**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**ý****          ****QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For thequarterly period ended September 30, 2005**

 

**OR**

 

**o****          ****TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For the transition period from                         to                         **

 

**Commission File No. 0-28582**

 

**CHANNELL COMMERCIAL CORPORATION**

(Exact name of Registrant as specified in its charter)

 

**DELAWARE**

(State or other jurisdiction of incorporation or organization)

 

**95-2453261**

(I.R.S. Employer Identification No.)

 

**26040 Ynez Road, Temecula, California**

(Address of principal executive offices)

 

**92591**

(Zip Code)

 

**(951) 719-2600**

(Registrant’s telephone number, including area code)

 

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  **ý**    No  o

 

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

Yes  **o**    No  ý

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).  o Yes  ý No

 

9,536,584 shares of common stock of the Registrant were outstanding at November 14,2005.

 

 

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**PART 1 –**      FINANCIAL INFORMATION

 

**ITEM1.**          FINANCIAL STATEMENTS

 

**CHANNELL COMMERCIAL CORPORATIONCONSOLIDATED STATEMENTS OF INCOME ANDCOMPREHENSIVE INCOME(UNAUDITED)***(amounts in thousands,except per share data)*

 
| ** **                                                                             | ** ** | **Nine months ended**  | ** ** | **Three months ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                             | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                                             | ** ** | **2005**               | ** ** | **2004**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                   |       |                   |       |                   |       |   |   |   |   |
| Net sales                                                                              |       | $                      | 90,596     |                   | $          | 66,638 |   | $ | 26,858 |   | $ | 27,615 |   |
| Cost of goods  sold                                                                    |       | 64,095                 |       | 47,470                 |       | 20,319 |   | 19,719 |   |
|                                                                                   |       |                   |       |                   |       |   |   |   |   |
| Gross profit                                                                           |       | 26,501                 |       | 19,168                 |       | 6,539 |   | 7,896 |   |
| Operating expenses                                                                     |       |                   |       |                   |       |   |   |   |   |
| Selling                                                                                |       | 15,067                 |       | 9,308                  |       | 5,160 |   | 4,009 |   |
| General and administrative                                                             |       | 7,983                  |       | 6,039                  |       | 2,419 |   | 2,212 |   |
| Research and development                                                               |       | 2,205                  |       | 1,642                  |       | 699 |   | 577 |   |
| Restructuring charge (credit)                                                          |       | —                 |       | (686                   | )          | — |   | (686 | ) |
|                                                                                   |       | 25,255                 |       | 16,303                 |       | 8,278 |   | 6,112 |   |
| Income (loss) from operations                                                          |       | 1,246                  |       | 2,865                  |       | (1,739 | ) | 1,784 |   |
|                                                                                   |       |                   |       |                   |       |   |   |   |   |
| Interest expense, net                                                                  |       | 327                    |       | 320                    |       | 97 |   | 170 |   |
|                                                                                   |       |                   |       |                   |       |   |   |   |   |
| Income (loss) before income taxes                                                      |       | 919                    |       | 2,545                  |       | (1,836 | ) | 1,614 |   |
|                                                                                   |       |                   |       |                   |       |   |   |   |   |
| Income taxes (benefit)                                                                 |       | (235                   | )          | (679                   | )          | (1,161 | ) | (679 | ) |
|                                                                                   |       |                   |       |                   |       |   |   |   |   |
| Net income (loss) before minority interest                                             |       | 1,154                  |       | 3,224                  |       | (675 | ) | 2,293 |   |
|                                                                                   |       |                   |       |                   |       |   |   |   |   |
| Minority interest (loss)                                                               |       | 9                      |       | 75                     |       | (117 | ) | 75 |   |
|                                                                                   |       |                   |       |                   |       |   |   |   |   |
| Net income (loss)                                                                      |       | $                      | 1,145      |                   | $          | 3,149 |   | $ | (558 | ) | $ | 2,218 |   |
|                                                                                   |       |                   |       |                   |       |   |   |   |   |
| Net income (loss) per share                                                            |       |                   |       |                   |       |   |   |   |   |
| Basic                                                                                  |       | $                      | 0.12       |                   | $          | 0.34 |   | $ | (0.06 | ) | $ | 0.24 |   |
|                                                                                   |       |                   |       |                   |       |   |   |   |   |
| Diluted                                                                                |       | $                      | 0.12       |                   | $          | 0.34 |   | $ | (0.06 | ) | $ | 0.24 |   |
|                                                                                   |       |                   |       |                   |       |   |   |   |   |
| Net income  (loss)                                                                     |       | $                      | 1,145      |                   | $          | 3,149 |   | $ | (558 | ) | $ | 2,218 |   |
|                                                                                   |       |                   |       |                   |       |   |   |   |   |
| Other comprehensive (loss) income, net of tax  Foreign currency translation adjustment |       | (390                   | )          | (170                   | )          | 83 |   | 411 |   |
|                                                                                   |       |                   |       |                   |       |   |   |   |   |
| Comprehensive  income (loss)                                                           |       | $                      | 755        |                   | $          | 2,979 |   | $ | (475 | ) | $ | 2,629 |   |

 

**Theaccompanying notes are an integral part of these financial statements.**

 

1

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**CHANNELL COMMERCIAL CORPORATIONCONSOLIDATED BALANCE SHEETS(UNAUDITED)***(amounts in thousands)*

 
| ** **                                                                                                                                                                                                                                             | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                             | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                                                                                             |       |                         |       |                        |       |
| **Current assets**                                                                                                                                                                                                                                     |       |                         |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                                                              |       | $                            | 3,353      |                        | $          | 5,453 |   |
| Accounts receivable, net                                                                                                                                                                                                                               |       | 10,794                       |       | 13,936                      |       |
| Inventories                                                                                                                                                                                                                                            |       | 12,432                       |       | 14,164                      |       |
| Deferred income taxes                                                                                                                                                                                                                                  |       | 1,969                        |       | 1,951                       |       |
| Prepaid expenses and misc. receivables                                                                                                                                                                                                                 |       | 1,439                        |       | 859                         |       |
| Income taxes receivable                                                                                                                                                                                                                                |       | 1,985                        |       | 1,323                       |       |
| Total current assets                                                                                                                                                                                                                                   |       | 31,972                       |       | 37,686                      |       |
|                                                                                                                                                                                                                                                   |       |                         |       |                        |       |
| **Property and equipment at cost, net**                                                                                                                                                                                                                |       | 19,549                       |       | 19,301                      |       |
| **Deferred income taxes**                                                                                                                                                                                                                              |       | 4,027                        |       | 4,043                       |       |
| **Goodwill**                                                                                                                                                                                                                                           |       | 14,913                       |       | 14,724                      |       |
| **Intangible assets, net**                                                                                                                                                                                                                             |       | 1,586                        |       | 1,763                       |       |
| **Other assets**                                                                                                                                                                                                                                       |       | 814                          |       | 964                         |       |
|                                                                                                                                                                                                                                                   |       |                         |       |                        |       |
| Total assets                                                                                                                                                                                                                                           |       | $                            | 72,861     |                        | $          | 78,481 |   |
|                                                                                                                                                                                                                                                   |       |                         |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                         |       |                         |       |                        |       |
| **Current liabilities**                                                                                                                                                                                                                                |       |                         |       |                        |       |
| Accounts payable                                                                                                                                                                                                                                       |       | $                            | 11,989     |                        | $          | 16,111 |   |
| Short term debt (including current maturities of  long term debt and capital leases)                                                                                                                                                                   |       | 2,626                        |       | 4,368                       |       |
| Accrued restructuring liability                                                                                                                                                                                                                        |       | 38                           |       | 150                         |       |
| Accrued expenses                                                                                                                                                                                                                                       |       | 6,746                        |       | 7,619                       |       |
| Total current liabilities                                                                                                                                                                                                                              |       | 21,399                       |       | 28,248                      |       |
|                                                                                                                                                                                                                                                   |       |                         |       |                        |       |
| **Long term debt, less current maturities**                                                                                                                                                                                                            |       | 4,256                        |       | 4,368                       |       |
| **Capital lease obligations, less current  maturities**                                                                                                                                                                                                |       | 101                          |       | 104                         |       |
| **Deferred gain on sale leaseback transaction**                                                                                                                                                                                                        |       | 408                          |       | 453                         |       |
| **Commitments and contingencies**                                                                                                                                                                                                                      |       | —                       |       | —                      |       |
| **Minority Interest**                                                                                                                                                                                                                                  |       | 2,771                        |       | 2,824                       |       |
|                                                                                                                                                                                                                                                   |       |                         |       |                        |       |
| **Stockholders’ equity**                                                                                                                                                                                                                          |       |                         |       |                        |       |
| Preferred stock, par value $.01 per share,  authorized - 1,000 shares, none issued and outstanding                                                                                                                                                     |       | —                       |       | —                      |       |
| Common stock, par value $.01 per share, authorized -  19,000 shares; issued - 9,608 shares at December 31, 2004 and 9,772 at September 30,  2005; outstanding - 9,364 shares at December 31, 2004 and 9,528 at September 30,  2005 |       | 98                           |       | 96                          |       |
| Additional paid-in capital                                                                                                                                                                                                                             |       | 30,356                       |       | 29,671                      |       |
| Treasury stock - 244 shares in 2004 and 2005                                                                                                                                                                                                           |       | (1,871                       | )          | (1,871                      | )          |
| Retained earnings                                                                                                                                                                                                                                      |       | 14,694                       |       | 13,549                      |       |
| Accumulated other comprehensive income - Foreign  currency translation                                                                                                                                                                                 |       | 649                          |       | 1,039                       |       |
|                                                                                                                                                                                                                                                   |       |                         |       |                        |       |
| **Total stockholders’ equity**                                                                                                                                                                                                                    |       | 43,926                       |       | 42,484                      |       |
|                                                                                                                                                                                                                                                   |       |                         |       |                        |       |
| **Total liabilities and stockholders’ equity**                                                                                                                                                                                                    |       | $                            | 72,861     |                        | $          | 78,481 |   |

 

The accompanying notes are an integral part of thesefinancial statements.

