**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM10-Q**

 
| **ý** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                                                                                                                                                                  |
|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|       | **For the quarterly period ended September 30,  2004**                                                                                                                                                                                                                                                                                                                                                                                                                        |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|       | **OR**                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| **o**      | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                                                                                                                                                                 |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|       | **For the transition period from                                       to                                    ** |

 

**Commission File No. 0-28582**

 

**CHANNELLCOMMERCIAL CORPORATION**

(Exact name of Registrantas 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)      |

 

Indicate by checkmark whether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.
|   | Yes  **ý** | No  o |
|--------|---------------------------|-----------------|

 

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

 

9,302,774 shares of common stock of the Registrantwere outstanding at November 1, 2004.

 

 

----

 

**PART 1 –    FINANCIALINFORMATION**

** **

**ITEM1.     FINANCIAL STATEMENTS**

** **

**CHANNELL COMMERCIAL CORPORATION**

**CONSOLIDATED STATEMENTS OF INCOMEAND COMPREHENSIVE INCOME(Unaudited)**

*(amounts in thousands, except pershare data)*

 
| ** **                                                                               | ** ** | **Nine months ended  September 30,** | ** ** | **Three months ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                               | ** ** | **2004**                             | ** ** | **2003**                              | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                     |       |                                 |       |                                  |       |   |   |   |   |
| Net sales                                                                                |       | $                                    | 66,638     |                                  | $          | 55,937 |   | $ | 27,615 |   | $ | 19,434 |   |
| Cost of goods  sold                                                                      |       | 47,470                               |       | 39,491                                |       | 19,719 |   | 13,919 |   |
|                                                                                     |       |                                 |       |                                  |       |   |   |   |   |
| Gross profit                                                                             |       | 19,168                               |       | 16,446                                |       | 7,896 |   | 5,515 |   |
| Operating  expenses                                                                      |       |                                 |       |                                  |       |   |   |   |   |
| Selling                                                                                  |       | 9,308                                |       | 6,994                                 |       | 4,009 |   | 2,347 |   |
| General and administrative                                                               |       | 6,039                                |       | 5,776                                 |       | 2,212 |   | 2,048 |   |
| Research and  development                                                                |       | 1,642                                |       | 1,193                                 |       | 577 |   | 408 |   |
| Restructuring  charge                                                                    |       | (686                                 | )          | —                                |       | (686 | ) | — |   |
|                                                                                     |       | 16,303                               |       | 13,963                                |       | 6,112 |   | 4,803 |   |
| Income from  operations                                                                  |       | 2,865                                |       | 2,483                                 |       | 1,784 |   | 712 |   |
|                                                                                     |       |                                 |       |                                  |       |   |   |   |   |
| Interest  expense, net                                                                   |       | 320                                  |       | 438                                   |       | 170 |   | 178 |   |
|                                                                                     |       |                                 |       |                                  |       |   |   |   |   |
| Income before  income taxes                                                              |       | 2,545                                |       | 2,045                                 |       | 1,614 |   | 534 |   |
|                                                                                     |       |                                 |       |                                  |       |   |   |   |   |
| Income taxes  (benefit)                                                                  |       | (679                                 | )          | 730                                   |       | (679 | ) | (1 | ) |
|                                                                                     |       |                                 |       |                                  |       |   |   |   |   |
| Net income  before minority interest                                                     |       | 3,224                                |       | 1,315                                 |       | 2,293 |   | 535 |   |
|                                                                                     |       |                                 |       |                                  |       |   |   |   |   |
| Minority  interest                                                                       |       | 75                                   |       | —                                |       | 75 |   | — |   |
|                                                                                     |       |                                 |       |                                  |       |   |   |   |   |
| Net income                                                                               |       | $                                    | 3,149      |                                  | $          | 1,315 |   | $ | 2,218 |   | $ | 535 |   |
|                                                                                     |       |                                 |       |                                  |       |   |   |   |   |
| Net income per  share                                                                    |       |                                 |       |                                  |       |   |   |   |   |
| Basic                                                                                    |       | $                                    | 0.34       |                                  | $          | 0.14 |   | $ | 0.24 |   | $ | 0.06 |   |
|                                                                                     |       |                                 |       |                                  |       |   |   |   |   |
| Diluted                                                                                  |       | $                                    | 0.34       |                                  | $          | 0.14 |   | $ | 0.24 |   | $ | 0.06 |   |
|                                                                                     |       |                                 |       |                                  |       |   |   |   |   |
| Net income                                                                               |       | $                                    | 3,149      |                                  | $          | 1,315 |   | $ | 2,218 |   | $ | 535 |   |
|                                                                                     |       |                                 |       |                                  |       |   |   |   |   |
| Other  comprehensive (loss) income, net of tax Foreign currency translation  adjustments |       | (170                                 | )          | 1,281                                 |       | 411 |   | 79 |   |
|                                                                                     |       |                                 |       |                                  |       |   |   |   |   |
| Comprehensive  net income                                                                |       | $                                    | 2,979      |                                  | $          | 2,596 |   | $ | 2,629 |   | $ | 614 |   |

 

The accompanying notesare an integral part of these financial statements.

 

1

----

 

**CHANNELLCOMMERCIAL CORPORATION**

**CONSOLIDATEDBALANCE SHEETS**

*(amountsin thousands)*

 
| ** **                                                                                                                                                                                                                         | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                                                         | ** ** | **(Unaudited)**         | ** ** | ** **             | ** ** |
| **ASSETS**                                                                                                                                                                                                                         |       |                    |       |                   |       |
| **Current  assets**                                                                                                                                                                                                                |       |                    |       |                   |       |
| Cash and cash  equivalents                                                                                                                                                                                                         |       | $                       | 4,064      |                   | $          | 9,527 |   |
| Accounts  receivable, net                                                                                                                                                                                                          |       | 13,989                  |       | 10,051                 |       |
| Inventories                                                                                                                                                                                                                        |       | 13,377                  |       | 8,855                  |       |
| Deferred income  taxes                                                                                                                                                                                                             |       | 812                     |       | 876                    |       |
| Prepaid expenses  and other current assets                                                                                                                                                                                         |       | 1,136                   |       | 996                    |       |
| Income taxes  receivable                                                                                                                                                                                                           |       | 1,587                   |       | 102                    |       |
|                                                                                                                                                                                                                               |       |                    |       |                   |       |
| Total current assets                                                                                                                                                                                                               |       | 34,965                  |       | 30,407                 |       |
|                                                                                                                                                                                                                               |       |                    |       |                   |       |
| **Property  and equipment at cost, net**                                                                                                                                                                                           |       | 18,945                  |       | 17,164                 |       |
| **Deferred  income taxes**                                                                                                                                                                                                         |       | 5,535                   |       | 5,277                  |       |
| **Intangible  assets, net**                                                                                                                                                                                                        |       | 15,368                  |       | 613                    |       |
| **Other  assets**                                                                                                                                                                                                                  |       | 742                     |       | 504                    |       |
|                                                                                                                                                                                                                               |       |                    |       |                   |       |
|                                                                                                                                                                                                                               |       | $                       | 75,555     |                   | $          | 53,965 |   |
|                                                                                                                                                                                                                               |       |                    |       |                   |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                     |       |                    |       |                   |       |
| **Current  liabilities**                                                                                                                                                                                                           |       |                    |       |                   |       |
| Accounts payable                                                                                                                                                                                                                   |       | $                       | 13,944     |                   | $          | 5,103 |   |
| Short term debt  (including current maturities of long term debt)                                                                                                                                                                  |       | 5,567                   |       | 952                    |       |
| Current  maturities of capital lease obligations                                                                                                                                                                                   |       | 11                      |       | 57                     |       |
| Accrued  restructuring liability                                                                                                                                                                                                   |       | 245                     |       | 2,857                  |       |
| Accrued expenses                                                                                                                                                                                                                   |       | 6,731                   |       | 4,240                  |       |
|                                                                                                                                                                                                                               |       |                    |       |                   |       |
| Total current  liabilities                                                                                                                                                                                                         |       | 26,498                  |       | 13,209                 |       |
|                                                                                                                                                                                                                               |       |                    |       |                   |       |
| **Long  term debt, less current maturities**                                                                                                                                                                                       |       | 4,633                   |       | 2,830                  |       |
| **Capital  lease obligations, less current maturities**                                                                                                                                                                            |       | 127                     |       | 67                     |       |
| **Deferred  gain on sale leaseback transaction**                                                                                                                                                                                   |       | 468                     |       | 513                    |       |
| **Commitments  and contingencies**                                                                                                                                                                                                 |       | —                  |       | —                 |       |
| **Minority  interest**                                                                                                                                                                                                             |       | 2,790                   |       | —                 |       |
|                                                                                                                                                                                                                               |       |                    |       |                   |       |
| **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 - 9,372 shares  at December 31, 2003 and 9,547 at September 30, 2004; outstanding - 9,128  shares at December 31, 2003 and 9,303 at September 30, 2004 |       | 95                      |       | 94                     |       |
| Additional  paid-in capital                                                                                                                                                                                                        |       | 29,377                  |       | 28,664                 |       |
| Treasury stock -  244 shares in 2003 and 2004                                                                                                                                                                                      |       | (1,871                  | )          | (1,871                 | )          |
| Retained  earnings                                                                                                                                                                                                                 |       | 13,619                  |       | 10,470                 |       |
| Accumulated  other comprehensive loss - Foreign currency translation                                                                                                                                                               |       | (181                    | )          | (11                    | )          |
|                                                                                                                                                                                                                               |       |                    |       |                   |       |
| **Total  stockholders’ equity**                                                                                                                                                                                               |       | 41,039                  |       | 37,346                 |       |
|                                                                                                                                                                                                                               |       |                    |       |                   |       |
| **Total  liabilities and stockholders’ equity**                                                                                                                                                                               |       | $                       | 75,555     |                   | $          | 53,965 |   |

 

The accompanying notesare an integral part of these financial statements.

