreport on Form 10-K for the 2005 fiscal year, management determinedthat its segment disclosures did not comply with SFAS No. 131. As aresult, the financial information presented for 2005 in the table below hasbeen restated.

Prior to filing theannual report on Form 10-K for the 2005 fiscal year, managementconcluded that there are four reportable segments within its two principalindustry groups; the Heating and Cooling segment and the Evaporative Coolingsegment in the HVAC industry group and the Concrete, Aggregates andConstruction Supplies segment and the Door segment in the Construction Productsindustry group. The Heating and Cooling segment produces and sells gas-firedwall furnaces, console heaters and fan coils from the Company’s wholly-ownedsubsidiary, Williams Furnace Co. of Colton, California. The Evaporative Coolingsegment produces and sells evaporative coolers from the Company’s wholly-ownedsubsidiary, Phoenix Manufacturing, Inc. of Phoenix, Arizona. Theoperations of these two segments were previously combined and reported as theHeating and Air Conditioning segment. Sales of these two segments arenationwide, but are concentrated in the southwestern United States. Concrete,Aggregates and Construction Supplies are offered from numerous

5

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locations along the FrontRange of Colorado operated by the Company’s wholly-owned subsidiaries CastleConcrete Company and Transit Mix Concrete Co., of Colorado Springs, Transit Mixof Pueblo, Inc. of Pueblo and Rocky Mountain Ready Mix Concrete, Inc.of Denver. Doors are fabricated and sold along with the related hardware fromthe Company’s wholly-owned subsidiary, McKinney Door and Hardware, Inc. ofPueblo, Colorado. The operations of these two segments were previously combinedand reported as the Construction Materials segment. Sales of these two segmentsare highly concentrated in the Front Range area in Colorado although door salesare also made throughout the United States.

The Company evaluatesthe performance of its segments and allocates resources to them based on anumber of criteria including operating income, return on investment and otherstrategic objectives. Operating income is determined by deducting operatingexpenses from all revenues. In computing operating income, none of thefollowing has been added or deducted: unallocated corporate expenses, interest,other income or loss or income taxes.

In addition to the above reporting segments, an “Unallocated Corporate”classification is used to report the unallocated expenses of the corporateoffice which provides treasury, insurance and tax services as well as strategicbusiness planning and general management services and an “Other” classificationis used to report a small real estate operation. Expenses related to thecorporate information technology group are allocated to all locations,including the corporate office.

The following table presents information aboutreported segments for the three months ended April 1, 2006 and April 2,2005 along with the items necessary to reconcile the segment information to thetotals reported in the financial statements (amounts in thousands):