 

2

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**CHANNELL COMMERCIAL CORPORATIONCONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)***(amounts in thousands)*

 
| ** **                                                                           | ** ** | **Nine months ended**  | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                           | ** ** | **September 30,** | ** ** |
| ** **                                                                           | ** ** | **2005**               | ** ** | **2004** | ** ** |
| **Cash  flows from operating activities:**                                           |       |                   |       |   |   |
| Net income                                                                           |       | $                      | 1,145      |   | $ | 3,149 |   |
| *Adjustments to reconcile net income to net cash provided  by operating activities:* |       |                   |       |   |   |
| Depreciation and amortization                                                        |       | 3,621                  |       | 3,484 |   |
| Deferred income taxes                                                                |       | (15                    | )          | 221 |   |
| Gain on disposal of fixed asset                                                      |       | (6                     | )          | (20 | ) |
| Amortization of deferred gain on sale leaseback                                      |       | (45                    | )          | (45 | ) |
| Minority interest (loss)                                                             |       | 9                      |       | — |   |
| Change in assets and liabilities:                                                    |       |                   |       |   |   |
| (Increase) decrease in assets:                                                       |       |                   |       |   |   |
| Accounts receivable                                                                  |       | 2,969                  |       | (1,558 | ) |
| Inventories                                                                          |       | 1,538                  |       | (1,998 | ) |
| Prepaid expenses                                                                     |       | (588                   | )          | (40 | ) |
| Other assets                                                                         |       | 234                    |       | (234 | ) |
| Income taxes receivable                                                              |       | (658                   | )          | (1,481 | ) |
| Increase (decrease) in liabilities:                                                  |       |                   |       |   |   |
| Accounts payable                                                                     |       | (3,869                 | )          | 5,558 |   |
| Accrued expenses                                                                     |       | (1,329                 | )          | 697 |   |
| Restructuring liability                                                              |       | (104                   | )          | (2,687 | ) |
|                                                                                 |       |                   |       |   |   |
| Net cash  provided by operating activities                                           |       | 2,902                  |       | 5,046 |   |
|                                                                                 |       |                   |       |   |   |
| **Cash  flows from investing activities:**                                           |       |                   |       |   |   |
| Acquisition of property and equipment                                                |       | (3,972                 | )          | (2,054 | ) |
| Proceeds from the sales of property and equipment                                    |       | 24                     |       | 24 |   |
| Business acquisitions, net of cash required                                          |       | —                 |       | (17,503 | ) |
|                                                                                 |       |                   |       |   |   |
| Net cash used in  investing activities                                               |       | (3,948                 | )          | (19,533 | ) |
|                                                                                 |       |                   |       |   |   |
| **Cash  flows from financing activities:**                                           |       |                   |       |   |   |
| Proceeds from issuance of debt                                                       |       | —                 |       | 6,958 |   |
| Repayment of debt                                                                    |       | (2,964                 | )          | (714 | ) |
| Borrowings (Repayment) of obligations under capital  lease                           |       | (27                    | )          | 18 |   |
| Borrowings from credit facilities                                                    |       | 1,277                  |       | — |   |
| Proceeds from minority investor                                                      |       | —                 |       | 2,715 |   |
| Proceeds from issuance of stock                                                      |       | —                 |       | 714 |   |
| Exercise of employee stock options                                                   |       | 687                    |       | — |   |
|                                                                                 |       |                   |       |   |   |
| Net cash (used  in) provided by financing activities                                 |       | (1,027                 | )          | 9,691 |   |
|                                                                                 |       |                   |       |   |   |
| Effect of  exchange rates on cash                                                    |       | (27                    | )          | (667 | ) |
|                                                                                 |       |                   |       |   |   |
| Decrease in cash  and cash equivalents                                               |       | (2,100                 | )          | (5,463 | ) |
|                                                                                 |       |                   |       |   |   |
| Cash and cash  equivalents, beginning of period                                      |       | 5,453                  |       | 9,527 |   |
|                                                                                 |       |                   |       |   |   |
| Cash and cash  equivalents, end of period                                            |       | $                      | 3,353      |   | $ | 4,064 |   |
|                                                                                 |       |                   |       |   |   |
| **Cash  paid during the period for:**                                                |       |                   |       |   |   |
| Interest                                                                             |       | $                      | 381        |   | $ | 223 |   |
|                                                                                 |       |                   |       |   |   |
| Income taxes                                                                         |       | $                      | 282        |   | $ | 601 |   |
|                                                                                 |       |                   |       |   |   |   |   |
| **Supplemental disclosure of non-cash investing  and financing activities:**         |       |                   |       |   |   |   |   |
| Goodwill adjustment for contingency settlements                                      |       | $                      | 534        |   | $ | — |   |

 

The accompanying notes are an integral part of these financialstatements.

 

3

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**CHANNELL COMMERCIAL CORPORATIONCONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITYNine months ended September 30, 2005(UNAUDITED)**(amounts inthousands)

 
| ** **                            | ** ** | ** **        | ** ** | ** **  | ** ** | ** **          | ** ** | ** **   | ** ** | ** **        | ** ** | ** **             | ** ** | **Accumulated**    | ** ** | ** ** | ** ** |
|---------------------------------------|------------|-------------------|------------|-------------|------------|---------------------|------------|--------------|------------|-------------------|------------|------------------------|------------|--------------------|------------|------------|------------|
| ** **                            | ** ** | ** **        | ** ** | ** **  | ** ** | **Additional**      | ** ** | ** **   | ** ** | ** **        | ** ** | ** **             | ** ** | **other**          | ** ** | **Total**  | ** ** |
| ** **                            | ** ** | **Common  stock** | ** ** | **paid-in** | ** ** | **Treasury  stock** | ** ** | **Retained** | ** ** | **comprehensive** | ** ** | **stockholders’** | ** ** |
| ** **                            | ** ** | **Shares**        | ** ** | **Amount**  | ** ** | **capital**         | ** ** | **Shares**   | ** ** | **Amount**        | ** ** | **earnings**           | ** ** | **Income  (loss)** | ** ** | **equity** | ** ** |
|                                  |       |              |       |        |       |                |       |         |       |              |       |                   |       |               |       |       |       |
| Balance, January  1, 2005 as restated |       | 9,608             |       | $           | 96         |                | $          | 29,671       |       | 244               |       | $                      | (1,871     | )                  | $          | 13,549     |       | $ | 1,039 |   | $ | 42,484 |   |
|                                  |       |              |       |        |       |                |       |         |       |              |       |                   |       |               |       |       |       |
| Exercise of  employee stock options   |       | 164               |       | 2           |       | 685                 |       | —       |       | —            |       | —                 |       | —             |       | 687        |       |
| Foreign currency  translation         |       | —            |       | —      |       | —              |       | —       |       | —            |       | —                 |       | (390               | )          | (390       | )          |
| Net income for  the period            |       | —            |       | —      |       | —              |       | —       |       | —            |       | 1,145                  |       | —             |       | 1,145      |       |
|                                  |       |              |       |        |       |                |       |         |       |              |       |                   |       |               |       |       |       |
| Balance,  September 30, 2005          |       | 9,772             |       | $           | 98         |                | $          | 30,356       |       | 244               |       | $                      | (1,871     | )                  | $          | 14,694     |       | $ | 649 |   | $ | 43,926 |   |

 

**Theaccompanying notes are an integral part of these financial statements.**

 

4

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**CHANNELL COMMERCIAL CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)September 30, 2005 and 2004***(amounts in thousands,except per share data)*

 

1.          *Unaudited financial statements.*  In the opinion of management, theaccompanying unaudited consolidated financial statements contain alladjustments necessary to present fairly the consolidated financial position ofChannell Commercial Corporation (the “Company”) as of September 30, 2005and the results of its operations for the three months and nine months ended September 30,2005 and 2004, and its cash flows for the nine months ended September 30,2005 and September 30, 2004.  Theresults of operations and cash flows for the nine months ended September 30,2005 are not necessarily indicative of the results to be expected for any otherinterim period or the full year. Although the Company believes that the disclosures are adequate to makethe information presented not misleading, it is suggested that these interimconsolidated financial statements be read in conjunction with the consolidatedfinancial statements and the notes thereto included in the Company’s Form10-K/A-1 for the year ended December 31, 2004. Amounts related to disclosures of December 31, 2004 balances withinthese interim statements were derived from the aforementioned Form 10-K/A-1.

 

2.          *Inventories.*  Inventoriesare stated at the lower of cost (first-in, first-out method) or market and aresummarized as follows:

 
| ** **      | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------|------------|------------------------|------------|-----------------------|------------|
| ** **      | ** ** | **2005**               | ** ** | **2004**              | ** ** |
|            |       |                   |       |                  |       |
| Raw Materials   |       | $                      | 5,099      |                  | $          | 4,777 |   |
| Work-in-Process |       | 2,769                  |       | 3,050                 |       |
| Finished Goods  |       | 4,564                  |       | 6,337                 |       |
|            |       | $                      | 12,432     |                  | $          | 14,164 |   |

 

3.          *Income (loss) per share.* Basic income (loss) per share excludes dilution and is computed bydividing net income (loss) available to common stockholders by the weightedaverage number of common shares outstanding for the nine month and three month periodsended September 30, 2005 and 2004. Diluted income per share reflects the potential dilution that couldoccur if dilutive options to acquire common stock were exercised.  For the three months ended September 30,2005, there is no calculation of dilution since the Company incurred a loss forthe period, thereby resulting in the options becoming antidilutive.  The following is a reconciliation of thenumber of shares (denominator) used in the basic and diluted income (loss)  per share computations for the nine month and threemonth periods ended September 30, 2005 and 2004 (shares in thousands):

 
| ** **                        | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------------|------------|------------------------------------------|------------|
| ** **                        | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| ** **                        | ** ** | **Shares**                               | ** ** | **Per  Share  Amount** | ** ** | **Shares** | ** ** | **Per  Share  Amount** | ** ** |
| Basic income per  share           |       | 9,416                                    |       | $ | 0.12 |   | 9,165 |   | $ | 0.34 |   |
| Effect of  dilutive stock options |       | 418                                      |       | — |   | 11 |   | — |   |
| Diluted income  per share         |       | 9,834                                    |       | $ | 0.12 |   | 9,176 |   | $ | 0.34 |   |

 
| ** **                        | ** ** | **Three months ended September 30,** | ** ** |
|-----------------------------------|------------|-------------------------------------------|------------|
| ** **                        | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| ** **                        | ** ** | **Shares**                                | ** ** | **Per  Share  Amount** | ** ** | **Shares** | ** ** | **Per  Share  Amount** | ** ** |
| Basic income per  share           |       | 9,475                                     |       | $ | (0.06 | ) | 9,240 |   | $ | 0.24 |   |
| Effect of  dilutive stock options |       | —                                    |       | — |   | 3 |   | — |   |
| Diluted income  per share         |       | 9,475                                     |       | $ | (0.06 | ) | 9,243 |   | $ | 0.24 |   |

 

5

----

 

Thefollowing options were not included in the computation of diluted income pershare due to their antidilutive effect:

 
| ** **                                 | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------------------|------------|------------------------------------------|------------|
| ** **                                 | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
|                                       |       |                                     |       |   |   |
| Options to purchase shares of common stock |       | 79                                       |       | 1,401 |   |
| Exercise prices                            |       | $7.50 - $13.75                           |       | $4.84 - $13.75 |   |
| Expiration dates                           |       | July 2006 - August 2015        |       | July 2006 - September 2013 |   |

 
| ** **                                  | ** ** | **Three months ended September 30,** | ** ** |
|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                  | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
|                                        |       |                                      |       |   |   |
| Options to  purchase shares of common stock |       | 1,203                                     |       | 1,461 |   |
| Exercise prices                             |       | $3.25 - $13.75                            |       | $4.75 - $13.75 |   |
| Expiration dates                            |       | July 2006 - August 2015         |       | July 2006 - September 2013 |   |

 

4.          *Stock Based Compensation.* Statement of Financial Accounting Standards (“SFAS”)No. 148, “*Accounting for Stock Based Compensation –Transition and Disclosure, an Amendment of SFAS 123”*, encourages,but does not require, companies to record compensation cost for stock-basedemployee compensation plans at fair value. The Company has chosen to continue to account for stock-basedcompensation using the intrinsic value method prescribed in previously issuedstandards.  Accordingly, compensationcost for stock options is measured as the excess, if any, of the quoted marketprice of the Company’s stock at the date of grant over the amount an employeemust pay to acquire the stock.

