**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

**ý****QUARTERLY REPORT PURSUANT TO SECTION 13OR**

**15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

Forthe quarterly period ended**October 1, 2005**

 

**OR**

 

**o****TRANSITION REPORT PURSUANT TO SECTION 13OR**

**15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thetransition 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 |       | (I.R.S. Employer Identification No.) |
| incorporation or organization)  |       |                                 |

 

**200 South Wacker Drive, Suite 4000, Chicago,Illinois  60606**

(Address of principal executive offices)

(Zip Code)

 

**(312) 541-7200**

(Registrant’s telephonenumber, including area code)

 

 

(Former name, former address and former fiscal

year, if changed since last report)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

 

ý   Yes       o   No

 

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

 

o   Yes       ý   No

 

Indicate by  check mark whether the registrant is a shellcompany (as defined in Rule 12b-2 of the Exchange Act).

 

o   Yes       ý   No

 

Numberof common shares outstanding at November 7, 2005                                                                                                                                                                                                                                                                                                                                             1,605,461

 

 

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PART I – FINANCIAL INFORMATION

 

**Item1.   Financial Statements**

 

CONTINENTAL MATERIALS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

OCTOBER 1, 2005 and JANUARY 1, 2005

(Unaudited)

(000’s omitted except share data)

 
| ** **                                                                                   | ** ** | **OCTOBER 1,** | ** ** | **JANUARY 1,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------|------------|---------------------|------------|
| ** **                                                                                   | ** ** | **2005**            | ** ** | **2005**            | ** ** |
| ***ASSETS***                                                                                 | ** ** | ** **          | ** ** | ** **          | ** ** |
| Current assets:                                                                              |       |                |       |                |       |
| Cash and cash  equivalents                                                                   |       | $                   | 2,497      |                | $          | 2,828 |   |
| Receivables, net                                                                             |       | 20,293              |       | 18,418              |       |
| Receivable for  insured losses                                                               |       | 2,118               |       | 4,466               |       |
| Inventories:                                                                                 |       |                |       |                |       |
| Finished goods                                                                               |       | 8,206               |       | 7,343               |       |
| Work in process                                                                              |       | 1,362               |       | 1,684               |       |
| Raw materials  and supplies                                                                  |       | 8,819               |       | 7,582               |       |
| Prepaid expenses                                                                             |       | 3,909               |       | 3,559               |       |
| Total current  assets                                                                        |       | 47,204              |       | 45,880              |       |
|                                                                                         |       |                |       |                |       |
| Property, plant and equipment, net                                                           |       | 29,796              |       | 30,033              |       |
|                                                                                         |       |                |       |                |       |
| Goodwill                                                                                     |       | 7,374               |       | 7,374               |       |
| Non-compete agreements                                                                       |       | 784                 |       | 953                 |       |
| Other assets                                                                                 |       | 1,393               |       | 1,643               |       |
|                                                                                         |       |                |       |                |       |
|                                                                                         |       | $                   | 86,551     |                | $          | 85,883 |   |
|                                                                                         |       |                |       |                |       |
| ***LIABILITIES***                                                                            |       |                |       |                |       |
| Current liabilities:                                                                         |       |                |       |                |       |
| Current portion  of long-term debt                                                           |       | $                   | 2,000      |                | $          | 2,000 |   |
| Accounts payable  and accrued expenses                                                       |       | 15,506              |       | 14,239              |       |
| Liability for  unpaid claims covered by insurance                                            |       | 2,118               |       | 4,466               |       |
| Income taxes                                                                                 |       | —              |       | 767                 |       |
| Total current  liabilities                                                                   |       | 19,624              |       | 21,472              |       |
|                                                                                         |       |                |       |                |       |
| Long-term debt                                                                               |       | 10,500              |       | 7,000               |       |
| Deferred income taxes                                                                        |       | 3,796               |       | 3,796               |       |
| Other long-term liabilities                                                                  |       | 2,361               |       | 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                                                               |       | 1,874               |       | 1,982               |       |
| Retained earnings                                                                            |       | 64,268              |       | 62,573              |       |
| Accumulated other comprehensive losses (interest  rate swap adjustments)                     |       | (2                  | )          | (67                 | )          |
| Treasury shares, 968,803 and 923,850, at cost                                                |       | (16,513             | )          | (13,683             | )          |
|                                                                                         |       | 50,270              |       | 51,448              |       |
|                                                                                         |       |                |       |                |       |
|                                                                                         |       | $                   | 86,551     |                | $          | 85,883 |   |

 

See accompanying notes

 

2

----

 

CONTINENTAL MATERIALS CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS ANDRETAINED EARNINGS

FOR THE THREE MONTHS ENDED OCTOBER 1,2005 AND OCTOBER 2, 2004

(Unaudited)