 

2

----

 

**CHANNELLCOMMERCIAL CORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

*(amountsin thousands)*

 
| ** **                                           | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                           | ** ** | **2004**                             | ** ** | **2003** |   |
| **Cash  flows from operating activities:**           |       |                                 |       |   |   |
| Net income                                           |       | $                                    | 3,149      |   | $ | 1,315 |   |
| Depreciation and  amortization                       |       | 3,484                                |       | 4,785 |   |
| Deferred income taxes                                |       | 221                                  |       | (100 | ) |
| (Gain) Loss on disposal  of fixed asset              |       | (20                                  | )          | 62 |   |
| Amortization of  deferred gain on sale leaseback     |       | (45                                  | )          | 16 |   |
| Change in assets  and liabilities:                   |       |                                 |       |   |   |
| (Increase) decrease in  assets:                      |       |                                 |       |   |   |
| Accounts receivable                                  |       | (1,558                               | )          | 374 |   |
| Inventories                                          |       | (1,998                               | )          | (859 | ) |
| Prepaid expenses                                     |       | (40                                  | )          | (160 | ) |
| Other                                                |       | (234                                 | )          | (70 | ) |
| Income taxes receivable                              |       | (1,481                               | )          | (71 | ) |
| Increase (decrease) in  liabilities:                 |       |                                 |       |   |   |
| Accounts payable                                     |       | 5,558                                |       | (789 | ) |
| Accrued expenses                                     |       | 697                                  |       | 1,003 |   |
| Restructuring liability                              |       | (2,687                               | )          | (899 | ) |
|                                                 |       |                                 |       |   |   |
| Net cash  provided by operating activities           |       | 5,046                                |       | 4,607 |   |
|                                                 |       |                                 |       |   |   |
| **Cash  flows from investing activities:**           |       |                                 |       |   |   |
| Acquisition of  property and equipment               |       | (2,054                               | )          | (915 | ) |
| Proceeds from  the sales of property and equipment   |       | 24                                   |       | 2,320 |   |
| Business  acquisitions, net of cash acquired         |       | (17,503                              | )          | — |   |
|                                                 |       |                                 |       |   |   |
| Net cash (used  in) provided by investing activities |       | (19,533                              | )          | 1,405 |   |
|                                                 |       |                                 |       |   |   |
| **Cash  flows from financing activities:**           |       |                                 |       |   |   |
| Proceeds from  issuance of debt                      |       | 6,958                                |       | — |   |
| Repayment of  debt                                   |       | (714                                 | )          | (1,809 | ) |
| Repayment of  obligations under capital lease        |       | 18                                   |       | (614 | ) |
| Proceeds from  minority investor                     |       | 2,715                                |       | — |   |
| Proceeds from  issance of stock                      |       | 714                                  |       | — |   |
| Exercise of  stock options                           |       | —                               |       | 9 |   |
|                                                 |       |                                 |       |   |   |
| Net cash  provided by (used in) financing activities |       | 9,691                                |       | (2,414 | ) |
|                                                 |       |                                 |       |   |   |
| Effect of  exchange rates on cash                    |       | (667                                 | )          | 525 |   |
|                                                 |       |                                 |       |   |   |
| (Decrease)  increase in cash and cash equivalents    |       | (5,463                               | )          | 4,123 |   |
|                                                 |       |                                 |       |   |   |
| Cash and cash  equivalents, beginning of period      |       | 9,527                                |       | 3,162 |   |
|                                                 |       |                                 |       |   |   |
| Cash and cash  equivalents, end of period            |       | $                                    | 4,064      |   | $ | 7,285 |   |
|                                                 |       |                                 |       |   |   |
| **Cash  paid during the period for:**                |       |                                 |       |   |   |
| Interest                                             |       | $                                    | 223        |   | $ | 239 |   |
|                                                 |       |                                 |       |   |   |
| Income taxes                                         |       | $                                    | 601        |   | $ | 757 |   |

 

The accompanying notesare an integral part of these financial statements.

 

3

----

** **

**CHANNELLCOMMERCIAL CORPORATION**

**CONSOLIDATEDSTATEMENT OF STOCKHOLDERS’ EQUITY**

**Ninemonths ended September 30, 2004**

*(amountsin thousands)*

 
| ** **                    | ** **         | ** ** | ** ** | **Additional  paid-in  capital** | ** ** | ** ** | ** ** | **Retained  earnings** | ** ** | **Accumulated  other  comprehensive  Income (loss)** | ** ** | **Total  stockholders  equity** | ** ** |
|-------------------------------|--------------------|------------|------------|----------------------------------|------------|------------|------------|------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|
| ** **                    | ** **         | ** ** | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **             | ** ** | ** **                                           | ** ** | ** **                      | ** ** |
| **Common stock**              | **Treasury stock** |
| **Shares**                    | ** **         | **Amount** | **Shares** | ** **                       | **Amount** |
| Balance, January  1, 2004     |               | 9,372      |       | $                                | 94         |       | $          | 28,664                 |       | 244                                                  |       | $                               | (1,871     | ) | $ | 10,470 |   | $ | (11 | ) | $ | 37,346 |   |
|                          |               |       |       |                             |       |       |       |                   |       |                                                 |       |                            |       |   |   |   |   |
| Shares issued                 |               | 175        |       | 1                                |       | 713        |       |                   |       |                                                 |       |                            |       |   |   | 714 |   |
| Foreign currency  translation |               |       |       |                             |       |       |       |                   |       |                                                 |       |                            |       | (170 | )  | (170 | )  |
| Net income for  the period    |               |       |       |                             |       |       |       |                   |       |                                                 |       | 3,149                           |       |   |   | 3,149 |   |
|                          |               |       |       |                             |       |       |       |                   |       |                                                 |       |                            |       |   |   |   |   |
| Balance,  September 30, 2004  |               | 9,547      |       | $                                | 95         |       | $          | 29,377                 |       | 244                                                  |       | $                               | (1,871     | ) | $ | 13,619 |   | $ | (181 | ) | $ | 41,039 |   |

 

**The accompanying notes are an integral part of thisfinancial statement.**

 

4

----

 

**CHANNELL COMMERCIAL CORPORATION**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS  (Unaudited)**

**September 30, 2004 and 2003**

*(amounts in thousands, except pershare data)*

 

1.                       *Unaudited financialstatements.*  In the opinion ofmanagement, the accompanying unaudited consolidated financial statementscontain all adjustments necessary to present fairly the consolidated financialposition of Channell Commercial Corporation (the “Company”) as of September 30,2004 and the results of its operations for the three months and nine monthsended September 30, 2004 and September 30, 2003 and its cash flows for the ninemonths ended September 30, 2004 and September 30, 2003.  The results of operations and cash flows forthe nine months ended September 30, 2004 are not necessarily indicative of theresults to be expected for any other interim period or the full year.  These consolidated financial statementsshould be read in combination with the audited consolidated financialstatements and notes thereto for the year ended December 31, 2003.