 

Had compensation cost for the plan been determinedbased on the fair value of the options at the grant dates based on thedisclosure requirements of SFAS 123, the Company’s net income (loss) and income(loss) per share would have been as follows:

 
| ** **                                                                           | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                           | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| Reported net  income                                                                 |       | $                                        | 1,145      |   | $ | 3,149 |   |
| Add stock-based  compensation expense reported in net income                         |       | —                                   |       | — |   |
| Less total stock-based compensation expense,  determined under the fair value method |       | 391                                      |       | 327 |   |
| Proforma net  income                                                                 |       | $                                        | 754        |   | $ | 2,822 |   |
|                                                                                 |       |                                     |       |   |   |
| Reported basic  net income per share                                                 |       | $                                        | 0.12       |   | $ | 0.34 |   |
| Add stock-based  compensation expense reported in net income                         |       | —                                   |       | — |   |
| Less total stock-based compensation expense,  determined under the fair value method |       | 0.04                                     |       | 0.04 |   |
| Proforma basic  net income per share                                                 |       | $                                        | 0.08       |   | $ | 0.30 |   |
|                                                                                 |       |                                     |       |   |   |
| Reported diluted  net income per share                                               |       | $                                        | 0.12       |   | $ | 0.34 |   |
| Add stock-based  compensation expense reported in net income                         |       | —                                   |       | — |   |
| Less total stock-based compensation expense, determined  under the fair value method |       | 0.04                                     |       | 0.04 |   |
| Proforma diluted  net income per share                                               |       | $                                        | 0.08       |   | $ | 0.30 |   |

 

6

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| ** **                                                                           | ** ** | **Three months ended September 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                           | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| Reported net  (loss) income                                                          |       | $                                         | (558       | ) | $ | 2,218 |   |
| Add stock-based  compensation expense reported in net income                         |       | —                                    |       | — |   |
| Less total stock-based compensation expense,  determined under the fair value method |       | 148                                       |       | 106 |   |
| Proforma net  (loss) income                                                          |       | $                                         | (706       | ) | $ | 2,112 |   |
|                                                                                 |       |                                      |       |   |   |
| Reported basic  net (loss) income per share                                          |       | $                                         | (0.06      | ) | $ | 0.24 |   |
| Add stock-based  compensation expense reported in net income                         |       | —                                    |       | — |   |
| Less total stock-based compensation expense,  determined under the fair value method |       | 0.01                                      |       | 0.01 |   |
| Proforma basic  net (loss) income per share                                          |       | $                                         | (0.07      | ) | $ | 0.23 |   |
|                                                                                 |       |                                      |       |   |   |
| Reported diluted  net (loss) income per share                                        |       | $                                         | (0.06      | ) | $ | 0.24 |   |
| Add stock-based  compensation expense reported in net income                         |       | —                                    |       | — |   |
| Less total stock-based compensation expense,  determined under the fair value method |       | 0.01                                      |       | 0.01 |   |
| Proforma diluted  net (loss) income per share                                        |       | $                                         | (0.07      | ) | $ | 0.23 |   |

 

The fair value of options at date of grant wasestimated using the Black-Scholes model with the following weighted averageassumptions:

 
| ** **               | ** ** | **Periods ended September 30,** | ** ** |
|--------------------------|------------|--------------------------------------|------------|
| ** **               | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| Expected life  (years)   |       | 5 years                              |       | 5 years |   |
| Risk-free  interest rate |       | 3.90                                 | %          | 3.50 | % |
| Expected  volatility     |       | 50                                   | %          | 40 | % |

 

5.          *Segments*.  There aretwo segments:  Americas andInternational.  Americas includes theUnited States, Central and South America and Canada.  International includes Europe, Africa, MiddleEast, Australia and Asia.  The followingtable summarizes segment information for the nine months and three months endedSeptember 30, 2005 and 2004:

 
| ** **                             | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------------------|------------|------------------------------------------|------------|
| ** **                             | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| Revenues from  unrelated entities (1): |       |                                     |       |   |   |
| Americas                               |       | $                                        | 52,709     |   | $ | 51,064 |   |
| International                          |       | 37,887                                   |       | 15,574 |   |
|                                   |       | $                                        | 90,596     |   | $ | 66,638 |   |
| Income (loss)  from operations:        |       |                                     |       |   |   |
| Americas                               |       | $                                        | 768        |   | $ | 3,463 |   |
| International                          |       | 478                                      |       | (598 | ) |
|                                   |       | $                                        | 1,246      |   | $ | 2,865 |   |
|                                   |       |                                     |       |   |   |
| Interest  expense, net:                |       |                                     |       |   |   |
| Americas                               |       | $                                        | 148        |   | $ | 133 |   |
| International                          |       | 179                                      |       | 187 |   |
|                                   |       | $                                        | 327        |   | $ | 320 |   |

 

----

(1) Note:Revenues from Australia exceeded 10% of total revenues for the nine monthperiods ended September 30, 2005 and 2004. Revenues from Australia totaled$32,296 and $10,452 for the nine month periods in 2005 and 2004, respectively.

 

7

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| ** **                             | ** ** | **Three months ended September 30,** | ** ** |
|----------------------------------------|------------|-------------------------------------------|------------|
| ** **                             | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| Revenues from  unrelated entities (1): |       |                                      |       |   |   |
| Americas                               |       | $                                         | 14,333     |   | $ | 18,282 |   |
| International                          |       | 12,525                                    |       | 9,333 |   |
|                                   |       | $                                         | 26,858     |   | $ | 27,615 |   |
| Income (loss)  from operations:        |       |                                      |       |   |   |
| Americas                               |       | $                                         | (1,175     | ) | $ | 1,168 |   |
| International                          |       | (564                                      | )          | 616 |   |
|                                   |       | $                                         | (1,739     | ) | $ | 1,784 |   |
| Interest  expense, net:                |       |                                      |       |   |   |
| Americas                               |       | $                                         | 46         |   | $ | 105 |   |
| International                          |       | 51                                        |       | 65 |   |
|                                   |       | $                                         | 97         |   | $ | 170 |   |

 

----

(1) Note:Revenues from Australia exceeded 10% of total revenues for the three monthperiods ended September 30, 2005 and 2004. Revenues from Australia totaled$11,126 and $7,503 for the three month periods ins 2005 and 2004, respectively.

 

The Company has revenuesfrom external customers from the following product lines:

 
| ** **             | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------|------------|------------------------------------------|------------|
| ** **             | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| Product lines          |       |                                     |       |   |   |
| Enclosures             |       | $                                        | 39,644     |   | $ | 45,350 |   |
| Water related products |       | 43,564                                   |       | 13,182 |   |
| Connectivity           |       | 6,833                                    |       | 7,101 |   |
| Other                  |       | 555                                      |       | 1,005 |   |
|                   |       | $                                        | 90,596     |   | $ | 66,638 |   |

 
| ** **             | ** ** | **Three months ended September 30,** | ** ** |
|------------------------|------------|-------------------------------------------|------------|
| ** **             | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| Product lines          |       |                                      |       |   |   |
| Enclosures             |       | $                                         | 11,139     |   | $ | 14,184 |   |
| Water related products |       | 13,169                                    |       | 10,033 |   |
| Connectivity           |       | 2,268                                     |       | 3,024 |   |
| Other                  |       | 282                                       |       | 374 |   |
|                   |       | $                                         | 26,858     |   | $ | 27,615 |   |

 

The Company hasidentifiable assets in the following geographic regions:

 
| ** **            | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------|------------|------------------------|------------|-----------------------|------------|
| ** **            | ** ** | **2005**               | ** ** | **2004**              | ** ** |
|                  |       |                   |       |                  |       |
| Identifiable  Assets: |       |                   |       |                  |       |
| Americas              |       | $                      | 38,186     |                  | $          | 42,918 |   |
| International         |       | 34,675                 |       | 35,563                |       |
|                  |       | $                      | 72,861     |                  | $          | 78,481 |   |

 

8

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6.***    ***     *Recent AccountingPronouncements. *OnMarch 3, 2005, the Financial Accounting Standards Board (“FASB”) issuedFASB Staff Position (“FSP”)  FIN 46(R)-5,“Implicit Variable Interests under FASB Interpretation No. 46 (revised December 2003),*Consolidation of Variable Interest Entities.”*  FSP FIN 46(R)-5 provides guidance on whethera reporting enterprise should consider if it holds an implicit variableinterest in a variable interest entity (“VIE”) or potential VIE.  FSP FIN 46(R)-5 requires that if an entityhas a controlling financial interest in a VIE, then the assets and liabilitiesand results of activities of the VIE should be included in the consolidatedfinancial statements of the entity.  FSPFIN 46(R)-5 is effective in the first reporting period beginning after March 3,2005****in accordance with the transitionprovisions of FIN 46(R).  The provisionsof FSP FIN 46(R)-5 had no impact on the Company’s results of operations orfinancial position.

 

In November 2004, the FASB issued SFAS No. 151,“Inventory Costs, an Amendment of ARB No. 43, Chapter 4.”  SFAS No. 151 retains the generalprinciple of ARB No.43, Chapter 4, “Inventory Pricing,” that inventories arepresumed to be stated at cost; however, it amends ARB No. 43 to clarifythat abnormal amounts of idle facilities, freight, handling costs and spoilageshould be recognized as current period expenses.  Also, SFAS No. 151 requires fixedoverhead costs be allocated to inventories based on normal productioncapacity.  The guidance in SFAS No. 151is effective for inventory costs incurred during fiscal years beginning after June 15,2005.  The Company believes thatimplementing SFAS No. 151 will not have a material impact on its financialcondition or results of operations.

 

In December 2004, the FASB issued SFAS 123(revised 2004), Share-Based Payment (SFAS 123(R)).  This Statement is a revision to SFAS 123,Accounting for Stock-Based Compensation, and supersedes Opinion 25, Accountingfor Stock Issued to Employees.  SFAS123(R) requires the measurement of the cost of employee services received inexchange for an award of equity instruments based on the grant-date fair valueof the award.  The cost will berecognized over the period during which an employee is required to provideservice in exchange for the award.  Nocompensation cost is recognized for equity instruments for which employees donot render service.  The Company will adoptSFAS 123(R) on January 1, 2006, requiring compensation cost to berecognized as expense for the portion of outstanding unvested awards, based onthe grant-date fair value of those awards calculated using the Black-Scholesoption pricing model under SFAS 123 for pro forma disclosures.  Management estimates a potential impact ofapproximately $500 of expense net of tax for 2006.

 

7.*    *     *Restructuring Charges*. In the fourth quarter of 2003, the Company evaluated Internationaloperations to improve profitability.  Aplan was developed to close a manufacturing facility in Internationaloperations by June 2004.  As part ofthe plan, there was a reduction of approximately 39 employees in theInternational operations.  Therestructuring charge totaled $1,565.  Theprincipal components of the 2003 restructuring charge involved the closure offacilities and a reduction in head count.

 

The restructuring charges were determined based on formal plansapproved by the Company’s management using the best information available to itat the time.  The amounts the Company mayultimately incur could differ materially as the restructuring initiative isexecuted.  The Company anticipates thatthe restructuring will be completed by December 31, 2005.  The changes in the accrual for restructuringcharges during the nine month period ended September 30, 2005 aresummarized in the table below:

 
| ** **                                                       | ** ** | ** **     | ** ** | **Workforce** | ** ** | ** ** | ** ** |
|------------------------------------------------------------------|------------|----------------|------------|---------------|------------|------------|------------|
| ** **                                                       | ** ** | **Facilities** | ** ** | **Reduction** | ** ** | **Total**  | ** ** |
|                                                             |       |           |       |          |       |       |       |
| Restructuring  accrual balance at December 31, 2004         |       | $              | 147        |          | $          | 3          |       | $ | 150 |   |
| Costs incurred  in the nine months ended September 30, 2005 |       | 112            |       | —        |       | 112        |       |
| Restructuring  accrual balance at September 30, 2005        |       | $              | 35         |          | $          | 3          |       | $ | 38 |   |

 

8.          *Sale Leaseback Agreement*. In June, 2002, the Company entered into a sale and leaseback agreement fora facility located in Temecula, California. The proceeds from the sale totaled approximately $6,200 and resulted ina pretax deferred gain of $604.  Theresulting lease is being accounted for as an operating lease.  The lease base term is ten years with twofive-year options at rental amounts to be adjusted to the fair market rentalvalue at the end of the base term.  Aportion of the proceeds from the sale was used to pay the outstanding mortgagebalance on the facility of $4,036.  Theunamortized balance of the deferred gain is being amortized over the ten-yearlease base term, and as of September 30, 2005, such balance was $408.