(000’s omitted except per-share amounts)

 
| ** **                                                             | ** ** | **OCTOBER 1,  2005** | ** ** | **OCTOBER 2,  2004** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
|                                                                   |       |                      |       |                      |       |
| Sales                                                                  |       | $                         | 36,415     |                      | $          | 30,900 |   |
|                                                                   |       |                      |       |                      |       |
| Costs and expenses:                                                    |       |                      |       |                      |       |
| Cost of sales  (exclusive of depreciation, depletion and amortization) |       | 29,325                    |       | 24,736                    |       |
| Depreciation,  depletion and amortization                              |       | 1,201                     |       | 1,421                     |       |
| Selling and  administrative                                            |       | 4,337                     |       | 3,756                     |       |
|                                                                   |       |                      |       |                      |       |
| Gain on disposition of property and equipment                          |       | —                    |       | 24                        |       |
|                                                                   |       | 34,863                    |       | 29,889                    |       |
|                                                                   |       |                      |       |                      |       |
| Operating income                                                       |       | 1,552                     |       | 1,011                     |       |
|                                                                   |       |                      |       |                      |       |
| Interest                                                               |       | (225                      | )          | (154                      | )          |
| Other income, net                                                      |       | 37                        |       | 59                        |       |
|                                                                   |       |                      |       |                      |       |
| Income before income taxes                                             |       | 1,364                     |       | 916                       |       |
|                                                                   |       |                      |       |                      |       |
| Provision for income taxes                                             |       | 326                       |       | 330                       |       |
|                                                                   |       |                      |       |                      |       |
| Net income                                                             |       | 1,038                     |       | 586                       |       |
|                                                                   |       |                      |       |                      |       |
| Retained earnings, beginning of period                                 |       | 63,230                    |       | 60,676                    |       |
|                                                                   |       |                      |       |                      |       |
| Retained earnings, end of period                                       |       | $                         | 64,268     |                      | $          | 61,262 |   |
|                                                                   |       |                      |       |                      |       |
| Basic earnings per share                                               |       | $                         | .66        |                      | $          | .35 |   |
|                                                                   |       |                      |       |                      |       |
| Average shares  outstanding                                            |       | 1,563                     |       | 1,663                     |       |
|                                                                   |       |                      |       |                      |       |
| Diluted earnings per share                                             |       | $                         | .65        |                      | $          | .34 |   |
|                                                                   |       |                      |       |                      |       |
| Average shares  outstanding                                            |       | 1,596                     |       | 1,699                     |       |
|                                                                   |       |                      |       |                      |       |
| Comprehensive income:                                                  |       |                      |       |                      |       |
| Net income (loss)                                                      |       | $                         | 1,038      |                      | $          | 586 |   |
| Comprehensive income from interest rate swap, net of  tax of $2 and $6 |       | 18                        |       | 8                         |       |
|                                                                   |       | $                         | 1,056      |                      | $          | 594 |   |

 

See accompanying notes

 

3

----

 

CONTINENTAL MATERIALS CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS ANDRETAINED EARNINGS

FOR THE NINE MONTHS ENDED OCTOBER 1, 2005AND OCTOBER 2, 2004

(Unaudited)

(000’s omitted except per-share amounts)

 
| ** **                                                               | ** ** | **OCTOBER 1,** | ** ** | **OCTOBER 2,** | ** ** |
|--------------------------------------------------------------------------|------------|---------------------|------------|---------------------|------------|
| ** **                                                               | ** ** | **2005**            | ** ** | **2004**            | ** ** |
|                                                                     |       |                |       |                |       |
| Sales                                                                    |       | $                   | 104,445    |                | $          | 92,724 |   |
|                                                                     |       |                |       |                |       |
| Costs and expenses:                                                      |       |                |       |                |       |
| Cost of sales  (exclusive of depreciation, depletion and amortization)   |       | 84,668              |       | 74,595              |       |
| Depreciation,  depletion and amortization                                |       | 3,632               |       | 4,040               |       |
| Selling and  administrative                                              |       | 13,744              |       | 12,269              |       |
|                                                                     |       |                |       |                |       |
| Gain on disposition of property and equipment                            |       | 115                 |       | 242                 |       |
|                                                                     |       | 101,929             |       | 90,662              |       |
|                                                                     |       |                |       |                |       |
| Operating income                                                         |       | 2,516               |       | 2,062               |       |
|                                                                     |       |                |       |                |       |
| Interest                                                                 |       | (515                | )          | (465                | )          |
| Other income, net                                                        |       | 107                 |       | 63                  |       |
|                                                                     |       |                |       |                |       |
| Income before income taxes                                               |       | 2,108               |       | 1,660               |       |
|                                                                     |       |                |       |                |       |
| Provision for income taxes                                               |       | 413                 |       | 598                 |       |
|                                                                     |       |                |       |                |       |
| Net income                                                               |       | 1,695               |       | 1,062               |       |
|                                                                     |       |                |       |                |       |
| Retained earnings, beginning of period                                   |       | 62,573              |       | 60,200              |       |
|                                                                     |       |                |       |                |       |
| Retained earnings, end of period                                         |       | $                   | 64,268     |                | $          | 61,262 |   |
|                                                                     |       |                |       |                |       |
| Basic earnings per share                                                 |       | $                   | 1.06       |                | $          | .63 |   |
|                                                                     |       |                |       |                |       |
| Average shares  outstanding                                              |       | 1,601               |       | 1,690               |       |
|                                                                     |       |                |       |                |       |
| Diluted earnings per share                                               |       | $                   | 1.03       |                | $          | .62 |   |
|                                                                     |       |                |       |                |       |
| Average shares  outstanding                                              |       | 1,643               |       | 1,726               |       |
|                                                                     |       |                |       |                |       |
| Comprehensive income:                                                    | ** ** | ** **          | ** ** | ** **          | ** ** |
| Net income                                                               |       | $                   | 1,695      |                | $          | 1,062 |   |
| Comprehensive income from interest rate swap, net of  tax of $41 and $56 |       | 65                  |       | 153                 |       |
|                                                                     |       | $                   | 1,760      |                | $          | 1,215 |   |