 
| ** **                                      | ** ** | **Construction Products**                                    | ** ** | **HVAC Products** | ** ** | ** **                           | ** ** | ** **                | ** ** | ** **               | ** ** |
|-------------------------------------------------|------------|--------------------------------------------------------------|------------|-------------------|------------|--------------------------------------|------------|---------------------------|------------|--------------------------|------------|
| **Quarter ended  April 1, 2006** | ** ** | **Concrete,  Aggregates &  Construction  Supplies** | ** ** | **Doors**         | ** ** | **Combined  Construction  Products** | ** ** | **Heating  and  Cooling** | ** ** | **Evaporative  Cooling** | ** ** | **Combined  HVAC  Products** | ** ** | **Unallocated  Corporate** | ** ** | **Other** | ** ** | **Total** | ** ** |
|                                            |       |                                                         |       |              |       |                                 |       |                      |       |                     |       |   |   |   |   |   |   |   |   |
| Revenues from external  customers               |       | $                                                            | 20,085     |              | $          | 2,139                                |       | $                         | 22,224     |                     | $          | 6,586 |   | $ | 4,788 |   | $ | 11,374 |   | $ | — |   | $ | 86 |   | $ | 33,684 |   |
| Depreciation, depletion  and amortization       |       | 890                                                          |       | 34                |       | 924                                  |       | 98                        |       | 150                      |       | 248 |   | 18 |   | — |   | 1,190 |   |
| Operating income (loss)                         |       | 75                                                           |       | 138               |       | 213                                  |       | 205                       |       | (27                      | )          | 178 |   | (838 | ) | 27 |   | (420 | ) |
| Segment assets                                  |       | 48,387                                                       |       | 3,854             |       | 52,241                               |       | 16,134                    |       | 15,832                   |       | 31,966 |   | 1,874 |   | 4 |   | 86,085 |   |
| Capital expenditures                            |       | 1,214                                                        |       | 65                |       | 1,279                                |       | 5                         |       | 125                      |       | 130 |   | 2 |   | — |   | 1,411 |   |
|                                                 |            |                                                              |            |                   |            |                                      |            |                           |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                        | ** ** | **Construction Products**                               | ** ** | **HVAC Products** | ** ** | ** **                                    | ** ** | ** **                | ** ** | ** **               | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|------------------------|------------|-----------------------------------------------|------------|---------------------------|------------|--------------------------|------------|
| **Quarter ended  April 2, 2005  as restated** | ** ** | **Concrete,  Aggregates &  Construction  Supplies** | ** ** | **Doors**              | ** ** | **Combined  Construction  Products (a)** | ** ** | **Heating  and  Cooling** | ** ** | **Evaporative  Cooling** | ** ** | **Combined  HVAC  Products (a)** | ** ** | **Unallocated  Corporate** | ** ** | **Other** | ** ** | **Total** | ** ** |
| Revenues from external  customers                                 |       | $                                                            | 17,010     |                   | $          | 1,968                                         |       | $                         | 18,978     |                     | $          | 6,237 |   | $ | 4,456 |   | $ | 10,693 |   | $ | — |   | $ | 86 |   | $ | 29,757 |   |
| Depreciation, depletion  and amortization                         |       | 906                                                          |       | 22                     |       | 928                                           |       | 125                       |       | 144                      |       | 269 |   | 19 |   | — |   | 1,216 |   |
| Operating income (loss)                                           |       | (365                                                         | )          | 229                    |       | (136                                          | )          | 602                       |       | (8                       | )          | 594 |   | (812 | ) | 16 |   | (338 | ) |
| Segment assets (b)                                                |       | 47,180                                                       |       | 2,914                  |       | 50,094                                        |       | 16,986                    |       | 12,544                   |       | 29,530 |   | 7,373 |   | 63 |   | 87,060 |   |
| Capital expenditures                                              |       | 887                                                          |       | 25                     |       | 912                                           |       | 53                        |       | 125                      |       | 178 |   | 284 |   | — |   | 1,374 |   |
|                                                                   |            |                                                              |            |                        |            |                                               |            |                           |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

(a)            Columns for 2005represent the segments as reported in the April 2, 2005 Form 10-Q.

(b)           Segmentassets are as of December 31, 2005.

There are no differencesin the basis of segmentation or in the basis of measurement of segment profitor loss from the last annual report.

 

6

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6.               OnJanuary 1, 2006 the Company purchased the assets of Colorado State Safe &Lock Co. (CSSL), a company in Colorado Springs offering electronic access andlocking capabilities, for $352,000. The assets were acquired by MDHI in theDoor segment. The purchase price allocation included $100,000 of goodwill,which represents the only change to the Company’s recorded goodwill during thequarter, and $100,000 for a non-compete agreement. The non-compete agreement isbeing amortized over its four year term.

7.               Identifiableintangible assets as of April 1, 2006 consist of four amortizablenon-compete agreements, including the non-compete agreement related to CSSLacquired during the first quarter of 2006 (see Note 6), that were carried at$766,000, net of $1,334,000 accumulated amortization. The pre-tax amortizationexpense for intangible assets during the quarter ended April 2, 2005 was$62,000. Based upon the intangible assets recorded on the balance sheet at April 1,2006, amortization expense for the next five years is estimated to be asfollows: 2006 — $241,000, 2007 — $162,000, 2008 — $150,000, 2009 — $150,000,and 2010 — $125,000.