 

9

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9.         *Income Taxes.* The taxbenefit recorded in 2005 for the third quarter and year-to-date is the resultof the expectation of a net operating loss carryforward for tax purposes in2005 in the United States.  The benefit of this expected net operatingloss has been recorded in the form of a deferred tax asset on the balancesheet.  The effective tax rate of (25.6)% for the nine months endedSeptember 30, 2005 differed from the combined federal and state statutory rateof 39.8% as a result of tax benefits for losses generated from foreignsubsidiaries.  In particular, an entity within the International segmentgenerated $730 of income in the first nine months with no related tax expensedue to existing operating loss carryforwards that have not been previouslyrecognized as deferred tax assets.

 

    The Federal income taxes of the Company for the years ended December 31, 2000,2001 and 2002 are currently under examination by the Internal Revenue Service(“IRS”).  Included in the examination of the 2001 tax year is a credit forresearch and development (“R&D”).  The IRS is also examining anR&D credit included in the 2002 tax year.  The IRS has denied theR&D credit for both the 2001 and 2002 tax years.  The cumulativeamount of R&D credit denied by the IRS is $533.  The Company has notprovided any benefit on its financial statements with regard to the R&Dcredits in question.  The Company is in discussions with the IRS in orderto resolve the open issues surrounding this dispute.  Management believesthat the ultimate outcome of IRS audits for the years ended 2000, 2001 and 2002will not have a material adverse impact on the Company’s consolidated resultsof operations or financial position.

 

10.        *Commitments and Contingencies. *In2001, the State of Texas issued a report assessing the Company additional salesand use tax of $1,600, including interest for the period of January 1,1996 through December 31, 1999. The Company appealed the assessment andprovided the State of Texas with documentation to support the Company’scontention that the transactions did not require the Company to remit sales anduse tax to the State of Texas. The State of Texas agreed to a reduction of theamount owed to $587 plus interest of $330. The Company has paid the State ofTexas the entire amount of the assessment and interest owed of $917. The Companyhas accrued for the remaining sales and use tax assessments, includinginterest, from the State of Georgia of $119 and the State of Massachusetts of$16. The ultimate outcome of the tax assessments from the State of Georgia andthe State of Massachusetts will not have a material impact on the Company’sconsolidated results of operations or financial position.

 

For a number of years, the Company has purchased gradelevel boxes from Carson Industries LLC (“Carson”) for resale to the Company’scustomers.  In 2004, the Company’scustomers began to report failure of Carson boxes in the field.  The Company has determined that certain boxessold to the Company by Carson in 2004, and thereafter, did not conform tocertain specifications and/or did not perform properly in the field.  On June 9, 2005, Carson filed a lawsuitagainst the Company (*Carson Industries LLC v.Channell Commercial Corporation (Calif. Superior Court Case No. BC334759)*,principally seeking approximately $360 for product sold to the Company but notyet paid for.  On July 26, 2005, theCompany cross-complained against Carson for, among other things, breach ofcontract, breach of express and implied warranties, fraud and intentionalinterference with contractual relations. The Company has not stated a specific dollar remedy that it is seekingfrom Carson.  The Company intends tovigorously defend the Carson lawsuit and prosecute its own claims againstCarson.

 

As of September 30, 2005 the Company has placedpurchase orders totaling $6,552 with its suppliers for deliveries through September 30,2006.

 

11.        *Related Party Transactions. *InMay 2002, the Company sold its RF line of passive electronic devices toRMS Communications, Inc., which is owned by Gary Napolitano, a formerofficer of the Company.  A sale in theamount of $800 was recorded.  RMSCommunications, Inc. paid the Company $125 in cash at the time of sale,and the remaining $675 is payable in monthly installments through June 30,2003, bearing interest at 7% per annum.  A payment of $10 was received in September 2005with a payment of $5 per month scheduled until the outstanding balance is fullypaid. The account is currently in arrears. The amount due from RMS Communications, Inc. included in accountsreceivable at September 30, 2005 is $237.  The Company has a security interest in theinventory and a personal guarantee from Mr. Napolitano and believes theamount will be paid in full.  No reservehas been recorded against the receivable at September 30, 2005.  The Company purchases RF devices from Mr. Napolitanoand from other sources depending on price and supply of product.  The RF devices purchased from Mr. Napolitano’sfirm in 2004 approximated $87 and in 2005 approximated $4 and were used ascomponents in the Company’s product lines. The purchases in 2004 and 2005 did not result in a cash payment to Mr. Napolitanoas the amounts owed were used to offset the account receivable.

 

The Company has twoleases for approximately 261,000 square feet of manufacturing, warehouse and officespace in Temecula, California, with the Channell Family Trust, an affiliate ofWilliam H. Channell Sr., the Company’s principal stockholder and the Chairmanof the Board, and Jacqueline M. Channell, a director and the Company secretary. The lease term of the lease for 108,000square feet is through December 31, 2015. The lease term of the lease for 153,000 square feet is through December 31,2005, with two five-year renewal options. Both leases provide for payments of insurance, repairs, maintenance andproperty taxes.  Rent expense paid underthe leases was $971 and $1,001 for the nine months ended September 30,2004, and 2005 respectively.  The Companybelieves that at the time the leases were consummated, the terms of theseleases were no less favorable to the Company than could have been obtained froman independent third party.  Under FIN 46and FIN 46(R), the Channell Family Trust does not qualify as a “variableinterest entity” subject to consolidation since (a) the total equity investmentat risk in the Trust is sufficient to permit financing without additionalfinancial support from the Company and (b) William Channell, Sr., theadministrator of the Channell Family Trust, has the direct ability to makedecisions about the Trust’s activities.

 

10

----

 

The Company’s facilitiesin Orange, Dalby, Terang and Adelaide Australia are leased from shareholders ofthe Company.  These shareholders areformer owners of Bushman Tanks.  Thefacilities consist of 94,000 square feet of manufacturing, warehouse and officespace.  The lease term on all fourfacilities is through February 28, 2010 with a five-year renewaloption.  The rent expense paid under theleases in the nine months ended September 30, 2005 was $243.  The Company hired an independent firm toappraise the market lease rates for these facilities, and it was determinedthat the existing leases are in excess of fair market value by approximately$27 per year.  Included in liabilities is$206 related to these unfavorable leases.

 

12.        *Concentrations.*  Salesto Verizon of $19,430 in the first nine months of 2005 represented 21.4% of theCompany’s sales in the period.  Sales toVerizon of $11,420 in the first nine months of 2004 represented 17.1% of the Company’ssales.  The second largest customer inthe first nine months of 2005 was Comcast with sales of $6,991, representing 7.7%of the Company sales.  Sales to Comcastof $11,560 in the first nine months of 2004 represented 17.3% of the Company’ssales for the period.

 

Accounts receivable from Verizon of $782 and from Comcastof $1,164 represented 7% and 11%, respectively, of Company accounts receivableat September 30, 2005.  Accountsreceivable from Comcast of $960 and from Verizon of $4,070 represented 7% and 29%,respectively, of Company accounts receivable at September 30, 2004.

 

13.        *Guarantees.*  In 1997,the Company guaranteed debt of the Channell Family Trust.  The guaranteed debt was incurred inconnection with construction of the facilities leased to the Company and iscollateralized by said facilities.  Theloan amount subject to the unsecured guarantee is expected to decline beforeexpiring in 2017. It is not practicable to estimate the fair value of theguarantee; however, the Company does not anticipate that it will incur lossesas a result of this guarantee.  TheCompany has not recorded a liability for this guarantee.  If the Channell Family Trust were to defaulton the outstanding loan balance, the Company might be required to repay the remainingprincipal balance.  The maximum potentialamount the Company would be required to pay is equal to the outstandingprincipal and interest balance of the loan to the Trust.  At September  30, 2005, the outstandingloan balance subject to the guarantee totaled $561.  The Channell Family Trust does not qualify as a“variable interest entity” subject to consolidation under FIN 46 or FIN 46(R)since there are sufficient assets held by the Trust that the lender couldattach in the event of default on the loan.  Under FIN 46 and FIN 46(R), the Company andthe Channell Family Trust do not qualify as “variable interest entities”subject to consolidation since (a) the total equity investment at risk inthe Trust is sufficient to permit financing without additional financialsupport from the Company and (b) William Channell, Sr., theadministrator of the Channell Family Trust, has the direct ability to makedecisions about the Trust’s activities.

 

14.        *Goodwill and Other**Intangible Assets.*  The balance of the intangible assets on theCompany’s balance sheet fluctuates from period to period due to the applicationof foreign currency translation to United States dollars in calculating thebalance of goodwill and other intangible assets of the Company’s foreignsubsidiaries.  Effective January 1,2002, the Company adopted SFAS No. 142, “Goodwill and Other IntangibleAssets”.  SFAS 142 requires that goodwilland certain intangibles no longer be amortized, but instead be reviewed atleast annually for impairment.  TheCompany tests the value of goodwill for impairment annually (December 31for the Canadian reporting unit and June 30 for the Bushman’s reportingunit) or whenever events or changes in circumstance indicate that expectedfuture discounted cash flows may be insufficient to support the carrying amountof the asset.  The test involvessignificant judgment in estimating fair value determined through futureperformance of the operating segment.  Incalculating the fair value, the Company relies on factors such as operatingresults, business plans, economic projections, and anticipated cash flows usedin discounting the cash flows.  TheCompany has tested Bushman’s goodwill at June 30, 2005, utilizing anindependent appraiser.  The independent evaluationof Bushman’s goodwill shows there was no impairment at June 30, 2005.  Inherent uncertainties exist in determiningand applying the aforementioned factors.

 

In August 2004, the Company, through amajority-owned subsidiary, acquired a controlling interest in Bushman Tanks, amanufacturer and distributor of rotational molded plastic (polyethylene) waterstorage tanks.  The Share and AssetPurchase Agreement provides for total contingent consideration of approximately$2,900 if the Bushman Tanks business achieves certain sales and cost reductiontargets.  Any amounts paid as contingentconsideration will result in additional goodwill.  If sales targets in 2005 and 2006 are achieved,a total of approximately $1,500 will be payable to the sellers.  Management has assessed that an earn-out ofapproximately $760 has been earned for achieving the 2005 sales targets as of July 31,2005.  This amount has been booked togoodwill during the third quarter of 2005. If certain cost reduction targets are achieved in 2005 through 2009, thesellers will receive one-half of the amounts of the cost reductions in thespecified cost items.  In the event thatthe costs incurred for these items exceed a predetermined threshold, the sellerwill be liable to the Company for the amount of the costs exceeding thethreshold.  Accordingly, $226 wasrecorded as a contingent receivable for warranty claims in the third quarter2005.