 

See accompanying notes

 

4

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CONTINENTAL MATERIALS CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED OCTOBER 1, 2005AND OCTOBER 2, 2004

(Unaudited)

(000’s omitted)

 
| ** **                                    | ** ** | **OCTOBER 1,  2005** | ** ** | **OCTOBER 2,  2004** | ** ** |
|-----------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                    | ** ** | ** **                | ** ** | ** **                | ** ** |
| Net cash provided by operating activities     |       | $                         | 2,869      |                      | $          | 1,413 |   |
|                                          |       |                      |       |                      |       |
| Investing activities:                         |       |                      |       |                      |       |
| Capital  expenditures                         |       | (3,239                    | )          | (3,178                    | )          |
| Proceeds from  sale of property and equipment |       | 130                       |       | 346                       |       |
| Net cash used in investing activities         |       | (3,109                    | )          | (2,832                    | )          |
|                                          |       |                      |       |                      |       |
| Financing activities:                         |       |                      |       |                      |       |
| Borrowings under  revolving credit facility   |       | —                    |       | 100                       |       |
| Long-term  borrowings                         |       | 5,000                     |       | —                    |       |
| Repayment of  long-term debt                  |       | (1,500                    | )          | (1,470                    | )          |
| Proceeds from  exercise of stock options      |       | 488                       |       | —                    |       |
| Payment to  acquire treasury stock            |       | (4,079                    | )          | (1,820                    | )          |
| Net cash used in financing activities         |       | (91                       | )          | (3,190                    | )          |
|                                          |       |                      |       |                      |       |
| Net decrease in cash and cash equivalents     |       | (331                      | )          | (4,609                    | )          |
| Cash and cash equivalents:                    |       |                      |       |                      |       |
| Beginning of  period                          |       | 2,828                     |       | 4,609                     |       |
|                                          |       |                      |       |                      |       |
| End of period                                 |       | $                         | 2,497      |                      | $          | — |   |
|                                          |       |                      |       |                      |       |
| Supplemental disclosures of cash flow items:  |       |                      |       |                      |       |
| Cash paid during the nine months for:         |       |                      |       |                      |       |
| Interest                                      |       | $                         | 626        |                      | $          | 516 |   |
| Income taxes                                  |       | 573                       |       | 695                       |       |

 

See accompanying notes

 

5

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CONTINENTAL MATERIALS CORPORATION

SECURITIES AND EXCHANGE COMMISSION FORM 10-Q

NOTES TO THE QUARTERLY CONSOLIDATED FINANCIAL STATEMENTS

QUARTER ENDED OCTOBER 1, 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 fair statementof the results for the interim periods.

 

2.               Theprovision for income taxes for fiscal 2005 is projected to be 24% whichincludes the estimated impact of the American Jobs Creation Act of 2004. The effectivetax rate for the quarter ended October 1, 2005 was 24% reflecting theeffect of the release of certain tax contingencies during the third quarterrelated to the closure of income tax audits. The effective tax rate for thenine months ended October 1, 2005 was 20% primarily due to the release ofcertain tax contingencies during the second and third quarters related to theclosure of income tax audits.

 

3.               Operatingresults for the first nine 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 nine months ended October 1, 2005and October 2, 2004 (amounts in thousands except per-share data).

 
| ** **                 | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|----------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **Income**             | ** ** | **Shares**            | ** ** | **Per-share  earnings** | ** ** | **Income** | ** ** | **Shares** | ** ** | **Per-share  earnings** | ** ** |
| October 1, 2005       |       |                   |       |                  |       |   |   |   |   |   |   |   |   |
| Basic EPS                  |       | $                      | 1,038      |                  | 1,563      |   | $ | .66 |   | $ | 1,695 |   | 1,601 |   | $ | 1.06 |   |
| Effect of dilutive options |       | —                 |       | 33                    |       |   |   | — |   | 42 |   |   |   |
| Diluted EPS                |       | $                      | 1,038      |                  | 1,596      |   | $ | .65 |   | $ | 1,695 |   | 1,643 |   | $ | 1.03 |   |
|                       |       |                   |       |                  |       |   |   |   |   |   |   |   |   |
| October 2, 2004       |       |                   |       |                  |       |   |   |   |   |   |   |   |   |
| Basic EPS                  |       | $                      | 586        |                  | 1,663      |   | $ | .35 |   | $ | 1,062 |   | 1,690 |   | $ | .63 |   |
| Effect of dilutive options |       | —                 |       | 36                    |       |   |   | — |   | 36 |   |   |   |
| Diluted EPS                |       | $                      | 586        |                  | 1,699      |   | $ | .34 |   | $ | 1,062 |   | 1,726 |   | $ | .62 |   |