 

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

 
| ** **      | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------|------------|-------------------------|------------|------------------------|------------|
| Raw Materials   |       | $                       | 4,185      |                   | $          | 2,895 |   |
| Work-in-Process |       | 3,284                   |       | 2,468                  |       |
| Finished Goods  |       | 5,908                   |       | 3,492                  |       |
|            |       | $                       | 13,377     |                   | $          | 8,855 |   |

 

3.                       *Income**per share.*  Basicincome per share excludes dilution and is computed by dividing net incomeavailable to common stockholders by the weighted average number of commonshares outstanding for the nine month and three month periods ended September30, 2004 and 2003.  Diluted income pershare reflects the potential dilution that could occur if dilutive options toacquire common stock were exercised.  Thefollowing is a reconciliation of the number of shares (denominator) used in thebasic and diluted income per share computations for the nine month and threemonth periods ended  September 30, 2004and 2003 (shares in thousands):

 
| ** **                        | ** ** | **Nine  months ended September 30,** | ** ** |
|-----------------------------------|------------|--------------------------------------|------------|
| ** **                        | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **                        | ** ** | **Shares**                           | ** ** | **Per  Share  Amount** | ** ** | **Shares** | ** ** | **Per  Share  Amount** | ** ** |
| Basic income per  share           |       | 9,165                                |       | $ | 0.34 |   | 9,126 |   | $ | 0.14 |   |
| Effect of  dilutive stock options |       | 11                                   |       | — |   | 38 |   | — |   |
| Diluted income  per share         |       | 9,176                                |       | $ | 0.34 |   | 9,164 |   | $ | 0.14 |   |

 

The following optionswere not included in the computation of diluted income per share due to theirantidilutive effect.

 
| ** **                                  | ** ** | **Nine months ended September 30,** | ** ** |
|---------------------------------------------|------------|-------------------------------------|------------|
| ** **                                  | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| Options to  purchase shares of common stock |       | 1,401                               |       | 101 |   |
| Exercise prices                             |       | $4.84 - $13.75                      |       | $6.50 - $13.75 |   |
| Expiration dates                            |       | July 2006 - September  2013         |       | July 2006 - May 2012 |   |

 
| ** **                        | ** ** | **Three months ended September 30,** | ** ** |
|-----------------------------------|------------|--------------------------------------|------------|
| ** **                        | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **                        | ** ** | **Shares**                           | ** ** | **Per Share  Amount** | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** |
| Basic income per  share           |       | 9,240                                |       | $ | 0.24 |   | 9,127 |   | $ | 0.06 |   |
| Effect of  dilutive stock options |       | 3                                    |       | — |   | 88 |   | — |   |
| Diluted income  per share         |       | 9,243                                |       | $ | 0.24 |   | 9,215 |   | $ | 0.06 |   |

 

5

----

 

The followingoptions were not included in the computation of diluted income per share due totheir antidilutive effect.

 
| ** **                                  | ** ** | **Three months ended September 30,** | ** ** |
|---------------------------------------------|------------|--------------------------------------|------------|
| ** **                                  | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| Options to  purchase shares of common stock |       | 1,461                                |       | 101 |   |
| Exercise prices                             |       | $4.75 - $13.75                       |       | $6.50 - $13.75 |   |
| Expiration dates                            |       | July 2006 - September  2013          |       | July 2006 - May 2012 |   |

 

In February 2003, theCompany offered current employees and non-employee directors an opportunity toexchange their outstanding options granted under the 1996 Stock Plan.  Pursuant to the offer, a total of 1,326,890options were cancelled on March 20, 2003. On September 24, 2003, a total of 1,324,090 new options were exchangedfor options cancelled in March 2003.

 

4.               *Stock Based Compensation.* Statement of Financial Accounting StandardsNo. 148, “*Accounting for Stock Based Compensation –Transition and Disclosure on 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, compensation costfor stock options is measured as the excess, if any, of the quoted market priceof the Company’s stock at the date of grant over the amount an employee mustpay to acquire the stock.

 

Pursuant to the exchange offer described in Note 3 above, participatingeligible option holders were granted a new option for each old cancelledoption.  For each new option granted, thevesting status and vesting schedule of the old option was preserved.  The weighted average fair value of theoptions issued in September 2003 was $1.91. The weighted average exercise price was $4.84.

 

Had compensation cost for the plan been determined based on the fairvalue of the options at the grant dates based on the above method, the Company’snet income and income per share would have been:

 
| ** **                                                                      | ** ** | **Nine months ended September 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                      | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| Reported net  income                                                            |       | $                                   | 3,149      |   | $ | 1,315 |   |
| Less expense  determined under fair value accounting for all awards, net of tax |       | 327                                 |       | 890 |   |
| Proforma net  income                                                            |       | $                                   | 2,822      |   | $ | 425 |   |
|                                                                            |       |                                |       |   |   |
| Reported basic  and diluted net income per share                                |       | $                                   | 0.34       |   | $ | 0.14 |   |
| Less expense  determined under fair value accounting for all awards, net of tax |       | 0.04                                |       | 0.09 |   |
| Proforma basic  and diluted net income per share                                |       | $                                   | 0.30       |   | $ | 0.05 |   |

 

 
| ** **                                                                      | ** ** | **Three months ended September 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                      | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| Reported net  income                                                            |       | $                                    | 2,218      |   | $ | 535 |   |
| Less expense  determined under fair value accounting for all awards, net of tax |       | 106                                  |       | 838 |   |
| Proforma net  income (loss)                                                     |       | $                                    | 2,112      |   | $ | (303 | ) |
|                                                                            |       |                                 |       |   |   |
| Reported basic  and diluted net income per share                                |       | $                                    | 0.24       |   | $ | 0.06 |   |
| Less expense  determined under fair value accounting for all awards, net of tax |       | 0.01                                 |       | 0.01 |   |
| Proforma basic  and diluted net income (loss) per share                         |       | $                                    | 0.23       |   | $ | (0.03 | ) |

 

6

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The fair value ofoptions at date of grant was estimated using the Black-Scholes model with thefollowing weighted average assumptions:

 
| ** **               | ** ** | **Periods ended September 30,** | ** ** |
|--------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | **2004**                        | ** ** | **2003** | ** ** |
| Expected life  (years)   |       | 5 years                         |       | 5 years |   |
| Risk-free  interest rate |       | 3.50                            | %          | 3.00 | % |
| Expected  volatility     |       | 40                              | %          | 40 | % |
| Expected  dividend yield |       | —                          |       | — |   |

 

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, 2004 and 2003:

 
| ** **                             | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------------------|------------|-------------------------------------|------------|
| ** **                             | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| Revenues from  unrelated entities (1): |       |                                |       |   |   |
| Americas                               |       | $                                   | 51,064     |   | $ | 47,218 |   |
| International                          |       | 15,574                              |       | 8,719 |   |
|                                   |       | $                                   | 66,638     |   | $ | 55,937 |   |
|                                   |       |                                |       |   |   |
| Income (loss)  from operations:        |       |                                |       |   |   |
| Americas                               |       | $                                   | 3,463      |   | $ | 3,679 |   |
| International                          |       | (598                                | )          | (1,196 | ) |
|                                   |       | $                                   | 2,865      |   | $ | 2,483 |   |
|                                   |       |                                |       |   |   |
| Interest  expense, net:                |       |                                |       |   |   |
| Americas                               |       | $                                   | 133        |   | $ | 75 |   |
| International                          |       | 187                                 |       | 363 |   |
|                                   |       | $                                   | 320        |   | $ | 438 |   |

 
| ** **                             | ** ** | **Three months ended September 30,** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|
| ** **                             | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| Revenues from  unrelated entities (1): |       |                                 |       |   |   |
| Americas                               |       | $                                    | 18,282     |   | $ | 16,762 |   |
| International                          |       | 9,333                                |       | 2,672 |   |
|                                   |       | $                                    | 27,615     |   | $ | 19,434 |   |
| Income (loss)  from operations:        |       |                                 |       |   |   |
| Americas                               |       | $                                    | 1,168      |   | $ | 1,189 |   |
| International                          |       | 616                                  |       | (477 | ) |
|                                   |       | $                                    | 1,784      |   | $ | 712 |   |
|                                   |       |                                 |       |   |   |
| Interest  expense, net:                |       |                                 |       |   |   |
| Americas                               |       | $                                    | 105        |   | $ | 60 |   |
| International                          |       | 65                                   |       | 118 |   |
|                                   |       | $                                    | 170        |   | $ | 178 |   |

 

----

(1) Note: Revenues fromAustralia exceeded 10% of total revenues for both the three month and nine monthperiods ended September 30, 2004. Revenues from Australia totaled $7,503 forthe three month and $10,452 for the nine month period. Revenues from individualforeign countries did not exceed 10% of total revenues during the correspondingperiods in 2003.