 

11

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Management is unable to assess, as of September 30,2005, whether any additional contingent consideration will be payable.  The changes in the net carrying amounts ofgoodwill for the nine months ended September 30, 2005 are as follows:

 
| ** **                                 | ** ** | **Goodwill** | ** ** |
|--------------------------------------------|------------|--------------|------------|
|                                       |       |         |       |   |
| Balance at December 31,  2004         |       | $            | 14,724     |   |
| Effect of  foreign currency translation    |       | (345         | )          |
| Contingent receivable  for warranty claims |       | (226         | )          |
| Contingent  earnout payment                |       | 760          |       |
|                                       |       |         |       |
| Balance at September 30,  2005        |       | $            | 14,913     |   |

 

In the Share and Asset Purchase Agreement, the sellersof Bushman Tanks agreed to a “non-compete” clause whereby the sellers ofBushman Tanks would not directly orindirectly carry on or be engaged or involved in any trade, business orundertaking that is in competition with the Bushman Tanks business.  The Company performed an evaluation of the non-competeagreement and determined the fair value to be US dollars $1,600. The non-compete agreement is recorded in the reporting unit of BushmanTanks, which is part of the International segment, as a separately identifiableintangible asset and is being amortized over the ten-year contractualterm on a straight line basis.  As of September 30,2005, the Company had the following acquired intangible asset recorded:

 
| ** **                              | ** ** | **Non-Compete** | ** ** |
|-----------------------------------------|------------|-----------------|------------|
| ** **                              | ** ** | **Agreement**   | ** ** |
| ** **                              | ** ** | ** **      | ** ** |
| Gross carrying  amount                  |       | $               | 1,600      |   |
| Accumulated  amortization               |       | (173            | )          |
| Net carrying  amount                    |       | 1,427           |       |
|                                    |       |            |       |
| Effect of  foreign currency translation |       | 159             |       |
|                                    |       |            |       |
| Balance at September 30,  2005     |       | $               | 1,586      |   |

 

The following tablesummarizes the estimated annual pretax amortization expense for the non-competeintangible asset:

 
| **Fiscal Year**           | ** ** | ** ** | ** ** |
|---------------------------|------------|------------|------------|
| 2005 (remainder  of year) |       | $          | 40         |   |
| 2006                      |       | 160        |       |
| 2007                      |       | 160        |       |
| 2008                      |       | 160        |       |
| 2009                      |       | 160        |       |
| Thereafter                |       | 747        |       |
| Total                     |       | $          | 1,427      |   |

 

15.        *Loan and Security Agreements*.  The Company entered into a three-year Loanand Security Agreement, which includes a term loan and a revolving line ofcredit, with an asset-based lender in the United States in September 2002.  Maximum borrowings available under thisfacility total $25,000.  The maximumavailability under the revolver is $4.9 million, which includes a $1,000sub-limit for letters of credit.  As of September 30,2005, outstanding letters of credit totaled $986.  The Agreement contains various financial andoperating covenants that impose limitations on the Company’s ability, amongother things, to incur additional indebtedness, merge or consolidate, sellassets except in the ordinary course of business, make certain investments,enter into leases and pay dividends.  TheCompany is also required to comply with a fixed charge coverage ratio and otherfinancial covenants.  The Agreementrequires the Company to maintain a lockbox on the revolving creditfacility.  The

 

12

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lockboxreceipts automatically reduce the outstanding balance of the revolving creditbalance, if any.  The Agreement alsocontains a subjective acceleration clause should the Company come into adefault, which allows the asset-based lender to terminate the facility andrequire that any outstanding obligation to be repaid.  There was no balance outstanding under therevolving line of credit at September 30, 2005 (other than the outstandingletter of credit).  The Loan and SecurityAgreement also contains a three-year term loan that is repayable in equalquarterly payments through December 31, 2005, based on a five-yearamortization schedule with a balloon payment at maturity.  Amounts borrowed under this facility bearinterest at a variable rate based on either the lender’s Base Rate orLIBOR.  At September 30, 2005, theoutstanding balance of the term loan was $2.1 million.  The weighted average interest rate under theterm loan was 4.68% at September 30, 2005. At September 30, 2005, the Company was not in compliance with one of thedebt covenants of the Loan and Security Agreement and has obtained a waiver forthe third quarter of 2005 from the lender.

 

Channell Pty Ltd., a subsidiary of the Company,entered into a one-year Loan and Security Agreement with a commercial bank inAustralia in July 2004.  The loancontains a revolving line of credit for working capital needs with a maximumavailable borrowing of Australian dollars $1,200, which translated at September 30,2005 exchange rates is approximately $912 US dollars.  Channell Pty Ltd. is required to comply withan interest coverage ratio.  TheAgreement contains various financial and operating covenants that imposelimitations on Channell Pty Ltd.’s ability, among other things, to incuradditional indebtedness, merge or consolidate, and sell assets except in theordinary course of business.  The Agreementis reviewed annually with the bank for renewals.  The Agreement contractually obligates ChannellPty Ltd. to repay the revolving credit facility as Channell Pty Ltd. receivespayments from its customers.  TheAgreement also contains a subjective acceleration clause should Channell PtyLtd. come into a default, which allows the bank to terminate the facility andrequire any outstanding obligation to be repaid.  There was no balance outstanding under therevolving line of credit at September 30, 2005.  Channell Pty Ltd. was in compliance as of September 30,2005 with the covenants of the Loan and Security Agreement.  Channell Pty Ltd. cancelled this revolvingline of credit as of October 31, 2005.

 

Channell Bushman Pty Ltd., a subsidiary of theCompany, entered into a five-year Loan and Security Agreement with a commercialbank in Australia in August 2004. The loan contains a five-year term loan with maximum borrowings ofAustralian dollars $8,000 that expires in July 2009, a revolving creditfacility with maximum borrowings of Australian dollars $2,000, a facility tofund future “earn-out” payments to the sellers of Bushman Tanks with maximumborrowings of Australian dollars $1,750, and a capital expenditure facilitywith maximum borrowings of Australian dollars $6,000.  Translated into US dollars at September 30,2005 exchange rates, the maximum borrowings are approximately:  five-year term loan $6,080, revolving creditfacility $1,520, “earn-out” facility $1,330, and capital expenditure facility $4,560.  The Agreement contains various financial andoperating covenants that impose limitations on Channell Bushman Pty Ltd.’sability, among other things, to incur additional indebtedness, merge orconsolidate, sell assets except in the ordinary course of business, makecertain investments, enter into leases and pay dividends.  Channell Bushman Pty Ltd. is required tocomply with an interest coverage ratio, debt service ratio, Debt/EBIT ratio andcapital adequacy ratio.  The Agreementcontractually obligates Channell Bushman Pty Ltd. to repay the revolving creditfacility as Channell Bushman Pty Ltd. receives payments from itscustomers.  The Agreement also contains asubjective acceleration clause should the Company come into a default, whichallows the bank to terminate the facility and require any outstandingobligation to be repaid.  ChannellBushman Pty Ltd. had an outstanding balance of US $0 on the revolving creditfacility at September 30, 2005.  Theweighted average interest rate was 6.9%. There was no balance outstanding underthe “earn-out” facility, as of September 30, 2005.  The capital expenditure facility had anoutstanding balance of US$190 at September 30, 2005.  The weighted average interest rate was6.60%.  At September 30, 2005, theoutstanding balance on the term loan was US $4,864.  The weighted average interest rate was 5.72%.  Channell Bushman Pty Ltd. was in complianceas of September 30, 2005 with the covenants of the Loan and SecurityAgreement.

 

16.        *Acquisition.*  In August 2004,the Company, through a majority-owned subsidiary, acquired a controllinginterest in Bushman Tanks, a manufacturer of rotational molded plastic(polyethylene) water storage tanks.  Thefollowing unaudited pro forma financial information reflects the consolidatedresults of operations of the Company as if the acquisition had taken place on January 1,2004.  The pro forma information includesthe historical operations of the Company and Bushman Tanks (translated at theaverage currency exchange rate for the applicable period) and gives effect tothe acquisition as if it had occurred at the beginning of the applicableperiod.  The pro forma financialinformation is based upon available information and assumptions and adjustmentsthat the Company believes are reasonable. The pro forma financial information does not purport to represent what theCompany’s results of operations actually would have been had the transactionbeen in effect on the assumed date.

 

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| ** **            | ** ** | **Amounts in thousands, except  per share data** | ** ** |
|-----------------------|------------|--------------------------------------------------|------------|
| ** **            | ** ** | **Nine months ended**                            | ** ** | **Three months ended** | ** ** |
| ** **            | ** ** | **September 30, 2004**                      | ** ** | **September 30, 2004** | ** ** |
| ** **            | ** ** | **Pro Forma**                                    | ** ** | **Pro Forma** | ** ** |
| Net sales             |       | $                                                | 84,071     |   | $ | 30,431 |   |
| Net income            |       | 2,851                                            |       | 2,327 |   |
|                  |       |                                             |       |   |   |
| Net income per  share |       |                                             |       |   |   |
| Basic                 |       | $                                                | 0.31       |   | $ | 0.25 |   |
| Diluted               |       | $                                                | 0.31       |   | $ | 0.25 |   |

 

**ITEM 2.****          MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

### **Results ofOperations**

 

In August of 2004 the Company acquired 75% of theBushman Tanks business (the “acquired company”).  Bushman Tanks isAustralia’s largest manufacturer of plastic water storage tanks.  TheBushman Tanks’ financial results have been consolidated in the Company’sfinancial statements for the nine months ended September 30, 2005 and for thetwo months ended September 30, 2004.  A minority interest has beenrecorded for the 25% equity owned by ANZ Private Equity, a unit of Australiaand New Zealand Banking Group Ltd.

 

**Comparisonof the Nine Months Ended September 30, 2005 with the Nine Months Ended September 30,2004**

 

*Net Sales*.  Net sales in the first nine months of 2005were $90.6 million, an increase of $24.0 million or 36% compared to the sameperiod in 2004.  The increase is primarilydue to the addition of the acquired company.

 

Americasnet sales were $52.7 million in the first nine months of 2005, an increase of $1.6million or 3.2% over the same period in 2004. The increase was primarily due tohigher sales of grade-level boxes to Verizon.

 

Internationalnet sales were $37.9 million, an increase of $22.3 million or 143%.  The increase is primarily due to sales of theacquired company.

 

Salesto Verizon of $19.4 million in the first nine months of 2005 represented 21.4%of the Company’s sales in the period. Sales to Verizon of $11.4 million in the first nine months of 2004represented 17.1% of the Company’s sales. The second largest customer in the first nine months of 2005 was Comcast,with sales of $7.0 million representing 7.7% of the Company sales.  Sales to Comcast of $11.6 million in thefirst nine months of 2004 represented 17.3% of the Company’s sales for theperiod.

 

*GrossProfit*.  Gross profitin the first nine months of 2005 was $26.5 million, an increase of $7.3 millionor 38.3% over the same period in 2004. The increase was primarily due to theaddition of gross profit earned by the acquired company, reduced by lowermargins in the Americas segment as a result of a weaker product mix.  Gross profit dollars in the Americas segmentwas $12.8 million in the first nine months of 2005 and $19.2 million for thesame period of 2004.  The product mix inthe Americas segment changed in the 2005 period to include higher volumes ofgrade level boxes.  Gross profit of $13.7million in the International segment, a $9.5 million increase over the 2004period, was due to the addition of the acquired company and the closure of amanufacturing facility in the United Kingdom. The closure of the United Kingdom facility lowered the overhead coststructure of International operations primarily due to the elimination offacility lease costs, middle management and indirect support costs.

 

As apercentage of net sales, gross profit increased from 28.8% in the first ninemonths of 2004 to 29.3% in the first nine months of 2005.  The improvement is due primarily to increasedvolume and margins in the International segment.

 

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*Selling*.  Selling expenses were $15.1 million in thefirst nine months of 2005, an increase of $5.8 million or 62% from the first ninemonths of 2004.  The increase is dueprimarily to the addition of selling expenses of the acquired company.