8.               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 gains, net of taxes, from December 31, 2005 to April 1,2006 was as follows (amounts in thousands):

| Balance at December 31,  2005                                                                                     |   | $      6 |   |
|------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|
| Comprehensive income  from interest rate swap, net of tax effect of $1, for the three months ended  April 1, 2006 |   | 3                                      |   |
| Comprehensive net gain                                                                                                 |   | $      9 |   |

 

9.               SUBSEQUENT EVENTS

FourthAmendment to Revolving Credit and Term Loan Agreement

On June 8, 2006, theCompany entered into the Fourth Amendment to Revolving Credit and Term LoanAgreement amending the Company’s existing Credit Agreement. The FourthAmendment increases the principal amount of the term loan portion of the CreditAgreement by $5,000,000 and increases the revolving credit facility by$5,000,000. With the increase in the term loan and revolving credit amounts,the total loan commitment, at the time of the signing, was $31,500,000. At thefiling date of this Form 10-Q, the commitment had been reduced to$31,000,000 due to a term loan repayment of $500,000, as scheduled.

The additional$5,000,000 proceeds of the term loan facility was drawn at the close ofbusiness, June 30, 2006 in conjunction with the acquisition discussedbelow. The amount available under the revolving credit facility of the CreditAgreement was increased primarily due to increased stand-by letters of creditrequirements to insurance carriers in support of self-insured amounts under theCompany’s risk management program and to provide additional liquidity. Allother material terms of the Credit Agreement remain in force, except to theextent they have been modified by the Fourth Amendment as described in thisparagraph.

Acquisition

The Company completedthe purchase of certain assets of a concrete producer in Colorado Springs atthe close of business, June 30, 2006 for $2,100,000 of cash and a$1,000,000 Note.

**Item 2.        Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

The following Management’s Discussion and Analysis gives effect to therestatement discussed in Note 5.

Company Overview

The Company operates in four reportable segments within its twoprincipal industry groups; the Heating and Cooling segment and the EvaporativeCooling segment in the HVAC industry group and the Concrete, Aggregates andConstruction Supplies segment and the Door segment in the Construction Productsindustry group.

The Heating and Cooling segment produces and sells gas-fired wallfurnaces, console heaters and fan coils from the Company’s wholly-ownedsubsidiary, Williams Furnace Co. (WFC) of Colton, California. The EvaporativeCooling segment produces and sells evaporative coolers from the Company’swholly-owned

7

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subsidiary, Phoenix Manufacturing, Inc. (PMI) of Phoenix, Arizona.Concrete, Aggregates and Construction Supplies are offered from numerouslocations along the Front Range of Colorado operated by the Company’swholly-owned subsidiaries Castle Concrete Company and Transit Mix Concrete Co.,of Colorado Springs, Transit Mix of Pueblo, Inc. of Pueblo and RockyMountain Ready Mix Concrete, Inc. (RMRM) of Denver.

Doors are fabricated and sold along with the related hardware from theCompany’s wholly-owned subsidiary, McKinney Door and Hardware, Inc. ofPueblo, Colorado.

In addition to the above reporting segments, an “Unallocated Corporate”classification is used to report the unallocated expenses of the corporateoffice which provides treasury, insurance and tax services as well as strategicbusiness planning and general management services and an “Other” classificationis used to report a small real estate operation. Expenses related to thecorporate information technology group are allocated to all locations,including the corporate office.

FinancialCondition

Salesof the Company’s HVAC products are seasonal and weather sensitive except forfan coils. Revenues in the Company’s Concrete, Aggregates and ConstructionSupplies segment are influenced by the level of construction activity andweather conditions along the Front Range of Colorado. Sales for the Doorsegment are not as strongly seasonal nor are they much affected by weatherconditions. Historically, the Company has experienced operating losses duringthe first quarter except when the weather is mild along the Front Range.Operating results typically improve in the second and third quarters reflectingmore favorable weather conditions in Colorado and the seasonal sales ofEvaporative Cooling segment. 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 half of the year reflecting operating results, theuse of sales dating programs (extended payment terms) related to theEvaporative Cooling segment and payments of the prior year’s accrued incentivebonuses and Company profit-sharing contributions. As a result, the Company’sborrowings against its revolving credit facility tend to peak during the secondquarter and then decline over the remainder of the year. This trend hascontinued thus far in 2006.

Asexpected, the Company’s cash flow during the first quarter was negative due tothe seasonality of sales, production schedules and the sales dating programsrelated to the evaporative cooler product line. Operations for the first threemonths of 2006 used $5,684,000 of cash compared to $1,745,000 during the firstthree months of 2005.