 

5.               OnJune 28,****2005, the Company entered intothe Third Amendment (Amendment) to Revolving Credit and Term Loan Agreement(Loan Agreement) dated September 5, 2003, as amended as of May 29,2004 and April 14, 2005. The Amendment increases the principal amount ofthe term loan portion of the Loan Agreement by $5 million. With the increase inthe term loan amount, the total loan commitment was $23.5 million.

 

TheLoan Agreement provides that, at the Company’s option, the term loan andrevolving credit facility will bear interest at prime or a performance-basedLIBOR rate. Based on the terms of the Amendment, the increase in the term loanand the Company’s performance for the twelve months ended October 1, 2005,the performance based rates would be LIBOR plus 1.50% for the term loan andLIBOR plus 1.25% for borrowings under the revolving credit facility.****Payment of accrued interest is due and payable quarterly bythe Company. Payments of principal under the term loan are payable on aquarterly basis, ending on March 31, 2011.

 

Theproceeds of the term loan facility were primarily used to fund the purchase ofthe Company’s stock under the recently completed modified Dutch auction tenderoffer and to pay related fees and expenses. The Amendment also reset the amountauthorized for the repurchase of the Company’s own stock to $1,438,000,

 

6

----

 

separatefrom purchases made in connection with the tender offer. All other materialterms of the Loan Agreement remain in force, except to the extent they havebeen modified by the Amendment.

 

6.               Thefollowing table presents information about the Company’s reported segments forthe nine- and three-month periods ended October 1, 2005 and October 2,2004 (segment assets presented as of October 1, 2005 and October 2,2004) along with the items necessary to reconcile the segment information tothe totals reported in the financial statements (amounts in thousands).

 
| ** **                       | ** ** | **Heating and Air** | ** ** | **Construction** | ** ** | ** **    | ** ** | **Unallocated** | ** ** | ** ** | ** ** |
|----------------------------------|------------|---------------------|------------|------------------|------------|---------------|------------|-----------------|------------|------------|------------|
| ** **                       | ** ** | **Conditioning**    | ** ** | **Materials**    | ** ** | **All Other** | ** ** | **Corporate**   | ** ** | **Total**  | ** ** |
| 2005                             |       |                |       |             |       |          |       |            |       |       |       |
| Nine Months                      |       |                |       |             |       |          |       |            |       |       |       |
| Revenues from external customers |       | $                   | 35,376     |             | $          | 68,811        |       | $               | 258        |       | $          | — |   | $ | 104,445 |   |
| Segment operating income (loss)  |       | 1,536               |       | 3,504            |       | 70            |       | (2,594          | )          | 2,516      |       |
| Segment assets                   |       | 28,505              |       | 53,139           |       | 4             |       | 4,903           |       | 86,551     |       |
| Three Months                     |       |                |       |             |       |          |       |            |       |       |       |
| Revenues from external customers |       | 10,871              |       | 25,458           |       | 86            |       | —          |       | 36,415     |       |
| Segment operating income (loss)  |       | 504                 |       | 1,773            |       | 27            |       | (752            | )          | 1,552      |       |
|                             |       |                |       |             |       |          |       |            |       |       |       |
| 2004                             |       |                |       |             |       |          |       |            |       |       |       |
| Nine Months                      |       |                |       |             |       |          |       |            |       |       |       |
| Revenues from external customers |       | $                   | 33,182     |             | $          | 59,282        |       | $               | 258        |       | $          | 2 |   | $ | 92,724 |   |
| Segment operating (loss) income  |       | 1,767               |       | 2,835            |       | 66            |       | (2,606          | )          | 2,062      |       |
| Segment assets                   |       | 27,956              |       | 51,498           |       | 264           |       | 1,917           |       | 81,635     |       |
| Three Months                     |       |                |       |             |       |          |       |            |       |       |       |
| Revenues from external customers |       | 9,070               |       | 21,744           |       | 86            |       | —          |       | 30,900     |       |
| Segment operating income (loss)  |       | 210                 |       | 1,539            |       | 27            |       | (765            | )          | 1,011      |       |

 

There are no differencesin the basis of segmentation or in the basis of measurement of segment profitor 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 October 1,2005 was as follows (amounts in thousands):

 
| 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 | )      |
| Comprehensive income from interest rate swap, net of  tax of ($13) |   | 18  |   |
| Balance at October 1, 2005                                    |   | $   | 2      |   |