 

As apercentage of net sales, selling expense increased from 14.0% in the 2004period to 16.6% in the 2005 period.  Thehigher percentage is primarily due to the increase in freight costs and theaddition of selling expenses for the acquired company.  The acquired company has a higher percentageof selling expense to net sales than the other Channell businesses primarilydue to freight costs incurred to transport water storage tanks to customers.

 

*Generaland Administrative*. General and administrative expenses were $8.0 million in the first ninemonths of 2005, an increase of $2.0 million or 32%.  The increase is due primarily to the additionof the general and administrative expenses of the acquired company.  In addition, the Company incurred costs ofapproximately $0.2 million associated with a project to review its internalcontrol structure in relation to the requirements of the Sarbanes Oxley Act.

 

As apercentage of net sales, general and administrative expense decreased from 9.1%in the 2004 period to 8.8% in the 2005 period. The decrease is due to the increased sales level without a proportionalincrease in general and administrative costs.

 

*Researchand Development*. Research and development expenses were $2.2 million in the first nine monthsof 2005, an increase of $0.6 million or 34.3% from the first nine months of2004.  The increase is due to spending onnew product development programs, primarily for telephone connectivity productsand thermoplastic enclosures and grade level boxes for cable customers.

 

As apercentage of net sales, research and development expenses decreased from 2.5%in the first nine months of 2004 to 2.4% in the first nine months of 2005.

 

*Incomefrom Operations*.  As aresult of the items discussed above, income from operations decreased $1.7million or 56.5% over the first nine months of 2004 to $1.2 million in thefirst nine months of 2005.  Operatingmargin as a percent of sales decreased from 4.3% to 1.4%.

 

*InterestExpense, Net*.  Netinterest expense was $0.3 million in the first nine months of 2004 and 2005.

 

*IncomeTaxes*.  Income taxexpense was $(0.7) million in the first nine months of 2004 and $(0.2) millionin the first nine months of 2005.  Theeffective tax rate was (25.6)% in the first nine months of 2005 and (26.7)% forthe same period in 2004.  In 2004, theCompany reported a profit before tax on a consolidated basis, which consistedof a profit in the Americas segment and a loss in the International segment.  The 2005 rate and the 2004 rate benefitedfrom the use of net operating loss carryforwards.  The Company expects to have a net operatingloss carry forward benefit for tax purposes in 2005.

 

**Comparisonof the Three Months Ended September 30, 2005 with the Three Months Ended September 30,2004**

 

*Net Sales*.  Net sales in the third quarter of 2005 were $26.9million, a decrease of $0.7 million or 2.7% compared to the third quarter of2004.  The decrease is due to a declinein sales in the Americas segment, partially offset by sales from the acquiredcompany.

 

Americasnet sales were $14.3 million in the third quarter of 2005, a decline of $4.0million or 21.6% over the same period in 2004. The decrease was due primarilyto lower sales of thermoplastic enclosures to Verizon.

 

Internationalnet sales were $12.5 million, an increase of $3.2 million or 34.2%.  The increase is primarily due to sales of theacquired company, reduced in part by lower sales of non-water storage products.

 

Salesto Verizon of $3.3 million in the third quarter of 2005 represented 12.1% ofCompany sales in the period.  Sales toVerizon of $6.1 million in the third quarter of 2004 represented 22.0% of theCompany’s sales for the period.  Thesecond largest customer in the third quarter of 2005 was Comcast with sales of$2.5 million, representing 9.2% of the Company’s sales.  Sales to Comcast of $3.0 million in the thirdquarter of 2004 represented 10.7% of the Company’s sales for the period.

 

*GrossProfit*.  Gross profitin the third quarter of 2005 was $6.5 million, a decrease of $1.4 million or 17.2%over the third quarter of 2004. The decrease was primarily due to a weaker productmix combined with reduced volumes in the United States.  Gross profit dollars in the Americas segment decreasedfrom $4.6 million in 2004 to $2.3 million in 2005.  The product mix in the Americas segment changedin the 2005 period to include higher volumes of grade level boxes and lowervolumes of thermoplastic enclosures. Gross profit of $4.2 million in the International segment, a $0.9 millionincrease over the 2004 period, was due to the addition of the acquired company.

 

15

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As apercentage of net sales, gross profit decreased from 28.6% in the third quarterof 2004 to 24.3% in the third quarter of 2005. The decline is the result of weaker margins and reduced volumes in theAmericas segment.

 

*Selling*.  Selling expenses were $5.2 million in the thirdquarter of 2005, an increase of $1.2 million or 28.7% from the third quarter of2004.  The increase is due primarily tothe addition of selling expenses of the acquired company, reduced in part bylower freight costs due to lower volume in the Americas segment.

 

As apercentage of net sales, selling expense increased from 14.5% in the 2004period to 19.2% in the 2005 period.  Thehigher percentage is primarily due to the increase in freight costs and theaddition of selling expenses for the acquired company.  The acquired company has a higher percentageof selling expense to net sales than the other Channell businesses primarilydue to freight costs incurred to transport water storage tanks to customers.

 

*Generaland Administrative*. General and administrative expenses were $2.4 million in the thirdquarter of 2005, an increase of $0.2 million or 9.4% from the third quarter of2004.  The increase is due primarily tothe addition of the general and administrative expenses of the acquired company.

 

As apercentage of net sales, general and administrative expense increased from 8.0%in the 2004 period to 9.0% in the 2005 period, due to the lower sales volume.

 

*Researchand Development*. Research and development expenses were $0.7 million in the third quarterof 2005, an increase of $0.1 million or 21.1% from the third quarter of2004.  The increase is due to spending onnew product development programs, primarily for telephone connectivity productsand grade level boxes for cable customers.

 

As apercentage of net sales, research and development expenses for the quarterincreased to 2.6% in 2005 from 2.1% in the third quarter of 2004.

 

*Incomefrom Operations*.  As aresult of the items discussed above, the Company incurred a loss fromoperations of $1.7 million during the quarter versus a profit of $1.8 millionduring the third quarter of 2004. Operating margin declined from 6.5% to (6.5)%.

 

*InterestExpense, Net*.  Netinterest expense declined from $0.2 million in the third quarter of 2004 to$0.1 million in 2005.

 

*IncomeTaxes*.  Income taxexpense was $(0.7) million in the third quarter of 2004 and $(1.2) million inthe third quarter of 2005.  The effectivetax rate was (63.2)% in the third quarter of 2005 and (42.1%) for the sameperiod in 2004.  In 2004, the Companyreported a profit before tax on a consolidated basis, which consisted of aprofit in the Americas segment and a loss in the International segment.  The 2005 rate and the 2004 rate benefitedfrom the use of net operating loss carryforwards.  The effective tax rate decreased from 35.0%in the second quarter of 2005 to (63.2)% in the third quarter of 2005 as aresult of reduced earnings performance and the expectation of a net operatingloss carry forward benefit for tax purposes in 2005.

 

**Liquidityand Capital Resources**

 

Netcash provided by operating activities was $2.9 million for the nine monthsended September 30, 2005, compared to $5.0 million in the same period in2004, which is a decrease of $2.1 million. Cash was provided by earnings and non-cash charges in 2005, reduced by aperiod to period $2.0 million decline in accounts payable.  The decline in accounts payable relates to theelimination of extended terms that were experienced in the fourth quarter of2004.  A period to period reduction of $3.1million in accounts receivable also contributed to the positive cash flowreflecting the lower sales volume in the third quarter of 2005.

 

Netcash used in investing activities was $(3.9) million for the nine months ended September 30,2005, compared to $(19.5) million in the 2004 period.  The 2004 amount includes $17.5 million forthe acquisition of Bushman Tanks.

 

Netcash used in financing activities was $1.0 million for the nine months ended September 30,2005, compared to net cash provided by financing activities of $9.7 million inthe same period of 2004.  The decreasewas primarily due to debt repayments made in 2005.

 

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Cashand cash equivalents on September 30, 2005 were $3.4 million, a decreaseof $2.1 million from December 31, 2004. The decrease in cash was due primarily to capital expenditures forproperty and equipment, combined with a reduction of debt levels.

 

Netaccounts receivable were $10.8 million at September 30, 2005 and $13.9 millionat December 31, 2004.  Days salesoutstanding decreased from 37 days at December 31, 2004 to 36 days at September 30,2005, due to lower sales volumes and improved collections.

 

Inventoriesdecreased to $12.4 million at September 30, 2005 from $14.2 million at December 31,2004 to better match current sales levels. Days inventory increased from 52 days at December 31, 2004 to 55days at September 30, 2005.

 

Accountspayable decreased from $16.1 million at December 31, 2004 to $12.0 millionat September 30, 2005.  The decreaseis due primarily to the reduction of vendor payment terms from the fourthquarter of 2004.  Payment terms had beenextended in the fourth quarter of 2004. Days payables decreased from 59 days at December 31, 2004 to 53days at September 30, 2005.

 

TheCompany believes that cash flow from operations coupled with availableborrowings under the credit facilities described in Note 15 will be sufficientto fund the Company’s capital expenditure and working capital requirementsthrough the balance of 2005. The Company’s term loan under the three-year Loanand Security Agreement with an asset-based lender and originally due in September 2005,has been extended to December 2005. The Company is currently considering various financing options.

 

**Contractual Obligations and Other Commitments**

 

The following table summarizes the Company’scontractual obligations and other commitments as of September 30, 2005:

 
| **(amounts in thousands)**     | ** ** | **October 1, 2005 -  September 30, 2006** | ** ** | **October 1, 2006 -  September 30, 2008** | ** ** | **October 1, 2008 -  September 30, 2010** | ** ** | **October 1, 2010  and Beyond** | ** ** | **Total** | ** ** |
|--------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|--------------------------------------|------------|-----------|------------|
| Contractual  Obligations       |       |                                                |       |                                                |       |                                                |       |                                 |       |      |       |
| Debt (1)                       |       | $                                                   | 2,618      |                                                | $          | 2,432                                               |       | $                                    | 1,824      |      | $          | — |   | $ | 6,874 |   |
| Capital Lease Obligations (2)  |       | 8                                                   |       | 101                                                 |       | —                                              |       | —                               |       | 109       |       |
| Operating Lease Obligations(3) |       | 2,649                                               |       | 5,071                                               |       | 4,511                                               |       | 1,510                                |       | 13,741    |       |
| Employment  Contracts (4)      |       | 1,062                                               |       | 2,048                                               |       | 129                                                 |       | —                               |       | 3,239     |       |
| Purchase  Obligations (5)      |       | 6,552                                               |       | —                                              |       | —                                              |       | —                               |       | 6,552     |       |
|                           |       | $                                                   | 12,889     |                                                | $          | 9,652                                               |       | $                                    | 6,464      |      | $          | 1,510 |   | $ | 30,515 |   |

 

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(1)   The Company entered into a three-year Loan andSecurity Agreement, which includes a term loan and revolving line of creditwith an asset-based lender in the United States on September 25,2002.  A subsidiary of the Companyentered into a one-year Loan and Security Agreement, which includes a revolvingline of credit with a commercial bank in Australia in July 2004.  Another subsidiary of the Company enteredinto a five-year Loan and Security Agreement, which includes a term loan,revolving line of credit, an “earn-out” facility, and a capital expenditurefacility with a commercial bank in Australia in August 2004.  The three financing agreements listed abovebear interest at variable rates.  Onlythe outstanding principal amounts are included in the Contractual Obligation table.

(2)   Includes principal only.

(3)   The Company leases manufacturing and officespace and machinery & equipment under several operating leasesexpiring through 2012.