 

7

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The Company has revenues from external customers fromthe following product lines:

 
| ** **             | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------|------------|-------------------------------------|------------|
| ** **             | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| Product lines          |       |                                |       |   |   |
| Enclosures             |       | $                                   | 45,350     |   | $ | 43,871 |   |
| Water related products |       | 13,182                              |       | 5,433 |   |
| Connectivity           |       | 7,101                               |       | 5,887 |   |
| Other                  |       | 1,005                               |       | 746 |   |
|                   |       | $                                   | 66,638     |   | $ | 55,937 |   |

 
| ** **              | ** ** | **Three months ended September 30,** | ** ** |
|-------------------------|------------|--------------------------------------|------------|
| ** **              | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| Product lines           |       |                                 |       |   |   |
| Enclosures              |       | $                                    | 14,184     |   | $ | 15,009 |   |
| Water related  products |       | 10,033                               |       | 1,919 |   |
| Connectivity            |       | 3,024                                |       | 2,265 |   |
| Other                   |       | 374                                  |       | 241 |   |
|                    |       | $                                    | 27,615     |   | $ | 19,434 |   |

 

The Company has identifiable assets in the followinggeographic regions:

 
| ** **            | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------------|------------|-------------------------|------------|------------------------|------------|
| ** **            | ** ** | **(Unaudited)**         | ** ** | ** **             | ** ** |
| Identifiable  Assets: |       |                    |       |                   |       |
| Americas              |       | $                       | 43,563     |                   | $          | 40,949 |   |
| International         |       | 31,992                  |       | 13,016                 |       |
|                  |       | $                       | 75,555     |                   | $          | 53,965 |   |

 

6.                       *Recent AccountingPronouncement.*  In March 2004, The Securities and ExchangeCommission (“SEC”) issued Staff Accounting Bulletin 104 “Revenue Recognition” (“SAB104”), an update to the guidance in SAB 101 “Revenue Recognition in FinancialStatements” 101 (codified in Topic 13: “Revenue Recognition”).  The primary objectives of SAB 104 are toreflect the issuance of EITF Issue 00-*21*, “Revenue Arrangements with MultipleDeliverables”, to delete the guidance on reporting revenues gross as aprincipal or net as an agent because EITF Issue 99-19, “Reporting Revenue Grossas a Principal versus Net as an Agent”, and to rescind SAB 101 “RevenueRecognition in Financial Statements - Frequently Asked Questions and Answers(FAQ)” and incorporate selected portions of the FAQ into Topic 13.  TheFAQ permitted registrants to elect a policy of not recognizing any revenue onequipment sold on an installed basis until installation is complete.  BecauseEITF Issue 00-21 requires revenue arrangements with multiple deliverables to bedivided into separate units of accounting if certain criteria are met, thiselection is no longer available to registrants upon adoption of EITF Issue00-21. The Company believes that SAB 104 has not had any effect on the Company’sfinancial position, cash flows, or results of operations.

 

7.               *        Restructuring Charges*.  In the fourth quarter of 2002, the Companyannounced a restructuring plan to rationalize international manufacturingoperations.  As part of the plan, variousmanufacturing operations in the International segment were either consolidatedor outsourced.  The management of allInternational operations was consolidated under the Managing Director,International.  The restructuring chargetotaled $1,228.  The principal actions inthe restructuring plan involved the closure of facilities and a reduction inhead count.

 

In the fourthquarter of 2003, the Company further evaluated International operations toimprove profitability.   A plan wasdeveloped to close a manufacturing facility in International operations by June2004.  As part of the plan, there was areduction of approximately 31 employees in the International operations.  There was one employee severed in the thirdquarter of 2004, and $0 severance payments were made. The restructuring chargetotaled $1,565.  The principal componentsof the 2003 restructuring charge involved the closure of facilities and areduction in head count.

 

A credit torestructuring charge of $686 was recorded in the third quarter of 2004primarily due to the assignment of the lease of a vacated facility in theUnited Kingdom at a cost less than previously estimated by management.  The

 

8

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facility closure costswere originally estimated in the third quarter of 2001.  Due to difficulties in negotiating a leasetermination or subletting of the facility, the estimate for the facilityclosure costs was subsequently increased in the fourth quarter of 2002 andfurther increased in the fourth quarter of 2003.  In July 2004, the lease on the facility wasassigned for the remaining lease term on more favorable terms than managementhad estimated and thus the credit to restructuring charge.

 

The restructuringcharges were determined based on formal plans approved by the Company’smanagement using the best information available to it at the time.  The amounts the Company may ultimately incurcould differ materially as the restructuring initiative is executed.   The changes in the accrual for restructuringcharges during the three month period ended September 30, 2004 are summarizedin the table below:

 
| ** **                                                         | ** ** | **Facilities** | ** ** | **Workforce  Reduction** | ** ** | **Total** | ** ** |
|--------------------------------------------------------------------|------------|----------------|------------|--------------------------|------------|-----------|------------|
|                                                               |       |           |       |                     |       |      |       |
| Restructuring  accrual balance at June 30, 2004                    |       | $              | 1,848      |                     | $          | 66        |       | $ | 1,914 |   |
| Costs incurred  in the three months ended September 30, 2004       |       | 1,021          |       | (38                      | )          | 983       |       |
| Credit to  operations in the three months ended September 30, 2004 |       | 686            |       | —                   |       | 686       |       |
| Restructuring  accrual balance at September 30, 2004               |       | $              | 141        |                     | $          | 104       |       | $ | 245 |   |

 

8.                    *Sale Leaseback Agreement*.   In June, 2002, the Company entered into asale and leaseback agreement for a facility located in Temecula,California.  The proceeds from the saletotaled approximately $6,200 and resulted in a pretax deferred gain of$604.  The resulting lease is beingaccounted for as an operating lease.  Thelease base term is ten years with two five-year options at rental amounts to beadjusted to the fair market rental value at the end of the base term.  A portion of the proceeds from the sale wasused to pay the outstanding mortgage balance on the facility of $4,036.  As of September 30, 2004 the unamortizedbalance of the deferred gain is $468.

 

9.                       *Income Taxes*.  In the second quarter of fiscal 2004, theCompany commissioned an independent appraisal of a subsidiary in the UnitedKingdom.  This appraisal follows theCompany’s announcement in February 2004 to close the European manufacturingoperations.  Based on the independentappraisal, the Company concluded that the subsidiary was insolvent as of June30, 2004 and therefore met the requirements of an ordinary worthless stockdeduction under the Internal Revenue Code. The amount of the worthless stock deduction is approximately $9,000 witha corresponding federal income tax benefit of approximately $3,000.  The Company has an effective tax rate of (26.7%)for the nine months ended September 30, 2004. This differs from the federal statutory rate of 34.0% primarily due tothe subsidiary stock deduction described above offset by foreign operatinglosses incurred without a tax benefit recorded and an increase in the Company’svaluation allowance against the deferred tax assets.  The Company has an effective tax rate for thethree months ended September 30, 2004 of (42.1%).

 

The Federal incometaxes of the Company for the years ended December 31, 1997, 1998, 2000, and2001 are currently under examination by the Internal Revenue Service(IRS).  In July 2002, the IRS issued theproposed result of their examination for the years ended December 31, 1997 and1998, which increases the 1997 income tax amount due by $315 related totransfer pricing for sales to the Company’s Canadian subsidiary.  In November 2003, the IRS agreed to reducethe transfer pricing assessment for the 1997 and 1998 tax years to $19 whichwas accrued at December 31, 2003. Management believes that the ultimate outcome of IRS audits for theyears ended 2000 and 2001 will not have a material adverse impact on theCompany’s consolidated results of operations or financial position.

 

10.                 *Commitments and Contingencies. *In 2001, the State of Texas issueda report assessing the Company additional sales and use tax of $1,600,including interest.  The Company hasappealed the assessment and is currently providing the State of Texas withdocumentation to support the Company’s contention that the transactions did notrequire the Company to remit sales and use tax to the State of Texas. The Stateof Texas has agreed to a reduction of the amount owed to $600.  The Company has paid the State of Texas$400.  The Company believes that it hasmeritorious defenses to the remaining claim of $200 and intends to vigorouslydefend its position.  The Companybelieves that the ultimate outcome of this examination will not result in a materialimpact on the Company’s consolidated results of operations or financialposition.

 

In June 2002, theCompany recorded a $1,573 allowance for doubtful accounts due to the Chapter 11bankruptcy filing of a major customer, Adelphia Communications.  The Company subsequently wrote off all of theopen receivables with Adelphia as of the bankruptcy date.  Based on the Company’s knowledge of thebankruptcy proceedings, the Company is unable to reasonably estimate thepotential recovery relating to the Adelphia receivables mentioned above.  Therefore, no recovery amount has beenrecorded in the Company’s financial statements. The Company has also been approached by a

 

9

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third party investor regarding the Company’s sale of its Adelphiareceivables at a discount.  However, nodefinitive agreement between the Company and the third party investor has beenreached at this time.

 

11.                 *Related Party Transactions. *In May 2002, the Company sold itsRF line of passive electronic devices to RMS Communications, Inc., which isowned by Gary Napolitano, a former officer of the Company.  A sale in the amount of $800 wasrecorded.  RMS Communications, Inc. paidthe Company $125 in cash at the time of sale, and the remaining $675 is payablein monthly installments through June 30, 2003, bearing interest at 7% perannum.  The Company purchased $87 ofinventory from RMS Communications, Inc. in the nine months ended September 30,2004 and has offset the amount payable to RMS Communications, Inc. against theopen receivable. The amount due from RMS Communications, Inc. included inaccounts receivable at September 30, 2004 is $249.  The account is currently in arrears.  The Company has a security interest in theinventory and a personal guarantee from Mr. Napolitano and believes the amountwill be paid in full.