 

7

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**Item 2.**                                   Management’s Discussion and Analysis ofFinancial Condition and Results of Operations

** **

CompanyOverview

 

TheCompany operates primarily in two industry segments, the heating and airconditioning segment and the construction materials segment. The primaryproducts manufactured by the heating and air conditioning segment are gas-firedwall furnaces, console heaters, evaporative coolers and fan coils. Gas-fired wallfurnaces, console heaters and fan coil products are manufactured at WilliamsFurnace Co., headquartered in Colton, California. Evaporative coolers aremanufactured at Phoenix Manufacturing, Inc., based in Phoenix, Arizona.The primary products of the construction materials segment are ready mixconcrete, construction aggregates, building supplies and doors, which areoffered by Transit Mix Concrete Co. and Castle Concrete Company in ColoradoSprings, Colorado and Transit Mix of Pueblo, Inc. and McKinney Door andHardware, Inc. in Pueblo, Colorado. Currently, Rocky Mountain Ready Mix Concrete, Inc. of Denver,Colorado, only offers ready mix concrete.

 

FinancialCondition 

 

TheCompany’s heating and air conditioning businesses are seasonal and weather sensitiveexcept for sales of fan coils. Revenues in the Company’s construction materialssegment are influenced by weather conditions along the Front Range of Colorado.Historically, the Company has experienced operating losses during the firstquarter except when the weather is mild along the Front Range. Operatingresults typically improve in the second and third quarters reflecting morefavorable weather conditions in Colorado and the seasonal sales of evaporativecoolers. Fourth quarter results can vary based on weather conditions inColorado as well as in the principal markets for the Company’s heatingequipment. The Company typically experiences operating cash flow deficitsduring the first and second quarters of the year reflecting operating results,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 nine months of 2005 provided $2,869,000 of cash compared to $1,413,000during the first nine months of 2004. By segment, operating cash flow was asfollows (amounts in thousands):

 
| ** **                     | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|
| Construction materials segment |       | $        | 3,391      |     | $          | 1,752 |   |
| Heating and air conditioning   |       | 1,826    |       | 2,506    |       |
| Corporate and Other            |       | (2,348   | )          | (2,845   | )          |
| Total                          |       | $        | 2,869      |     | $          | 1,413 |   |

 

Theimproved cash flow in the construction materials segment was primarily theresult of the improved operating results, a smaller increase in accountsreceivable during the first nine months of 2005 compared to the increase duringthe comparable 2004 period and an increase in accruals and payables during thefirst nine months of 2005 compared to a small decrease in payables during thecomparable 2004 period.

 

Thedecrease in cash provided by the heating and air conditioning segment wasprimarily due to reduced operating results as well as a smaller decrease inaccounts receivable during the first nine months of 2005 compared to the decreasein accounts receivable during the comparable 2004 period.

 

Theconstruction materials segment typically requires significant capitalinvestments, particularly when sales volume and demand are strong. Cash spenton capital expenditures during the first nine months of 2005 was comparable tothe 2004 period and was primarily in the construction materials segment.Current year expenditures included the completion of a batch plant in Puebloand a fines recovery system for the Colorado Springs’ sand operation. Expendituresduring 2005 also included the capitalization of subsidized leasehold improvementsin 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 completed during the second quarter, and to pay related fees and expenses.The balance of the additional term loan proceeds has been earmarked forpotential capital projects

 

8

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inthe construction materials segment. Scheduled debt repayments were made duringthe first nine months of both 2005 and 2004.

 

Asexpected, the Company paid off its revolving credit facility during the 2005 thirdquarter. During the first nine months of 2005, the highest amount of Companyborrowings outstanding under the revolving credit agreement was $4,400,000 andthe average amount outstanding was $1,061,000.

 

TheCompany believes that anticipated cash flow from operations, supplemented byseasonal borrowings against the revolving line of credit, (which was unused at October 1,2005) will be sufficient to cover expected cash needs, including servicing debtand planned capital expenditures for at least the next twelve months.

 

Operations– Comparison of Quarter Ended October 1, 2005 to Quarter Ended October 2,2004

 

Historically,the Company has experienced improved operating results during the third quarteras sales in the construction materials segment increase reflecting weather moreconducive to construction activity. The 2005 operating results were consistentwith this trend. A summary of operating information by segment for the quartersended October 1, 2005 and October 2, 2004 is as follows (amounts inthousands):