(4)   The Company has employment agreements with itsChairman of the Board expiring July 7, 2006 and its President and ChiefExecutive Officer expiring December 8, 2008.  Both contracts are renewable every 5years.  The Chairman of the Board’ssalary is set at $50,000 per annum for the remainder of the term.  The President and Chief Executive Officer’sbase salary is $773,939 per year effective July 2005, and is subject to anannual cost of living increase based on the consumer price index.  Base salary may also be increased based onthe discretion of the Board of Directors. In the event the President and Chief Executive Officer is terminated theCompany will be obligated to make a lump sum severance payment equal to threetimes his then current base salary.  On September 4,2005 the Company adopted the Long Term Incentive Plan (“LTIP”) for William H.Channell, Jr., CEO, effective as of December 9, 2003.  The LTIP was provided for in, and was adoptedpursuant to, the employment agreement, entered into as of December 9,2003, between the Company and Mr. Channell.  Mr. Channell received an award of$300,000 for fiscal year 2005 and an award of $500,000 for fiscal year2004.  For the three year period of 2004,2005 and 2006, the total potential aggregate award amount is now $1,300,000 ifall Plan criteria are met.

(5)   The Company believes it has adequate sourcesof supply for the raw materials used in its manufacturing processes and itattempts to develop and maintain multiple sources of supply in order to extendthe availability and encourage competitive pricing of these materials.  Most plastic resins are purchased underannual or multi-year pricing agreements to stabilize costs and improve supplierdelivery performance.  The Company is notcontractually obligated to purchase product over the life of these agreements.

 

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**Off-BalanceSheet Arrangements**

 

TheCompany’s off-balance sheet arrangements consist of operating leases,employment contracts and purchase obligations as described above.  In addition, the Company guaranteed the debtof the Channell Family Trust of approximately $754,000 in 1997.  The guaranteed debt was incurred inconnection with construction of the facilities leased to the Company and iscollateralized by said facilities.  Theloan amount subject to the unsecured guarantee is expected to decline beforeexpiring in 2017.  It is not practicableto estimate the fair value of the guarantee; however, the Company does notanticipate that it will incur losses as a result of this guarantee.  The Company has not recorded a liability forthis guarantee.  If the Channell FamilyTrust were to default on the outstanding loan balance, the Company might berequired to repay the remaining principal balance.  The maximum potential amount the Companywould be required to pay is equal to the outstanding principal and interestbalance of the loan to the Channell Family Trust.  At September 30, 2005, the outstandingloan balance subject to the guarantee totaled $561,000.

 

**CriticalAccounting Policies**

 

The Company’s discussion and analysis of its financialcondition and results of operations are based upon its consolidated financialstatements, which have been prepared in accordance with accounting principlesgenerally accepted in the United States of America. The preparation of thesefinancial statements requires the Company to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues and expenses, andrelated disclosure of contingent assets and liabilities.

 

TheCompany believes that the estimates, assumptions and judgments involved in theaccounting policies described in the “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” section of its most recentAnnual Report on Form 10-K have the greatest potential impact on itsfinancial statements, so it considers these to be its critical accountingpolicies. Because of the uncertainty inherent in these matters, actual resultscould differ from the estimates the Company uses in applying the criticalaccounting policies. Certain of these critical accounting policies affectworking capital account balances, including the policies for revenuerecognition, the reserve for uncollectible accounts receivable and inventoryreserves. These policies require that the Company make estimates in the preparationof its financial statements as of a given date.

 

Withinthe context of these critical accounting policies, the Company is not currentlyaware of any reasonably likely events or circumstances that would result inmaterially different amounts being reported.

 

**Forward-Looking Statements**

 

Certainstatements contained herein are “forward-looking” statements within the meaningof the Private Securities Litigation Reform Act of 1995 (the “Act”), whichprovides certain “safe harbor” provisions for forward-looking statements.  All forward-looking statements made hereinare made pursuant to the Act. Forward-looking statements include statements which are predictive innature; which depend upon or refer to future events or conditions; or whichinclude words such as “expects”, “anticipates”, “intends”, “plans”, “believes”,“estimates”, or variations or negatives thereof or by similar or comparablewords or phrases.  In addition, anystatement concerning future financial performance, ongoing business strategiesor prospects, and possible future Company actions that may be provided bymanagement are also forward-looking statements as defined by the Act.  Forward-looking statements are based oncurrent expectations and projections about future events and are subject torisks, uncertainties, and assumptions about the Company; and economic andmarket factors in the countries in which the Company does business, among otherthings.  These statements are notguarantees of future performance, and the Company has no specific intentions toupdate these statements.  Actual eventsand results may differ materially from those expressed or forecasted inforward-looking statements due to a number of factors including, among others: (1) thecommunications industry is in a state of rapid technological change, which canrender the Company’s products obsolete or unmarketable; (2) any failure bythe Company to anticipate or respond to technological developments or changesin industry standards or customer requirements, or any significant delays inproduct development or introduction, could have a material adverse effect onthe Company’s business, operating results and financial condition; (3) arelatively small number of telecommunications customers account for a largepercentage of the Company’s available market; (4) the Company expects thatsales to the telecommunications industry will continue to represent asubstantial portion of its total sales, and the demand for products within thisindustry depends primarily on capital spending by service providers; (5) theCompany’s cost of sales may be materially affected by increases in the marketprices of the raw materials used in the Company’s manufacturing processes;  (6)  the Company’s water related salescould be materially affected by weather conditions and government regulation; (7) theCompany is subject to the risks of conducting business internationally; and (8) theindustries in which the Company operates are highly competitive.  Additional risks and uncertainties areoutlined in the Company’s filings with the Securities and Exchange Commission,including its most recent Annual Report on Form 10-K.

 

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**ITEM 3.****          QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Therisk inherent in the Company’s market sensitive instruments is the potentialloss arising from adverse changes in interest rates and foreign currencyexchange rates.  All financialinstruments held by the Company described below are held for purposes otherthan trading.

 

TheCompany and its subsidiaries have entered into three financing agreements.  In September 2002, the Company enteredinto a three-year Loan and Security Agreement with an asset based lender in theUnited States.  The agreement contains aterm loan and a revolving line of credit. In July 2004, a subsidiary of the Company entered into a one-yearLoan and Security Agreement, which consists of a revolving line of credit witha commercial bank in Australia.  In August 2004,another subsidiary of the Company entered into a five-year Loan and SecurityAgreement which contains a term loan, revolving line of credit, an “earn-out”facility, and a capital expenditure facility with a commercial bank inAustralia.  The loan and securityagreements allow for the outstanding balance to bear interest at a variablerate based on the lender’s base rate. The credit facilities expose the Company to changes in short-terminterest rates since the interest rates on the credit facility are variable.

 

The Company has assets andliabilities outside the United States that are subject to fluctuations inforeign currency exchange rates.  Assetsand liabilities outside the United States are primarily located in the UnitedKingdom, Australia, and Canada.  TheCompany’s investment in foreign subsidiaries with a functional currency otherthan the U.S. dollar is generally considered long-term.  Accordingly, the Company does not hedge theseinvestments.  The Company also purchasesa limited portion of its raw materials from foreign countries.  These purchases are generally denominated inU.S. dollars and are accordingly not subject to exchange ratefluctuations.  The Company has minimalforeign currency transaction gains or losses. The Company has not engaged in forward purchases of foreign currency andother similar contracts to reduce its economic exposure to changes in exchangerates because the associated risk is not considered significant.

 

**ITEM 4.****          CONTROLSAND PROCEDURES**

 

**Evaluation of Disclosure Controls andProcedures**

 

The Company maintainsdisclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) of the Securities and Exchange Act of 1934 (the “Exchange Act”), thatare designed to ensure that information required to be disclosed in theCompany’s Exchange Act reports are recorded, processed, summarized, andreported within the time periods specified in rules and forms of the Securitiesand Exchange Commission regulations, and that such information is accumulatedand communicated to our management, including our Chief Executive Officer andChief Financial Officer, as appropriate, to allow timely decisions regardingrequired disclosure. 

 

As of September 30, 2005,the management of the Company carried out an assessment, under the supervisionof and with the participation of the Company’s Chief Executive Officer and theChief Financial Officer, of the effectiveness of the design and operation ofour disclosure controls and procedures pursuant to Exchange ActRules 13a-15(b) and 15d-15(b). As of the date of this assessment, theChief Executive Officer and the Chief Financial Officer concluded that theCompany’s disclosure controls and procedures were not effective as of September30, 2005, because of the material weaknesses described below. 

 

Due to the material weaknessesdescribed below, the Company’s management performed additional analyses andother post-closing procedures including reviewing all significant accountbalances and disclosures in the consolidated financial statements contained inthis Quarterly Report on Form 10-Q, to ensure the Company’s consolidatedfinancial statements are in accordance with accounting principles generallyaccepted in the United States of America. Accordingly, management believes thatthe consolidated financial statements included in this Quarterly Report, fairlypresent in all material respects, the Company’s financial condition, results ofoperations, and cash flows for all periods presented. 

 

**Management’sReport on Internal Control Over Financial Reporting**

 

Management of the Companyis responsible for establishing and maintaining adequate internal control overfinancial reporting, as such term is defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act. The Company’s internal control over financialreporting is a process designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external reporting purposes in accordance with accounting principlesgenerally accepted in the United States of America. Internal control overfinancial reporting includes those policies and procedures that(i) pertain to the maintenance of records that, in reasonable detail,accurately and fairly reflect the transactions and dispositions of the assetsof the Company; (ii) provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the Company are being made only in accordance withauthorizations of management and directors of the Company; and(iii) provide reasonable assurance regarding prevention or timelydetection of unauthorized acquisition, use, or disposition of the Company’sassets that could have a material effect on the interim or annual consolidatedfinancial statements. 

 

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate. 

 

The Company’s managementassessed the effectiveness of the Company’s internal control over financialreporting as of September 30, 2005. In performing its assessment of theeffectiveness of the Company’s internal control over financial reporting,management applied the criteria described in *InternalControl-Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission (“COSO”). 

 

A material weakness is acontrol deficiency, or combination of control deficiencies, that results inmore than a remote likelihood that a material misstatement of the annual orinterim financial statements will not be 

 

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prevented or detected.Management identified the following control deficiencies which representmaterial weaknesses in the Company’s internal control over financial reportingas of September 30, 2005: 

 

TheCompany did not maintain effective controls over the accuracy of its accountingfor income taxes and the determination of income taxes payable, deferred incometax assets and liabilities and the related income tax provision. Specifically,the Company did not have effective controls to accurately calculate currentincome tax expense. In addition, the Company did not have effective controls tomonitor the difference between the income tax basis and the financial reportingbasis of assets and liabilities and reconcile the difference to its deferredincome tax asset and liability balances. This control deficiency resulted inrestatements to the Company’s 2002, 2003, and 2004 annual consolidatedfinancial statements to correct deferred taxes and the tax provisions.Additionally, this control deficiency could result in a misstatement ofdeferred taxes, tax accruals and the tax provision that would result in amaterial misstatement to the Company’s interim or annual consolidated financialstatements that would not be prevented or detected. Accordingly, management hasdetermined that this control deficiency constitutes a material weakness.

 

The Company alsoidentified significant deficiencies in internal controls that rise to the levelof material weaknesses in revenue and purchasing cycles.

 

 

The control deficiencydescribed above could result in a misstatement of the aforementioned accountsor disclosures that would result in a material misstatement to the Company’sinterim or annual consolidated financial statements that would not be preventedor detected. Accordingly, management has determined that the controldeficiencies described above constitutes a material weakness. 

 

**Changesin Internal Control Over Financial Reporting**

 

During the third quarterof the year ended September 30, 2005, there were no changes in the Company’sinternal control over financial reporting that have materially affected, or wasreasonably likely to materially affect, our internal control over financialreporting. 