 

12.                 *Concentrations.*  Sales to Comcast of $11,560 in the first ninemonths of 2004 represented 17.3% of Company sales in the period.  Sales to Comcast of $14,360 in the first ninemonths of 2003 represented 25.7% of Company sales for the period.  The second largest *customer*in the first nine months of 2004 was Verizon with sales of $11,420 representing17.1% of the total.  Sales to Verizon of$6,060 in the first nine months of 2003 represented 10.8% of Company sales.

 

Sales to Verizonof $6,080 in the third quarter of 2004 represented 22.0% of Company sales inthe period.  Sales to Verizon of $2,030 inthe third quarter of 2003 represented 10.4% of Company sales for theperiod.  The second largest customer inthe third quarter of 2004 was Comcast with sales of $2,950 representing 10.7%of the total.  Sales to Comcast of $5,000in the third quarter of 2003 represented 25.7% of Company sales.

 

13.                 *Guarantees.*  In 1997, the Company guaranteed debt of theCompany’s principal stockholder and Chairman of the Board of approximately$754.  The guaranteed debt was incurredin connection 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 estimatethe fair value of the guarantee; however, the Company does not anticipate thatit will incur losses as a result of this guarantee.  The Company has not recorded a liability forthis guarantee.  If the principalstockholder were to default on the outstanding loan balance, the Company may berequired to repay the remaining principal balance. The maximum potential amountthe Company would be required to pay is equal to the outstanding principal andinterest balance of the loan to the stockholder.  At September 30, 2004, the outstanding loanbalance subject to the guarantee totaled $590.

 

14.                 *Bushman Tanks Acquisition.*   On August 2, 2004, the Company, through amajority-owned subsidiary, acquired a controlling interest in Bushman Tanks, amanufacturer and distributor of rotational molded plastic (polyethylene) waterstorage tanks.  Bushman Tanks operatesout of four leased facilities in Australia, located in Dalby, Orange, Terang,and Adelaide.  The purchase price was$16,838.  The Company also incurred anadditional $764 in direct costs of the acquisition.  An additional $1,400 is payable to thesellers in the event that the Bushman Tanks business achieves specified salestargets in 2005 and 2006. Additional amounts may be paid to the sellers ifcertain cost reduction targets are achieved. The sellers will receive one-half of the amounts of the cost reductionsin the specified cost items that are achieved between 2005 through 2009.  The maximum amount payable is $1,400 if thecost incurred on these specified items is reduced to zero.  In the event that the cost incurred for theseitems exceeded a predetermined threshold, the seller would be liable to theCompany for the amount of the cost exceeding the threshold. The purchaseagreement includes a working capital adjustment based on the April 30, 2004working capital amounts. The amount of the adjustment at present is notfinalized. The working capital adjustment as presently estimated by managementhas been included in the $16,838 purchase price. The final working capitaladjustment will result in a change to goodwill and the amount of considerationto the sellers.

 

Consideration forthe acquisition of $16,838 consisted of $8,016 in cash contributed by theCompany, 175,113 shares of the Company’s common stock valued at $714, a $5,520term loan from The National Australia Bank Ltd, and $2,588 in cash contributedby ANZ Private Equity, a unit of Australia and New Zealand Banking Group Ltd.As a result of the transaction, the Company acquired a 75% equity interest inBushman Tanks, and ANZ Private Equity acquired the remaining 25%. In addition,the Company incurred direct acquisition costs of $764.

 

The Bushman Tanksacquisition has been accounted for using the purchase method of accounting and,accordingly, the assets acquired and liabilities assumed have been recorded attheir estimated fair values based upon preliminary estimates as of theacquisition date. Further adjustments to the acquired assets and assumedliabilities will be made following more detailed reviews by management oftangible assets acquired and liabilities assumed. Changes in the estimated fairvalue of acquired assets and assumed liabilities will be reflected as a changein the allocated fair value

 

10

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of the identifiabletangible and intangible assets and liabilities and goodwill in the period inwhich this determination is made, which management expects to be by December31, 2004.

 

The followingtable summarizes the estimated fair value of the assets acquired andliabilities assumed in the Bushman Tanks acquisition at August 2, 2004:

 

| ** **                           | ** ** | **Allocated  Purchase  Price** | ** ** |
|--------------------------------------|------------|--------------------------------|------------|
| Acquired assets:                     | ** ** | ** **                     | ** ** |
| Cash                                 |       | $                              | 99         |   |
| Receivables, net                     |       | 2,212                          |       |
| Inventories                          |       | 2,399                          |       |
| Other assets                         |       | 490                            |       |
| Property, plant,  and equipment, net |       | 3,089                          |       |
| Goodwill                             |       | 14,048                         |       |
| Total Assets                         |       | 22,337                         |       |
|                                 |       |                           |       |
| Assumed  liabilities:                |       |                           |       |
| Accounts payable                     |       | 3,109                          |       |
| Short term debt                      |       | 35                             |       |
| Accrued  liabilities                 |       | 1,589                          |       |
| Total  liabilities                   |       | 4,733                          |       |
|                                 |       |                           |       |
| Purchase price                       |       | 16,838                         |       |
| Direct cost of  acquisition          |       | 764                            |       |
| Net assets  acquired                 |       | $                              | 17,602     |   |

 

Below is theunaudited pro forma condensed combined statement of operations for the threemonths and nine months ended September 30, 2004 and September 30, 2003.  The unaudited pro forma condensed combinedstatement of operations includes the historical operations of the Company andBushman Tanks (translated at the average currency exchange rate for theapplicable period) and gives effect to the acquisition as if it had occurred atthe beginning of the applicable period. The unaudited pro forma financialstatement is based upon available information and assumptions and adjustmentsthat the Company believes is reasonable. The unaudited pro forma condensed combined statement of operations doesnot purport to represent what our results of operations actually would havebeen.  The unaudited pro forma condensedcombined financial statement is qualified in its entirety and should be read inconjunction with the historical financial statements and accompanying notes ofthe Company included in the annual report on form 10-K for the year endedDecember 31, 2003, the quarterly report on form 10-Q for the three and sixmonth periods ended June 30, 2004, and the 8-KA filed October 18, 2004.

 

11

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**CHANNELLCOMMERCIAL CORPORATION AND BUSHMAN TANKS**

**UNAUDITEDPROFORMA**

**CONDENSEDCOMBINED STATEMENTS OF OPERATIONS**

**(amountsin thousands, except per share data)**

 
| ** **                            | ** ** | **Nine months ended  September 30,** | ** ** | **Three months ended  September 30,** | ** ** |
|---------------------------------------|------------|--------------------------------------|------------|---------------------------------------|------------|
| ** **                            | ** ** | **2004**                             | ** ** | **2003**                              | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                  |       |                                 |       |                                  |       |   |   |   |   |
| Net sales                             |       | $                                    | 84,071     |                                  | $          | 75,619 |   | $ | 30,431 |   | $ | 26,200 |   |
| Cost of goods sold                    |       | 57,277                               |       | 50,310                                |       | 21,303 |   | 17,551 |   |
|                                  |       |                                 |       |                                  |       |   |   |   |   |
| Gross profit                          |       | 26,794                               |       | 25,309                                |       | 9,128 |   | 8,649 |   |
|                                  |       |                                 |       |                                  |       |   |   |   |   |
| Operating expenses                    |       | 24,106                               |  *    | 21,287                                |       | 7,078 |   | 7,143 |   |
|                                  |       |                                 |       |                                  |       |   |   |   |   |
| Income from operations                |       | 2,688                                |       | 4,022                                 |       | 2,050 |   | 1,506 |   |
|                                  |       |                                 |       |                                  |       |   |   |   |   |
| Interest expense, net                 |       | 732                                  |       | 893                                   |       | 229 |   | 330 |   |
|                                  |       |                                 |       |                                  |       |   |   |   |   |
| Income before income taxes            |       | 1,956                                |       | 3,129                                 |       | 1,821 |   | 1,176 |   |
|                                  |       |                                 |       |                                  |       |   |   |   |   |
| Income taxes (benefit)                |       | (855                                 | )          | 1,055                                 |       | (617 | ) | 192 |   |
|                                  |       |                                 |       |                                  |       |   |   |   |   |
| Net income before minority interest   |       | 2,811                                |       | 2,074                                 |       | 2,438 |   | 984 |   |
|                                  |       |                                 |       |                                  |       |   |   |   |   |
| Minority interest                     |       | (40                                  | )          | 199                                   |       | 111 |   | 116 |   |
|                                  |       |                                 |       |                                  |       |   |   |   |   |
| Net income                            |       | $                                    | 2,851      |                                  | $          | 1,875 |   | $ | 2,327 |   | $ | 868 |   |
|                                  |       |                                 |       |                                  |       |   |   |   |   |
| Net income per share                  |       |                                 |       |                                  |       |   |   |   |   |
|                                  |       |                                 |       |                                  |       |   |   |   |   |
| Basic                                 |       | $                                    | 0.31       |                                  | $          | 0.20 |   | $ | 0.25 |   | $ | 0.09 |   |
|                                  |       |                                 |       |                                  |       |   |   |   |   |
| Diluted                               |       | $                                    | 0.31       |                                  | $          | 0.20 |   | $ | 0.25 |   | $ | 0.09 |   |
|                                  |       |                                 |       |                                  |       |   |   |   |   |
| Weighted number of shares outstanding |       |                                 |       |                                  |       |   |   |   |   |
|                                  |       |                                 |       |                                  |       |   |   |   |   |
| Basic                                 |       | 9,303                                |       | 9,301                                 |       | 9,303 |   | 9,302 |   |
|                                  |       |                                 |       |                                  |       |   |   |   |   |
| Diluted                               |       | 9,314                                |       | 9,339                                 |       | 9,306 |   | 9,390 |   |