 
| ** **                             | ** ** | **Quarter ended  October 1, 2005** | ** ** | **Quarter ended  October 2, 2004** | ** ** |
|----------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| Revenues from external customers       |       |                                    |       |                                    |       |
| Heating and air  conditioning          |       | $                                       | 10,871     |                                    | $          | 9,070 |   |
| Construction  materials                |       | 25,458                                  |       | 21,744                                  |       |
|                                   |       |                                    |       |                                    |       |
| Operating income (loss)                |       |                                    |       |                                    |       |
| Heating and air  conditioning          |       | 504                                     |       | 210                                     |       |
| Construction  materials                |       | 1,773                                   |       | 1,539                                   |       |
|                                   |       |                                    |       |                                    |       |
| Assets                                 |       |                                    |       |                                    |       |
| Heating and air  conditioning          |       | 28,505                                  |       | 27,956                                  |       |
| Construction  materials                |       | 53,139                                  |       | 51,498                                  |       |
|                                   |       |                                    |       |                                    |       |
| Operating income as a percent of sales |       |                                    |       |                                    |       |
| Heating and air  conditioning          |       | 4.6                                     | %          | 2.3                                     | %          |
| Construction  materials                |       | 7.0                                     |       | 7.1                                     |       |
|                                   |       |                                    |       |                                    |       |
| Return on assets                       |       |                                    |       |                                    |       |
| Heating and air  conditioning          |       | 1.8                                     | %          | .8                                      | %          |
| Construction  materials                |       | 3.3                                     |       | 3.0                                     |       |
|                                        |            |                                         |            |                                         |            |  |  |

 

Theheating and air conditioning segment reported a $1,801,000 increase in salesfor the third quarter of 2005 compared to the 2004 quarter, or 19.9%. Increasedsales were reported for evaporative coolers and fan coils while furnacesreported a small decline due to warm weather during the current quarter, whichis the early part of their season. The increases represent increased volumes forevaporative coolers and fan coils and price increases for all products reflectingthe pass through of increased steel costs. The increase in evaporative coolersduring the 2005 quarter is attributable to favorable weather conditionsextending into August. Cost of sales as a percentage of sales decreased slightlyfrom 78.9% for the third quarter of 2004 to 77.5% for the 2005 quarter. Withinthe segment the cost of sales percentage for the furnace line declined as 2005pricing recovered the increased steel costs compared to the 2004 quarter inwhich prior year pricing did not anticipate rising steel costs which began duringthe second quarter of 2004. Although fan coil sales volume was higher,reflecting a slight improvement in overall demand, pricing in the fan coil linedid not fully recover the higher steel prices due to competitive pressures and thestill soft market. Pricing in the evaporative cooler line encountered similarcompetitive pressures on selling prices. Depreciation remained relativelyconstant between the third quarter of 2004 and the second quarter of 2005.Selling and administrative costs during the third quarter of 2005 increased asa result of costs incurred related to the replacement of the general manager atWilliams Furnace Co. and the addition of personnel in the sales and engineeringdepartments. The improved operating income was primarily the result of the highermargins in the furnace line. Both operating income as a percent of sales andthe return on assets improved as a result of the improved furnace margin.

 

Salesin the construction materials segment during the third quarter of 2005increased $3,714,000, or 17.1%, over the comparable 2004 quarter. Despite acement shortage in the Colorado ready mix concrete market

 

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duringthe month of September, sales improved due to higher volumes of concrete soldand price increases in response to higher cement and fuel costs. Pricing in theDenver metropolitan market has improved. However, the increase in concreteprices were substantially equal to the higher cost of cement, aggregates andfuel. The Denver ready mix concrete market remains very competitive. Volumesimproved largely as a result of increased construction activity along the FrontRange of Colorado. The decline in sales at McKinney Door and Hardware duringthe second quarter of 2005 compared to the second quarter of 2004 was more thanmade up for during the third quarter of 2005. The sales of this company’sproducts can vary significantly from month-to-month reflecting the accelerationor deferral of delivery by McKinney’s customers due to construction schedules.McKinney’s sales order input has remained stable. Cost of sales in the constructionmaterials segment as a percentage of sales increased slightly from 80.6% forthe third quarter of 2004 to 81.9% for the 2005 third quarter reflecting thecompetitive market conditions which prevented sales price increases in excessof the material and fuel cost increases. Depreciation, depletion andamortization declined slightly reflecting the effect of reduced capitalspending in recent years. Selling and administrative costs increased inresponse to the improved sales. The improved operating profit during the thirdquarter of 2005 compared to 2004 was due to the increased profit at McKinneyDoor and Hardware resulting from their higher sales. Operating income as priceincreases largely represented the pass through of increased costs. The returnon assets improved slightly as the percentage increase in operating income washigher than the percentage increase in assets related to the constructionmaterials segment.

 

Netinterest expense was higher due to increased average levels of debt as well as anincrease in the average interest rate for the 2005 third quarter compared tothe third quarter of 2004.

 

Theprovision for income taxes for fiscal 2005 is projected to be 24% whichincludes the estimated impact of the American Jobs Creation Act of 2004. The effectivetax rate for the quarter ended October 1, 2005 was 24% reflectingprimarily the release of certain tax contingencies during the third quarterrelated to the closure of income tax audits.