Thereduced cash flow was primarily the result of an increase in receivables as aresult of the increased sales during the first quarter of 2006 as compared tothe comparable 2005 quarter.

OnJanuary 1, 2006 the Company purchased the assets of CSSL, a company inColorado Springs offering electronic access and locking capabilities, for$352,000 in cash. The assets were acquired by MDHI in the Door segment. Thepurchase price allocation included $100,000 of goodwill and $100,000 for anon-compete agreement. Capital expenditures, primarily for the Concrete,Aggregates and Construction Supplies segment, were comparable in amount to theprior year’s quarter and included an office building in Pueblo and routineequipment replacements.

Scheduleddebt repayments were made during the first quarter of both 2006 and 2005. Asexpected, the Company, borrowed against its revolving credit facility duringthe 2006 first quarter. The highest amount of Company borrowings outstandingunder the revolving credit agreement during the first quarter of 2006 was the$1,000,000 outstanding at April 1, 2006 and the average amount outstandingduring the first quarter was $27,000.

Webelieve that the anticipated cash flow from operations, supplemented by fundsas provided by the Fourth Amendment to Revolving Credit and Term Loan Agreement(see Note 9), will be sufficient to cover expected cash needs, including businessexpansion, servicing debt and planned capital expenditures for at least thenext twelve months.

Results of Operations - Comparison of Quarter Ended April 1,2006 to Quarter Ended April 2, 2005

Consolidatedsales during the first quarter of 2005 were $33,684,000 resulting in a $420,000operating loss. In the first quarter of 2005 sales were $29,757,000 with anoperating loss of $338,000. Historically, the

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Companyhas experienced operating losses during the first quarter except when theconstruction activity is strong and the weather is mild along the Front Rangein Colorado.

Althoughall segments reported increased sales, the Concrete, Aggregates andConstruction Supplies segment was responsible for most of the increase. Cost ofsales as a percentage of sales decreased slightly from 83.2% to 83.1% primarilydue to concrete price increases that slightly outpaced increased costs ofcement and fuel. Selling and administrative costs increased $826,000 largelydue to additional personnel in the sales and engineering departments of theHeating and Cooling segment. Some of the increase was also related to theincreased sales level. The resulting operating loss of $420,000 exceeded theprior year’s operating loss of $338,000.

Adiscussion of operations by segment follows.

**Construction Products**

The table below presents a summary of operating information for the tworeportable segments within the Construction Products group for the quartersended April 1, 2006 and April 2, 2005 (amounts in thousands):

 

|                                          | ** ** | **Concrete,  Aggregates and  Construction  Supplies** | ** ** | **Doors** | ** ** |
|------------------------------------------|------------|------------------------------------------------------------|------------|-----------|------------|
| Quarter ended  April 1, 2006        |       |                                                       |       |      |       |
| Revenues from external  customers        |       | $                                                          | 20,085     |      | $          | 2,139 |   |
| Segment operating  income                |       | 75                                                         |       | 138       |       |
| Operating income as a  percent of sales  |       | .4                                                         | %          | 6.5       | %          |
| Segment assets as of  April 1, 2006 |       | $                                                          | 48,387     |      | $          | 3,854 |   |
| Return on assets                         |       | .2                                                         | %          | 3.6       | %          |
|                                     |       |                                                       |       |      |       |
| Quarter ended  April 2, 2005        |       |                                                       |       |      |       |
| Revenues from external  customers        |       | $                                                          | 17,010     |      | $          | 1,968 |   |
| Segment operating  (loss) income         |       | (365                                                       | )          | 229       |       |
| Operating income as a  percent of sales  |       | (2.1                                                       | )%         | 11.6      | %          |
| Segment assets as of  April 2, 2005 |       | $                                                          | 49,082     |      | $          | 3,513 |   |
| Return on assets                         |       | (.7                                                        | )%         | 6.5       | %          |

 

Concrete, Aggregates andConstruction Supplies Segment

Salesin the Concrete, Aggregates and Construction Supplies segment for the firstquarter of 2006 increased 18.1% over the prior year’s comparable quarter as aresult of increased volume and improved pricing. Concrete and aggregatesvolumes improved as construction activity increased along the Front Range ofColorado; weather was favorable during the first quarter of 2006. Althoughconcrete pricing improved during the first quarter of 2006, the increases wereinstituted to offset increased cement and fuel costs. Cement supplies remainedtight during the 2006 quarter; however, we were able to obtain sufficientquantities to service our customers. Construction supplies volume and marginsdeclined in the 2006 quarter compared to the 2005 quarter primarily due to anincreased level of competition.