 

----

* Nine months ended September 30, 2004includes $1,077 of fringe benefit costs for the previous owners of BushmanTanks that are not expected to recur.

 

15.                                     *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 of our foreign subsidiaries.  The changes in goodwill are summarized in thetable below.

* *

| Balance, January 1, 2004               |   | $      | 614    |   |
|----------------------------------------|--------|--------|--------|--------|
| Additions due to business acquistion   |   | 14,048 |   |
| Effect of foreign currency translation |   | 706    |   |
| Balance, September 30, 2004            |   | $      | 15,368 |   |
|                                        |        |        |        |        |  |

 

12

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| **ITEM 2.** | ** ** | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** | ** ** |
|-------------|------------|-------------------------------------------------------------------------------------------------|------------|

 

### **Results of Operations**

 

In August of2004 the Company acquired 75% of the Bushman Tanks business (the “acquiredcompany”).  Bushman Tanks is Australia’slargest manufacturer of plastic water storage tanks.  The Bushman Tanks’ financial results havebeen consolidated in the Company’s financial statements for the three monthsand nine months ended September 30, 2004. The consolidated results include two months of business activity ofBushman Tanks.  A minority interest hasbeen recorded for the 25% equity owned by ANZ Private Equity, a unit ofAustralia and New Zealand Banking Group Ltd.

 

**Comparisonof the Nine Months Ended September 30, 2004 with the Nine Months EndedSeptember 30, 2003**

 

*Net Sales*. Net sales in the first nine months of 2004 were $66.6 million, anincrease of $10.7 million or 19.1% compared to the first nine months of2003.  The increase is due to the additionof the acquired business and growth in both the core Americas and Internationalsegments.

 

Americas netsales were $51.1 million in the first nine months of 2004, an increase of $3.8million or 8.1%.  The increase was due tohigher sales to a major telephone customer and due to growth in connectivityOEM sales.  The major telephone customerpurchased plastic enclosures for a construction project to install fibercommunication lines to customer premises.

 

Internationalnet sales were $15.6 million, an increase of $6.9 million or 78.6%.  The increase is primarily due to sales of theacquired company.  In addition, highersales to telephone customers in the Asian market contributed to the salesgrowth.

 

Sales toComcast of $11.6 million in the first nine months of 2004 represented 17.3% ofCompany sales in the period.  Sales toComcast of $14.4 million in the first nine months of 2003 represented 25.7% ofCompany sales for the period.  The secondlargest customer in the first nine months of 2004 was Verizon with sales of$11.4 million representing 17.1% of the total. Sales to Verizon of $6.1 million in the first nine months of 2003represented 10.8% of Company sales.

 

*Gross Profit*. Gross profit in the first nine months of 2004 was $19.2 million, anincrease of $2.7 million or 16.6%. The increase was primarily due to theaddition of gross profit earned by the acquired company.Gross profit dollars inthe Americas segment increased due to the higher sales level.  These increases were partially offset byincreased raw material costs for plastic and steel in the Americas and by costsincurred in the first half of 2004 to restructure the European manufacturingoperations.  The European manufacturingoperations were closed as of June 30, 2004.

 

As apercentage of net sales, gross profit decreased from 29.4% in the first ninemonths of 2003 to 28.8% in the first nine months of 2004.  The decline is due primarily to increased rawmaterial costs for plastic and steel in the Americas segment and costs torestructure European manufacturing operations.

 

*Selling*. Selling expenses were $9.3 million in the first nine months of 2004, anincrease of $2.3 million or 33.1% from the first nine months of 2003.  The increase is due to the addition ofselling expenses of the acquired company and higher commissions and freightcosts as a result of the increased sales level. The freight cost increase is also due to an increase in full truckloadshipments to customers in which the Company pays the freight cost.

 

As apercentage of net sales, selling expense increased from 12.5% in the 2003period to 14.0% in the 2004 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 the freight costs incurred to transport water storage tanks tocustomers.

 

*General and Administrative*.  General and administrative expenses were $6.0million in the first nine months of 2004, an increase of $0.3 million or4.6%.  The increase is due to theaddition of the general and administrative expenses of the acquired companypartially offset by lower general and administrative expenses in the Americassegment.

 

As apercentage of net sales, general and administrative expense decreased from10.3% in the 2003 period to 9.1% in the 2004 period.  The decrease is due to the lower costs in theAmericas segment as well as the increased sales level without a correspondingincrease in general and administrative costs.

 

13

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*Research and Development*.  Research and development expenses were $1.6million in the first nine months of 2004, an increase of $0.4 million or 37.6%from the first nine months of 2003.  Theincrease is due to spending on new product development programs, primarily fortelephone connectivity products and thermoplastic enclosures for cablecustomers.

 

As apercentage of net sales, research and development expenses increased from 2.1%in the first nine months of 2003 to 2.5% in the first nine months of 2004.

 

*Restructuring charge*.  A credit to restructuring charge of ($0.7)million was recorded in the first nine months of 2004 primarily due to theassignment of the lease of a vacated facility in the United Kingdom at a costless than previously estimated by management. The facility closure costs were originally estimated in the thirdquarter of 2001.  Due to difficulties innegotiating a lease termination or subletting of the facility, the estimate forthe facility closure costs was subsequently increased in the fourth quarter of2002 and further increased in the fourth quarter of 2003.  In July 2004, the lease on the facility wasassigned for the remaining lease term on more favorable terms than managementhad estimated and thus the credit to restructuring charge.

 

There was norestructuring charge in the first nine months of 2003.

 

*Income from Operations*.  Income from operations increased from $2.5million in the first nine months of 2003 to $2.9 million in the first ninemonths of 2004.  The increase isprimarily due to the addition of the acquired business, higher sales in boththe Americas and International segments and the favorable impact of therestructuring charge credit.

 

Income fromoperations as a percentage of sales decreased from 4.4% to 4.3%.  The decrease is due to the following coststhat increased at a higher percentage rate than the sales revenue increase:  1) costs of goods sold resulting from rawmaterial price increases,  2) sellingexpense including commission, freight and selling costs of the acquiredcompany, and  3) research and developmentexpense for telephone connectivity products and thermoplastic enclosures.

 

*Interest Expense, Net*.  Net interest expense was $0.4 million in thefirst nine months of 2003 and $0.3 million in the first nine months of2004.   The decrease is due to the lowerlevel of debt.

 

*Income Taxes*. Income tax expense was $0.7 million in the first nine months of 2003 and($0.7) million in the first nine months of 2004.  The effective tax rate was (26.7%) in thefirst nine months of 2004 and 35.7% for the same period in 2003.  The decline is due to an ordinary worthlessstock deduction in 2004 offset by an increase in the valuation allowance.

 

**Comparisonof the Three Months Ended September 30, 2004 with the Three Months EndedSeptember 30, 2003**

 

*Net Sales*. Net sales in the third quarter of 2004 were $27.6 million, an increaseof $8.2 million or 42.1% compared to the third quarter of 2003.  The increase is due to the addition of theacquired business and growth in both the core Americas and Internationalsegments.

 

Americas netsales were $18.3 million in the third quarter of 2004, an increase of $1.5million or 9.1%.  The increase was due tohigher sales to a major telephone customer and due to growth in connectivityOEM sales.  The major telephone customerpurchased plastic enclosures for a construction project to install fiber communicationlines to customer premises.

 

Internationalnet sales were $9.3 million in the third quarter of 2004, an increase of $6.7million or 249.2%.  The increase isprimarily due to sales of the acquired company and higher sales to telephonecustomers in the Asian market.