 

Operations- Comparison of Nine Months Ended October 1, 2005 to Nine Months Ended October 2,2004

 

Asummary of operating information by segment for the nine month periods ended October 1,2005 and October 2, 2004 is as follows (amounts in thousands):

 
| ** **                             | ** ** | **Nine Months ended  October 1, 2005** | ** ** | **Nine Months ended  October 2, 2004** | ** ** |
|----------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| Revenues from external customers       |       |                                        |       |                                        |       |
| Heating and air  conditioning          |       | $                                           | 35,376     |                                        | $          | 33,182 |   |
| Construction  materials                |       | 68,811                                      |       | 59,282                                      |       |
|                                   |       |                                        |       |                                        |       |
| Operating income                       |       |                                        |       |                                        |       |
| Heating and air  conditioning          |       | 1,536                                       |       | 1,767                                       |       |
| Construction  materials                |       | 3,504                                       |       | 2,835                                       |       |
|                                   |       |                                        |       |                                        |       |
| Assets                                 |       |                                        |       |                                        |       |
| Heating and air  conditioning          |       | 28,505                                      |       | 27,956                                      |       |
| Construction  materials                |       | 53,139                                      |       | 51,498                                      |       |
|                                   |       |                                        |       |                                        |       |
| Operating income as a percent of sales |       |                                        |       |                                        |       |
| Heating and air  conditioning          |       | 4.3                                         | %          | 5.3                                         | %          |
| Construction  materials                |       | 5.1                                         |       | 4.8                                         |       |
|                                   |       |                                        |       |                                        |       |
| Return on assets                       |       |                                        |       |                                        |       |
| Heating and air  conditioning          |       | 5.4                                         | %          | 6.3                                         | %          |
| Construction  materials                |       | 6.6                                         |       | 5.5                                         |       |
|                                        |            |                                             |            |                                             |            |  |  |

 

Consolidatedsales during the first nine months of 2005 were $104,445,000 yielding operatingprofit of $2,516,000. In the first nine months of 2004, sales were $92,724,000with operating income of $2,062,000.

 

Theheating and air conditioning segment reported a $2,194,000 increase in sales,or 6.6%. The sales increase is largely due to the improved sales of the thirdquarter discussed above. For the first nine months of 2005, all product linesreported increased sales primarily due to price increases reflecting the passthrough of increased steel costs. The fan coil product line reported anincrease in volume; however the furnace product line

 

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reporteda decrease in volume due to warm weather during the third quarter (the earlypart of their season), while cooler volumes were stable. For the nine monthperiods, cost of sales as a percentage of sales increased from 77.1% in 2004 to77.5% for 2005 reflecting a lower level of cooler production and the increasein steel costs discussed above. Depreciation remained relatively constantbetween the first six months of 2005 compared to the comparable 2004 period.Selling and administrative costs increased during the first nine months of 2005as a result of costs incurred related to the replacement of the general managerat Williams Furnace Co., including severance pay, and the addition of personnelin the sales and engineering departments. The decline in operating income wasprimarily the result of the narrower margins in the evaporative cooler and fancoil lines combined with the increased administrative costs discussed above.Operating income as a percent of sales and the return on assets were both loweras a result of these factors.

 

Salesin the construction materials segment during the first nine months of 2005increased $9,529,000, or 16.1%. 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 for the first nine months of 2005 remainedsteady at 82.9%, the same as for the comparable 2004 period. Depreciation,depletion and amortization declined reflecting the effect of reduced capitalspending in recent years as noted above. Selling and administrative costsincreased as a result of the improved sales. The gain on disposition ofproperty and equipment decreased due to the inclusion of a $180,000 gain on thesale of a west Pueblo property during the quarter ended July 3, 2004. The increasein operating income was primarily due to the improved volumes. Operating incomeas a percent of sales and the return on assets both improved as a result ofthese factors.

 

Netinterest expense increased primarily due to an increase in the average interestrate for the first nine months of 2005 compared to the comparable period of2004.

 

Theeffective tax rate for the nine months ended October 1, 2005 was 20%primarily due to the release of certain tax contingencies during the second andthird quarters related to the closure of income tax audits.

 

CRITICALACCOUNTING POLICIES AND ESTIMATES

 

The condensed andconsolidated 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 October 1, 2005 and January 1, 2005 and affect the reportedamounts of revenues and expenses for the periods reported. Actual results coulddiffer from those estimates.

 

Information with respectto the Company’s critical accounting policies which the Company believes couldhave the most significant effect on the Company’s reported results and requiresubjective or complex judgments by management is contained on pages 13 and14 in Item 7, Management’s Discussion and Analysis of Financial Condition andResults of Operations, of the Company’s Annual Report on Form 10-K for thefiscal year ended January 1, 2005. In addition, the following informationis provided:

 

The Company maintainedinsurance policies since March 31, 2005 with the following per incidentdeductibles 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         |       |
|                               |            |                |            |                   |            |  |  |

 

Shouldthe aggregated out-of-pocket payments for the three policies exceed $3,400,000during a policy year, deductibles on future claims are waived and the policiespay all amounts up to the policy limits. Should any, or all policy limits beexceeded, an umbrella policy is maintained which covers the next $25,000,000 ofclaims.