Operatingincome improved in the 2006 quarter over the 2005 quarter as a result of theincrease in volumes combined with pricing increases that slightly outpacedincreased costs. Depreciation, depletion and amortization as well as sellingand administrative costs declined as a percentage of sales during the firstquarter of 2006 as compared to the 2005 quarter reflecting the fixed nature ofsome of these costs, adding to the improved operating income. As a result, bothoperating income as a percent of sales and return on assets improved in the2006 quarter over the prior year’s quarter.

Door Segment

Salesduring the first quarter of 2006 in the Door segment rose 8.7% over thecomparable 2005 quarter primarily due to additional business resulting from theacquisition of the assets of CSSL. Sales prices increased in response toincreased costs, however, margins declined as a result of pricing decisionsmade in response to more competitive bidding on available jobs.

Operatingincome declined from $229,000 during the first quarter of 2005 to $138,000 forthe 2006 quarter as a result of the tighter margins and slight increases inboth depreciation and amortization and selling and

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administrativecosts. As a result, both operating income as a percent of sales and return onassets declined in the 2006 quarter from the prior year’s quarter.

**HVAC Products**

The table below presentsa summary of operating information for the two reportable segments within theHVAC products group for the quarters ended April 1, 2006 and April 2,2005 (amounts in thousands):

 

|                                                | ** ** | **Heating and  Cooling** | ** ** | **Evaporative  Cooling** | ** ** |
|------------------------------------------------|------------|-------------------------------|------------|--------------------------|------------|
| Quarter ended  April 1, 2006              |       |                          |       |                     |       |
| Revenues from external  customers              |       | $                             | 6,586      |                     | $          | 4,788 |   |
| Segment operating  income (loss)               |       | 205                           |       | (27                      | )          |
| Operating income (loss)  as a percent of sales |       | 3.1                           | %          | (.6                      | )%         |
| Segment assets as of  April 1, 2006       |       | $                             | 16,134     |                     | $          | 15,832 |   |
| Return on assets                               |       | 1.3                           | %          | (.2                      | )%         |
|                                           |       |                          |       |                     |       |
| Quarter ended  April 2, 2005              |       |                          |       |                     |       |
| Revenues from external  customers              |       | $                             | 6,237      |                     | $          | 4,456 |   |
| Segment operating  income                      |       | 602                           |       | (8                       | )          |
| Operating income as a  percent of sales        |       | 9.7                           | %          | (.2                      | )%         |
| Segment assets as of  April 2, 2005       |       | $                             | 14,181     |                     | $          | 17,242 |   |
| Return on assets                               |       | 4.2                           | %          | —                   | %          |

 

Heating and CoolingSegment

Sales in the Heating and Cooling segment increased $349,000, or 5.6%,during the first quarter of 2006 over the comparable 2005 quarter. Furnacevolume was responsible for the increase as sales remained strong through March.Fan coil volume declined as a result of restructuring the sales representativenetwork over the past six months which caused some short-term disruption inbidding on jobs. Pricing remained relatively constant.

Operating income declined from $602,000 during the first quarter of2005 to $205,000 for the 2006 quarter as a result of increased selling andadministrative expenses. These costs were higher due to the addition ofpersonnel in the sales and engineering departments and the opening of a salesand service center in Oklahoma City, Oklahoma. As a result, both operatingincome as a percent of sales and return on assets declined in the 2006 quarterfrom the prior year’s quarter.

Evaporative CoolingSegment

Sales in the Evaporative Cooling segment increased $332,000, or 7.5%,during the first quarter of 2006 over the comparable 2005 quarter. Hot, dryweather in the markets served prompted the improved sales.