 

Sales toVerizon of $6.1 million in the third quarter of 2004 represented 22.0% ofCompany sales in the period.  Sales toVerizon of $2.0 million in the third quarter of 2003 represented 10.4% ofCompany sales for the period.  The secondlargest customer in the third quarter of 2004 was Comcast with sales of $3.0million representing 10.7% of the total. Sales to Comcast of $ 5.0 million in the third quarter of 2003represented 25.7% of Company sales.

 

*Gross Profit*. Gross profit in the third quarter of 2004 was $7.9 million, an increaseof $2.4 million or 43.2%.   The increaseis due primarily to the addition of the acquired company.  Gross profit increased in the Internationalsegment due to cost savings associated with the closure of Europeanmanufacturing operations, which was effective June 30, 2004.  Gross profit in the Americas declined due toincreases in plastic and steel raw material costs.

 

As apercentage of net sales, gross profit increased from 28.4% in the third quarterof 2003 to 28.6% in the third quarter of 2004.  The increase is due to the acquired company which has a higher grossprofit percentage than the other Channell businesses and savings associatedwith the closure of European operations, partially offset by higher rawmaterial costs.

 

14

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*Selling*. Selling expenses were $4.0 million in the third quarter of 2004, anincrease of $1.7 million or 70.8% from the third quarter of 2003.  The increase is due to the addition of sellingexpenses of the acquired company and higher commissions and freight costs as aresult of the increased sales level.  Thefreight cost increase is also due to an increase in full truckload shipments tocustomers in which the Company pays the freight cost.

 

As apercentage of net sales, selling expense increased from 12.1% in the 2003period to 14.5% in the 2004 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 the freight costs to transport water storage tanks to customers.

 

*General and Administrative*.  General and administrative expenses were $2.2million in the third quarter of 2004, an increase of $0.1 million or 8.0% fromthe third quarter of 2003.  The increaseis due to the addition of the general and administrative expenses of theacquired company partially offset by lower general and administrative expensesin the Americas segment.

 

As apercentage of net sales, general and administrative expense decreased from10.5% in the 2003 period to 8.0% in the 2004 period.  The decrease is due to the lower costs in theAmericas segment as well as the increased sales level without a correspondingincrease in general and administrative costs.

 

*Research and Development*.  Research and development expenses were $0.6million in the third quarter of 2004, an increase of $0.2 million or 41.4% fromthe third quarter of 2003.  The increaseis due to spending on new product development programs, primarily for telephoneconnectivity products and thermoplastic enclosures for cable customers.

 

As apercentage of net sales, research and development expenses were 2.1% in boththe third quarter of 2003 and 2004.

 

*Restructuring charge*.  A credit to the restructuring charge of($0.7) million was recorded in the third quarter of 2004 primarily due to theassignment of the lease of a vacated facility in the United Kingdom at a costless than previously estimated by management. The facility closure cost was originally estimated in the third quarterof 2001.  Due to difficulties innegotiating a lease termination or subletting of the facility, the estimate forthe facility closure cost was subsequently increased in the fourth quarter of2002 and further increased in the fourth quarter of 2003.  In July 2004, the lease on the facility wasassigned for the remaining lease term on more favorable terms than managementhad estimated and thus the credit to restructuring charge.

 

There was norestructuring charge in the third quarter of 2003.

 

*Income from Operations*.  Income from operations increased from $0.7million in the third quarter of 2003 to $1.8 million in the third quarter of2004.  The increase is due to theaddition of the acquired business, higher sales in both the Americas andInternational segments and the favorable impact of the restructuring chargecredit.  Income from operations as apercentage of sales increased from 3.7% to 6.5%.

 

*Interest Expense, Net*.  Net interest expense was $0.2 million in thethird quarter of 2004, the same as the third quarter of 2003.

 

*Income Taxes*. Income tax expense was ($0.7) million in the third quarter of 2004 and($0.001) million in the third quarter of 2004. The effective tax rate was (42.1%) in the third quarter of 2004 and(0.002%) for the same period in 2003. The tax rate is lower in the third quarter of 2003 because the 2003 taxrate was favorably affected by a change in the estimate of the research anddevelopment tax credit available to offset the federal income tax liability forfiscal 2001, 2002 and the three months ended September 30, 2003.  The tax rate in the third quarter of 2004 islower than the statutory tax rate due to the ordinary worthless stock deductionoffset by the valuation allowance.

 

**Liquidityand Capital Resources**

 

Net cashprovided by operating activities was $5.0 million for the nine months endedSeptember 30, 2004, an increase of $0.4 million from the same period lastyear.  The increase in net cash providedby operating activities is due to the addition of the acquired company and anincrease in accounts payable.

 

Net accountsreceivable increased to $14.0 million at September 30, 2004 from $10.1 millionat December 31, 2003.  The increase isdue to the addition of the acquired company in the consolidated financialstatements.  Days sales outstandingdecreased from 50 days at December 31, 2003 to 45 days at September 30, 2004.

 

15

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Inventoriesincreased to $13.4 million at September 30, 2004 from $8.9 million at December31, 2003.  The increase is due to theaddition of the acquired company in the consolidated financial statements.  Days inventory was 59 days at both December31, 2003 and September 30, 2004.

 

Accountspayable increased from $5.1 million at December 31, 2003 to $13.9 million atSeptember 30, 2004.  The increase is dueto 1) the addition of the acquired company in the consolidated financialstatements, 2) the extension of vendor payment terms in the Americas segment,3) higher inventory purchases to meet sales demand, and 4) a higher percentageof product being purchased externally versus made in house.  Days payables were 35 days at December 31,2003 and 45 days at September 30, 2004.

 

Net cash usedby investing activities was ($19.5) million in the first nine months of 2004compared to net cash provided by investing activities of $1.4 million in thesame period of 2003.  The Companyacquired the Bushman Tanks business in August 2004.  Capital expenditures for property andequipment were higher in the 2004 period due to equipment required torefacilitate manufacturing facilities in the Americas as part of the transferof operations previously performed in Europe. The Company sold a building in the U.K. for $2.2 million in January2003.

 

Net cashprovided by financing activities was $9.7 million in the first nine months of2004 compared to net cash used of ($2.4) million in the first nine months of2003.  The Company acquired the BushmanTank business in the 2004 period and financed the purchase with a term loanfrom The National Australia Bank Ltd. and equity provided by ANZ PrivateEquity.  The Company repaid debt in the2003 period.

 

The cash andcash equivalents balance was $4.1 million at September 30, 2004, a decreasefrom $9.5 million at December 31, 2003. The decrease is due to cash used for the acquisition of Bushman Tankspartially offset by cash generated from on going operations and extended vendorpayment terms which had the affect of decreasing cash outflows.

 

The Board ofDirectors, on April 1, 1998, having determined such action to be in the bestinterest of the Company, authorized a stock repurchase plan of up to $2.0million worth of Company stock. The plan was subsequently increased to $2.75million by the Board on December 1, 2000. The Company repurchased 22,985 shares at a cost of approximately $0.2million in 1999; 30,900 shares of its common stock at a cost of approximately$0.2 million in 2000; and 52,300 shares of its common stock at a cost of $0.3million in 2001. The Company did not repurchase stock in 2002 or 2003, or inthe first nine months of 2004.

 

The Companyand its subsidiaries have entered into the following financing arrangements:

 

1.          TheCompany entered into a three year Loan and Security Agreement with anasset-based lender on September 25, 2002. The Loan and Security Agreement’sinitial term loan balance of $4.7 million and initial revolver balance of $2.1million as well as $9.6 million in cash were used to repay in full the priorCredit Agreement.  The three year term loan is repayable in quarterlypayments based on a five-year amortization schedule with a balloon repayment atmaturity.  At September 30, 2004, theoutstanding balance of the term loan was $3.1 million, with no outstandingbalance in the revolver.

 

Under the Loanand Security Agreement, the outstanding balance bears interest payable monthlyat a variable rate based on either LIBOR or the lender’s base rate.  The weighted average interest rate under theLoan and Security Agreement at September 30, 2004 was 3.5%.

 

The Loan andSecurity Agreement contains various financial and operating covenants thatimpose limitations on the Company’s ability, among other things, to incur additionalindebtedness, merge or consolidate, sell assets except in the ordinary courseof business, make certain investments, enter into leases and paydividends.  The Company is also required to comply with a fixed chargecoverage ratio financial covenant among others.  The Company was incompliance as of September 30, 2004 with the covenants of the Loan and SecurityAgreement.

 

2.          Asubsidiary of the Company located in Australia, Channell Pty Ltd., entered intoa one year Loan and Security Agreement with a commercial bank in Australia onOctober 23, 2003.  The Loan and SecurityAgreement contains a revolver line of credit for working capital needs.  At September 30, 2004, the outstandingbalance of the facility was $0.5 million.