 

Revenuesreceived for shipping and handling are classified as sales. Costs associatedwith shipping and handling are classified as costs of sales.

 

TheCompany annually assesses goodwill for potential impairment as of the last dayof its fiscal year.

 

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OUTLOOK

 

Thelevel of construction in the Denver market appears to have stabilized, however,concrete prices, though improved in 2005 compared to the first nine months of2004, are depressed and expected to remain very competitive. The constructionmarkets in Colorado Springs and Pueblo are relatively strong and stable. Theshortage of cement availability during September has eased, however therehas been a tight supply of cement nationwide in recent months that may againaffect our operations. Additionally, increases in interest rates, particularlymortgage interest rates, could slow the level of construction in all markets.

 

Thedemand for fan coil products has shown some improvement this year from therather depressed levels of the past three years. Sales of furnaces andevaporative coolers are not expected to grow significantly and will remainweather sensitive.

 

RECENTLYISSUED ACCOUNTING STANDARDS

 

The Company discussesrecently issued accounting standards and tax law changes in the CriticalAccounting 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 2004. Other than as discussed in those sections, theCompany does not currently have any transactions or circumstances that havebeen addressed by recently issued accounting pronouncements. Therefore,adoption of any of these statements or pronouncements would not have a materialimpact on the Company’s results of operations, financial position or liquidity.The Company has determined that it qualifies for certain deductions that theAmerican Jobs Creation Act of 2004 provides for income from qualified domesticproduction activities. Although the effect of the deduction is not expected tohave a material effect on the tax provision for 2005, a preliminary estimate ofthe deduction was included in the determination of the tax provision.

 

FORWARD-LOOKINGSTATEMENTS

 

The foregoingdiscussion contains forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933, as amended. Such forward-looking statements arebased on the beliefs of the Company’s management as well as on assumptions madeby and information available to the Company at the time such statements weremade.  When used in this Report, wordssuch as “anticipates,” “believes,” “contemplates,” “estimates,” “expects,” “plans,”“projects,” and similar expressions are intended to identify forward-lookingstatements. Actual results could differ materially from those projected in theforward-looking statements as a result of factors including but not limited to:weather, interest rates, availability of raw materials and their related costs,national and local economic conditions and competitive forces. Some of thesefactors are discussed 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 the Companyundertakes no obligation to publicly update them.

 

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

 

Therehave been no material changes in the market risks that the Company is exposedto since those discussed in the Company’s fiscal 2004 Annual Report on Form 10-K.At October 1, 2005, the amount subject to the interest rate swap agreementwas $4,500,000. See Note 7 of the Notes to Consolidated Financial Statements.

 

**Item 4.****                                       Controlsand Procedures**

 

(a)                          DisclosureControls and Procedures.

 

TheCompany’s chief executive officer and chief financial officer, with theparticipation of management, have evaluated the effectiveness of the Company’s “disclosurecontrols and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended) as of the end of the periodcovering this report. Based on their evaluation, they have concluded that theCompany’s disclosure controls and procedures as of such date are effective and arereasonably designed to ensure that all material information relating to theCompany (including its subsidiaries) required to be disclosed in this quarterlyreport is recorded, processed, summarized and reported within the time periodsspecified in the rules and forms of the Securities and Exchange Commission.

 

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(b)                         Changesin Internal Controls Over Financial Reporting.

 

Therewere no significant changes in the Company’s internal control over financialreporting identified in connection with the evaluation of such internal controlthat occurred during the last fiscal quarter that have materially affected, orare reasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

PART II – OTHER INFORMATION

 

Item 2.                                                UnregisteredSales of Equity Securities and Use of Proceeds

 

The following table presents information with respect to purchases madeby the Company of its common stock to become treasury stock for the period July 3through October 1, 2005.

 

Issuer Purchases of Equity Securities

 
| **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** | ** ** |
|--------------------------------------------|------------|--------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------|------------|
| July 3 – July 30, 2005      |       | 623                                              |       | $                                           | 30.59      |                                                                                                   | 623        |                                                                                                       | $          | 1,418,303 |   |
| July 31 – August 27, 2005   |       | —                                           |       | —                                      |       | —                                                                                                 |       | 1,418,303                                                                                                  |       |
| August 28 – October 1, 2005 |       | —                                           |       | —                                      |       | —                                                                                                 |       | 1,418,303                                                                                                  |       |
| Total                                      |       | 623                                              |       | $                                           | 30.59      |                                                                                                   | 623        |                                                                                                       | $          | 1,418,303 |   |

 

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. Effective May 29,2003, the Board increased the permitted amount to a total not to exceed$2,750,000 for purchases on or after May 29, 2004, separate from purchasesmade in connection with the June 2005 tender offer and shares acquired aspart of a cashless exercise of stock options.

 

Item6.                                     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         |

 

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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:  | November 11, 2005             |   | By: | /S/  Joseph J. Sum |   |
|   |                               | Joseph  J. Sum, Vice President |
|   |                               | and  Chief Financial Officer |
|        |                                    |  |  |  |  |

 

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