The operating loss grew slightly during the 2006 quarter as the cost ofsales percentage increased from the comparable 2005 quarter. A decrease inlabor efficiency, largely due to the use of more temporary workers, resulted inhigher production costs. Depreciation and amortization and selling andadministrative expenses increased modestly during the 2006 quarter but declinedas a percentage of sales compared to the first quarter of 2005. As a result,both operating income as a percent of sales and return on assets declined inthe 2006 quarter from the prior year’s quarter.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The condensedconsolidated financial statements have been prepared in accordance withaccounting principles generally accepted in the United States which require theCompany to make estimates and assumptions that affect the reported amounts ofassets and liabilities and disclosure of contingent assets and liabilities asof April 1, 2006 and December 31, 2005 and affect the reportedamounts of revenues and expenses for the periods reported. Actual results coulddiffer from those estimates.

Information withrespect 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 iscontained  in Item 7, Management’sDiscussion and Analysis of Financial Condition and Results of Operations, ofthe Company’s Annual Report on Form 10-K for the fiscal year ended December 31,2005.

 

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OUTLOOK

Concrete prices throughout our Colorado markets have improved comparedto 2005 although a substantial portion of the price increase was in response tohigher prices paid for cement and fuel. We expect the Denver concrete market toremain very competitive and a small new concrete producer in Colorado Springsis pursuing large home-builders with an aggressive pricing strategy. Commercialand industrial construction seems to be improving. There is some concern thatnew home construction may slow throughout Colorado, in part due to highermortgage interest rates. The sales volume and backlog for the door segmentremains strong.

Sales of the heating and cooling segment and the evaporative coolingsegment are not expected to grow significantly and will remain weathersensitive. However, the demand for fan coil products in the heating and coolingsegment is expected to show some improvement from the rather depressed levelsof recent years.

RECENTLY ISSUED ACCOUNTING STANDARDS

The Companydiscusses recently issued accounting standards and tax law changes in theCritical Accounting Policies section under Item 7 and in Note 1 to ConsolidatedFinancial Statements in Item 8 of the Company’s Annual Report on Form 10-Kfor the fiscal year 2005. Other than as discussed in those sections, or asnoted below, the Company does not currently have any transactions orcircumstances that have been addressed by recently issued accountingpronouncements. Therefore, adoption of any of these statements orpronouncements would not have a material impact on the Company’s results ofoperations, financial position or liquidity.

In November 2004,Statement of Financial Accounting Standards (SFAS) No. 151, “InventoryCosts - An Amendment of ARB No. 43, Chapter 4,” was issued which amendsthe guidance in Accounting Research Bulletin (“ARB”) No. 43, Chapter 4, “InventoryPricing,” to clarify the accounting for abnormal amounts of idle facilityexpense, freight, handling costs, and wasted material. Among other provisions,the new rule requires that items such as idle facility expense, excessivespoilage, double freight and rehandling costs be recognized as current -periodcharges regardless of whether they meet the criteria of “so abnormal” as statedin ARB No. 43. Additionally, SFAS 151 requires the allocation of fixedproduction overheads to the costs of conversion be based on the normal capacityof the production facilities. SFAS 151 is effective for fiscal years beginningafter June 1, 2005. The Company adopted this standard in the first quarterof fiscal 2006 and such adoption did not have a material impact on itsconsolidated results of operations, cash flows or financial condition.

In March 2005, theEmerging Issues Task Force reached a consensus on Issue 04-6, “Accountingfor Stripping Costs in the Mining Industry” (EITF 04-6) which becameeffective on January 1, 2006. EITF 04-6 states that stripping costsincurred after the first saleable minerals are extracted from the mine (i.e.post-production stripping costs) should be considered costs of the extractedminerals and recognized as a component of inventory to be recognized in costsof sales in the same period as the revenue from the sale of the inventory. Asdisclosed in the Company’s 2005 Annual Report on Form 10-K, theCompany has historically treated post-production stripping costs in the mannerprescribed by EITF 04-6 and, therefore, adoption of EITF 04-6 inthe first quarter of fiscal 2006 did not have a material impact on the Company’sconsolidated results of operations, cash flows or financial condition.

The Company hasdetermined 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 2006, a preliminary estimate of thededuction was included in the determination of the tax provision.