 

**RecentDevelopments Relating to the Company’s Internal Control Over FinancialReporting**

 

The Company isimplementing enhancements and changes to its internal control over financialreporting to remediate the material weakness described above. This remediationbegan in 2005.

 

Theseimprovements include further formalization of policies and procedures, improvedsegregation of duties, improved information technology system controls, andadditional monitoring controls.

 

TheCompany has enhanced the competence of the organization by hiring staffcompetent in accounting principles generally accepted in the United States ofAmerica (“GAAP”), and the Company will continue to enhance its financialaccounting and reporting competencies by recruiting additional qualified staffand further developing its existing staff by reinforcing existing continuingeducation programs.

 

The Company’s Audit Committee meets regularly withmanagement and the independent accountants to review accounting, auditing,financial matters and internal control structure.  The Audit Committee andthe independent accountants have free access to each other, with or withoutmanagement being present.

 

**PART II - OTHERINFORMATION**

 

**ITEM 1.****          LEGALPROCEEDINGS**

 

*CarsonIndustries LLC v. Channell Commercial Corporation (Calif. Superior Court Case No. BC334759)*.  For a number of years, the Company haspurchased grade level boxes from Carson Industries LLC (“Carson”) for resale tothe Company’s customers.  In 2004, theCompany’s customers began to report failure of Carson boxes in the field.  The Company has determined that certain boxessold to the Company by Carson in 2004 and thereafter did not conform to certainspecifications and/or did not perform properly in the field.  On June 9, 2005, Carson filed theabove-captioned lawsuit against the Company, principally seeking approximately$360,000 for product sold to the Company but not yet paid for.  On July 26, 2005, the Companycross-complained against Carson for, among other things, breach of contract,breach of express and implied warranties, fraud and intentional interferencewith contractual relations.  The Companyhas not stated a specific dollar remedy that it is seeking from Carson.  The Company intends to vigorously defend theCarson lawsuit and prosecute its own claims against Carson.

 

In addition, the Companyis from time to time involved in ordinary routine litigation incidental to theconduct of its business.  The Companyregularly reviews all pending litigation matters in which it is involved andestablishes reserves deemed appropriate for such litigation matters.  Management believes that no presently pendinglitigation matters are likely to have a material adverse effect on the Company’sfinancial statements or results of operations, taken as a whole.

 
| **ITEM 2.**                                                                                                                                                                                                 | ** ** | **UNREGISTERED SALES OF EQUITY SECURITIES AND USE  OF PROCEEDS** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------|
|                                                                                                                                                                                                        |       | Not applicable.                                                  |
|                                                                                                                                                                                                        |       |                                                             |
| **ITEM 3.**                                                                                                                                                                                                 | ** ** | **DEFAULTS UPON SENIOR SECURITIES**                              |
| ** **                                                                                                                                                                                                  | ** ** | ** **                                                       |
| At September 30, 2005, the Company was not in  compliance with one of the debt covenants of the U.S. Loan and Security  Agreement and has obtained a waiver for the third quarter of 2005 from the  lender. |
|                                                                                                                                                                                                        |       |                                                             |
| **ITEM 4.**                                                                                                                                                                                                 | ** ** | **SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS**         |
|                                                                                                                                                                                                        |       | Not applicable                                                   |
|                                                                                                                                                                                                        |       |                                                             |
| **ITEM 5.**                                                                                                                                                                                                 | ** ** | **OTHER INFORMATION**                                            |
|                                                                                                                                                                                                        |       | Not applicable.                                                  |

 

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**ITEM 6.****  EXHIBITS**

 
| **Exhibit  Number** | ** ** | **Description** |
|---------------------|------------|-----------------|
|                | 3.1        |            | Restated Certificate of  Incorporation of the Company (1) |
|                | 3.2        |            | Bylaws of the Company (1) |
|                | 4          |            | Form of Common Stock  Certificate (1) |
|                | 10.1       |            | Tax Agreement between the  Company and the Existing Stockholders (1) |
|                | 10.2.1*    |            | Channell Commercial  Corporation 1996 Incentive Stock Plan (including forms of Stock Option  Agreements and Restricted Stock Agreement)(1) |
|                | 10.2.2*    |            | Channell Commercial  Corporation 2003 Incentive Stock Plan (including forms of Stock Option  Agreement and Restricted Stock Agreement)(8) |
|                | 10.2.3*    |            | Channell Commercial  Corporation 2004 Incentive Bonus Plan(11) |
|                | 10.3       |            | Loan and Security Agreement  dated as of September 25, 2002 by and among the Company, Channell  Commercial Canada Inc., Fleet Capital Corporation, Fleet Capital Canada  Corporation and, under the circumstances set forth therein, Fleet National  Bank, London U.K. Branch, trading as Fleet Boston Financial, and the U.K.  Borrowers (as defined therein, if any) (6) |
|                | 10.3.1     |            | Loan and Security Agreement  dated October 24, 2003 by and among Channell Pty Ltd and National  Australia Bank Ltd (10) |
|                | 10.3.2     |            | Loan and Security Agreement  dated August 2, 2004 by and among Channell Bushman Pty Ltd and National  Australia Bank Ltd (10) |
|                | 10.3.3     |            | Loan and Security Agreement  dated August 2, 2004 by and among Channell Pty Ltd and National  Australia Bank  Ltd (10) |
|                | 10.3.4     |            | Investment and Shareholders  Agreement dated August 2, 2004 by and among Channell Bushman Pty Ltd and  Australia and New Zealand Banking Group Ltd (10) |
|                | 10.4*      |            | Employment Agreement  between the Company and William H. Channell, Sr., dated July 8,  1996 (1) |
|                | 10.6*      |            | Channell Commercial  Corporation 1996 Performance-Based Annual Incentive Compensation Plan (1) |
|                | 10.7       |            | Lease dated December 22,  1989 between the Company and the Channell Family Trust (as successor in  interest to William H. Channell, Sr., as amended (1) |
|                | 10.8       |            | Lease dated May 29,  1996 between the Company and the Channell Family Trust (1) |
|                | 10.9       |            | Lease dated October 26,  2000 between the Company and Belston Developments Inc. (4) |
|                | 10.10      |            | Third Amendment to Lease  dated December 22, 1989 between the Company and the Channell Family  Trust (as successor in interest to William H. Channell, Sr., effective  as of June 1, 2005 (13) |
|                | 10.11      |            | Form of Indemnity  Agreement (1) |
|                | 10.12      |            | Form of Agreement  Regarding Intellectual Property (1) |
|                | 10.13      |            | 401(k) Plan of the Company  (3) |
|                | 10.14      |            | A.C. Egerton (Holdings) PLC  Share Purchase Agreement (2) |
|                | 10.17      |            | Lease dated June 27,  2002 between the Company and Ynez Street, Ltd (5) |
|                | 10.19*     |            | Amendment to Employment  Agreement between the Company and William H. Channell, Sr., dated December 9,  2003 (9) |
|                | 10.20*     |            | Employment Agreement  between the Company and William H. Channell, Jr., dated December 9,  2003 (9) |
|                | 10.21      |            | Share and Asset Purchase  Agreement dated as of July 14, 2004 by and among Australia’s Bushman  Tanks Pty Ltd., Douglas Robin Young, Richard James Young, Lokan Nominees Pty  Ltd and Lenbridge Grange Pty Ltd, Belsiasun Pty Ltd and Elcarva Pty Ltd, the  holders of all the outstanding shares of Bushmans Group Pty Ltd, Hold-On  Industries Australia Pty Ltd, Australian Bushman Tanks Pty Ltd., and Polyrib  Tanks Pty Ltd, on the one hand, and Channell Commercial Corporation and  Channell Bushman Pty Limited, on the other hand.(12) |
|                | 10.22*     |            | Employment Letter between  the Company and Jerry Collazo, dated June 27, 2005 (14) |
|                | 10.23*     |            | Employment Letter between  the Company and Greg Balla, dated June 30, 2005 (15) |
|                | 10.24*     |            | Long-Term Incentive Plan  for William H. Channell, Jr.(16) |
|                | 10.25      |            | Waiver and Third Amendment  to U.S. Loan and Security Agreement, dated November 18, 2005 (17) |
|                | 10.26      |            | Assignment and Assumption  Agreement, dated November 18, 2005 by and between Banc of America Leasing and  Capital, LLC and Bank of America, N.A. (relating to U.S. Loan and Security  Agreement) (17) |
|                | 14         |            | Channell Commercial  Corporation Code of Business Conduct and Ethics (9) |
|                | 31.1       |            | Certification of Chief  Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) under  the Securities and Exchange Act of 1934 (17) |
|                | 31.2       |            | Certification of Chief  Financial Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) under  the Securities and Exchange Act of 1934 (17) |
|                | 32.1       |            | Certification pursuant to  18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the  Sarbanes- Oxley Act of 2002 by William H. Channell, Jr., CEO; and Jerry  Collazo, CFO. (17) |

 

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* Management contract orcompensatory plan or arrangement.

(1)   Incorporated byreference to the indicated exhibits filed in connection with the Company’sRegistration Statement on Form S-1 (File No. 333-3621).

(2)   Incorporated byreference to the indicated exhibits filed in connection with the Company’s Form 8-Kon May 18, 1998.

(3)   Incorporated byreference to the indicated exhibits filed in connection with the Company’s Form 10-Kon March 31, 1999.

(4)   Incorporated byreference to the indicated exhibits filed in connection with the Company’s Form 10-Kon April 2, 2001.

(5)   Incorporated byreference to the indicated exhibits filed in connection with the Company’s Form 10-Qon August 12, 2002.

(6)   Incorporated byreference to the indicated exhibits filed in connection with the Company’s Form 8-Kon September 25, 2002.

(7)   Incorporated byreference to the indicated exhibits filed in connection with the Company’s Form 10-Qon November 12, 2002.

(8)   Incorporated byreference to Appendix B filed in connection with the Company’s Definitive ProxyStatement on March 26, 2003.

(9)   Incorporated byreference to the indicated exhibits filed in connection with the Company’s Form 10-Kon March 5, 2004.

(10)Incorporated byreference to the indicated exhibits filed in connection with the Company’s Form 10-Qon November 15, 2004.

(11)Incorporated byreference to Appendix B filed in connection with the Company’s Definitive ProxyStatement on April 16, 2004.

(12)Incorporated byreference to the indicated exhibits filed in connection with the Company’s Form 8-Kon August 6, 2004.

(13)Incorporated byreference to the indicated exhibits filed in connection with the Company’s Form 8-Kon June 15, 2005.

(14)Incorporated byreference to the indicated exhibits filed in connection with the Company’s Form 8-Kon June 28, 2005.

(15)Incorporated byreference to the indicated exhibits filed in connection with the Company’s Form 10-Qon August 15, 2005.

(16)Incorporated byreference to the indicated exhibits filed in connection with the Company’s Form 8-Kon September 9, 2005.

(17)Filed herewith.

 

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SIGNATURES

 

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.

 

Dated:  November 21, 2005

 
|   |   |   | CHANNELL  COMMERCIAL CORPORATION                                             |
|--------|--------|--------|------------------------------------------------------------------------------|
|   |   |   | (Registrant)                                                                 |
|   |   |   |                                                                         |
|   |   |   |
|   |   | By     | /s/ Jerry Collazo                                                            |   |
|   |   |   | Jerry Collazo                                                                |
|   |   |   | Chief Financial  Officer                                                     |
|   |   |   | (Duly authorized officer and principal financial  officer of the Registrant) |
|   |   |   |

 

####

 

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