FORWARD-LOOKINGSTATEMENTS

The foregoing discussion contains forward-looking statements within themeaning of Section 27A of the Securities Act of 1933, as amended. Suchforward-looking statements are based on the beliefs of the Company’s managementas well as on assumptions made by and information available to the Company atthe 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

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these factors are discussed in more detail in the Company’s 2005 AnnualReport on Form 10-K. Changes in accounting pronouncements could alsoalter projected results. Forward-looking statements speak only as of the datethey were made, and the Company undertakes no obligation to publicly updatethem.

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

There have been no material changes in themarket risks that the Company is exposed to since those discussed in theCompany’s 2005 Annual Report on Form 10-K. At April 1, 2006,the amount subject to the interest rate swap agreement was $3,000,000. Also seeNote 8 to the quarterly financial statements above.

**Item 4.        Controlsand Procedures**

(a)            DisclosureControls 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 theSecurities Exchange Act of 1934, as amended) as of April 1, 2006. Based onthat evaluation, they have concluded that the Company’s disclosure controls andprocedures were not effective because the Company lacked a process to ensurethat all relevant information specified in Statement of Financial AccountingStandards No. 131, “Disclosures about Segments of an Enterprise andRelated Information” (SFAS 131) was evaluated to ensure that its segmentreporting included in the Notes to the Consolidated Financial Statements waspresented in accordance with SFAS 131. Due to the fact that this process didnot exist as of April 1, 2006, the Company performed additional proceduressubsequent to April 1, 2006 to ensure that its segment disclosuresincluded in this quarterly report are in compliance with SFAS 131. Suchprocedures included evaluating and analyzing internal management reporting,economic characteristics and other factors specified in SFAS 131.

The process noted above related to segmentreporting did not exist as of December 31, 2005 and, as a result, theCompany disclosed in its 2005 Annual Report on Form 10-K that amaterial weakness existed in the Company’s design of internal control overfinancial reporting. To address this material weakness, the Company designedand implemented a process during the second quarter in which the Company’sChief Financial Officer and Chief Accounting Officer discuss, evaluate andanalyze changes in internal management reporting, economic characteristics andother factors specified in SFAS 131 as they occur to determine whether any ofthe changes affect segment reporting on a quarterly basis in accordance withSFAS 131.

(b)           Changesin Internal Control Over Financial Reporting.

There have been nosignificant changes in the Company’s internal control over financial reportingidentified in connection with the evaluation of such changes in internalcontrol over financial reporting that occurred during the last fiscal quarterthat have materially affected, or are reasonably likely to materially affect,the Company’s internal control over financial reporting, except as describedabove.

PART II -OTHER INFORMATION

**Item 2.        Unregistered Sales of Equity Securitiesand Use of Proceeds**

There were no purchases made by the Company of its common stock tobecome treasury stock for the period January 1 through April 1, 2006.

On January 19, 1999, the Company initiated purchases under thecurrent open-ended program to repurchase its common stock. Purchases are madeon the open market or in block trades at the discretion of management. Thedollar amount authorized for the program has been periodically increased by theBoard of Directors and approved by the Company’s two banks as required by theCompany’s Revolving Credit and Term Loan Agreement. The June 28, 2005amendment to the Loan Agreement provides that the Company may make purchases ofits own stock in an amount not to exceed $1,438,000, separate from purchasesmade in connection with the 2005 tender offer and the exercise of cash-lessstock options. At April 1, 2006, the maximum dollar value of shares thatmay yet be purchased under the program was $1,418,942.

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**Item 6.        Exhibits**

| Exhibits         |   |                                                                                                                                                                                                                                                        |
|------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |   |                                                                                                                                                                                                                                                        |
| Exhibit No. |   | Description                                                                                                                                                                                                                                                 |   |   |
|             |   |                                                                                                                                                                                                                                                        |
| 31.1             |   | Certification of Chief  Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) and  Rule 13a-14(d)/15d-14(d) 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)/15d-14(a) and  Rule 13a-14(d)/15d-14(d) 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                                                            |

 

SIGNATURE

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                           |   |   | CONTINENTAL MATERIALS CORPORATION |
|---------------------------|--------|--------|-----------------------------------|
|                      |   |   |                              |
|                      |   |   |                              |
| Date: July 14,  2006 |   | By:    | /s/ JOSEPH J.  SUM                |
|                      |   |   | Joseph J. Sum, Vice President     |
|                      |   |   | and Chief Financial Officer       |

 

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