 

Under the Loanand Security Agreement, the balance bears interest payable monthly at avariable rate based on the lender’s base rate. The weighted average interest rate at September 30, 2004 was 5.5%.

 

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The Loan andSecurity Agreement contains various financial and operating covenants thatimpose limitations on Channell Pty Ltd.’s ability, among other things, to incuradditional indebtedness, merge or consolidate and sell assets except in theordinary course of business.  Channell Pty Ltd. is also required to complywith a interest coverage ratio.  Channell Pty Ltd. was in compliance as ofSeptember 30, 2004 with the covenants of the Loan and Security Agreement.

 

3.          Asubsidiary of the Company, Channell Bushman Pty Ltd., entered into a five yearLoan and Security Agreement with a commercial bank in Australia on August 2,2004.  Channell Bushman Pty Ltd. is theholding company established to acquire the Bushman Tanks business.  The Loan and Security Agreement’s initialterm loan balance of $5.8 million was used as part of the consideration paid toacquire the Bushman Tank business.  The five year term loan is repayablein quarterly payments based on a five-year amortization schedule.  The loan and security agreement also includesa revolving credit facility, reviewed annually, for working capital needs inthe amount of $1.4 million, a capital expenditure line of credit in the amountof $4.2 million and a $1.2 million facility to fund future “earn out” paymentsto the seller if the Bushman Tanks business achieves specified performancetargets in 2005 and 2006.  The Loan andSecurity Agreement is guaranteed by Channell Pty Ltd., a subsidiary of theCompany in Australia.  At September 30,2004, the outstanding balance of the term loan was $5.8 million and $0.8million on the revolving line of credit. There were no advances on either the capital expenditure line of creditor the earn out line of credit.

 

Under the Loanand Security Agreement, the outstanding balance bears interest payable monthlyat a variable rate based on the lender’s base rate.  The weighted average interest rate under theLoan and Security Agreement at September 30, 2004 was 5.5%.

 

The Loan andSecurity Agreement contains various financial and operating covenants that imposelimitations on Channell Bushman Pty Ltd.’s ability, among other things, toincur additional indebtedness, merge or consolidate, sell assets except in theordinary course of business, make certain investments, enter into leases andpay dividends.  Channell Bushman Pty Ltd. is also required to comply witha Debt/EBIT ratio, capital adequacy ratio, debit service coverage ratio andinterest coverage ratio.  ChannellBushman Pty Ltd. was in compliance as of September 30, 2004 with the covenantsof the Loan and Security Agreement.

 

4.          TheCompany and Channell Bushman Pty Ltd. entered into an Investment andShareholder’s Agreement with a private equity firm in Australia on August 2,2004.  The private equity investment wasobtained as part of the financing of the Bushman Tank acquisition.  The private equity party invested $2.6million, the net amount received after paying a capital raising fee, forownership of 25% of the outstanding and voting shares of Channell Bushman PtyLtd.  As part of the agreement, theprivate equity party has the right to appoint one member of the Board ofDirectors of Channell Bushman Pty Ltd. with the Company appointing theremaining three members.  The agreementspecifies that certain actions taken by the Board of Directors require unanimousapproval, among other things, a proposal to sell all or substantially all ofthe assets of Channell Bushman Pty Ltd., material asset acquisitions ordisposals not included in the annual business plan, any plan to limit ordissolve the business, the issuance of any securities, capital restructuring,granting of a security interest on assets and related party transactions.

 

It is theintent of the private equity party to exit its investment in Channell BushmanPty Ltd. within 5 years.  The Agreementcontains clauses to facilitate the exit of the private equity party.  The agreement specifies that after two years,the Company has an option to acquire all of the shares owned by the privateequity party.  The agreement specifiesthat the value of the shares is to be fair market value as determined by anindependent appraiser.  There are nominimum or maximum amounts specified in the agreement.  After five years, both the Company and theprivate equity party have the right to initiate a sale of Channell Bushman PtyLtd.  At such time, the other party mayelect to buy out the shares of the party initiating the sale at the fair marketvalue as determined by an independent appraiser.  Otherwise, Channell Bushman Pty Ltd. would beoffered for sale with the assistance of a financial advisor.

 

The Companybelieves that cash flow from operations coupled with borrowings under thecredit facilities described above will be sufficient to fund the Company’scapital expenditure and working capital requirements through 2004.

 

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**ContractualObligations and Other Commitments**

 

The followingtable summarizes the Company’s contractual obligations and other commitments asof September 30, 2004 in thousands: 

 
| ** **                      | ** ** | **Oct 2004 to  Sep 2005** | ** ** | **Oct 2005 to  Sep 2007** | ** ** | **Oct 2007 to  Sep 2009** | ** ** | **Oct 2009 and  Thereafter** | ** ** | **Total** | ** ** |
|---------------------------------|------------|---------------------------|------------|---------------------------|------------|---------------------------|------------|------------------------------|------------|-----------|------------|
| Contractual Obligations         |       |                      |       |                      |       |                      |       |                         |       |      |       |
| Long Term Debt (1)              |       | $                         | 927        |                      | $          | 1,853                     |       | $                            | 1,853      |      | $          | — |   | $ | 4,633 |   |
| Capital Lease Obligations (2)   |       | 44                        |       | 123                       |       | —                    |       | —                       |       | 167       |       |
| Operating Lease Obligations (3) |       | 2,634                     |       | 3,074                     |       | 2,086                     |       | 2,496                        |       | 10,290    |       |
| Employment Contracts (4)        |       | 768                       |       | 1,470                     |       | 838                       |       | —                       |       | 3,076     |       |
| Purchase Obligations (5)        |       | 12,158                    |       | —                    |       | —                    |       | —                       |       | 12,158    |       |
|                            |       | $                         | 16,531     |                      | $          | 6,520                     |       | $                            | 4,777      |      | $          | 2,496 |   | $ | 30,324 |   |

 

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(1)          The Company entered into a five year Loan andSecurity Agreement with an a commercial bank in Australia on August 2, 2004.

(2)          Capital lease obligations include amountsrepresenting interest of $29.

(3)          The Company leases manufacturing and officespace and machinery and equipment under several operating leases expiringthrough 2006.

(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 5 years.  The Chairman of the Board’s salary is set at$50 per annum for the remainder of the term. The President and Chief Executive Officer’s base year salary is $718 peryear, and is subject to an annual cost of living increase based on the consumerprice index.  Base salary may also beincreased based on the discretion of the Board of Directors.  In the event the President and ChiefExecutive Officer is terminated the Company will be obligated to make a lumpsum severance payment equal to three times his then current base salary.

(5)          The Company has adequate sources of supply forthe raw materials used in its manufacturing processes and attempts to developand maintain multiple sources of supply in order to extend the availability andencourage 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.

 

**Off-Balance Sheet Arrangements**

 

The Company’soff-balance sheet arrangements consist of operating leases, employmentcontracts and purchase obligations as described above.  In addition, the Company guaranteed debt ofthe Company’s principal stockholder and Chairman of the Board of approximately$754 in 1997.  The guaranteed debt wasincurred in connection with construction of the facilities leased to theCompany and is collateralized by said facilities.  The loan amount subject to the unsecuredguarantee is expected to decline before expiring in 2017.  It is not practicable to estimate the fairvalue of the guarantee; however, the Company does not anticipate that it willincur losses as a result of this guarantee. The Company has not recorded a liability for this guarantee.  If the principal stockholder were to defaulton the outstanding loan balance, the Company may be required to repay theremaining principal balance.  The maximumpotential amount the Company would be required to pay is equal to theoutstanding principal and interest balance of the loan to the stockholder.  At September 30, 2004, the outstanding loanbalance subject to the guarantee totaled $590.

 

**Critical Accounting Policies**

 

Our discussion andanalysis of our financial condition and results of operations are based uponour consolidated financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States of America.The preparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses, and related disclosure of contingent assets and liabilities.

 

We believe that theestimates, assumptions and judgments involved in the accounting policiesdescribed in the “Management’s Discussion and Analysis of Financial Conditionand Results of Operations” section of our most recent Annual Report on Form10-K have the greatest potential impact on our financial statements, so weconsider these to be our critical accounting policies. Because of theuncertainty inherent in these matters, actual results could differ from theestimates we use in applying the critical accounting policies. Certain of thesecritical accounting policies affect working capital account balances, includingthe policies for revenue recognition, the reserve for uncollectible accountsreceivable and inventory reserves. These policies require that we makeestimates in the preparation of our financial statements as of a given date.

 

Within the context ofthese critical accounting policies, we are not currently aware of anyreasonably likely events or circumstances that would result in materiallydifferent amounts being reported.

 

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**Forward-Looking Statements**

 

Certain statementscontained herein are “forward-looking” statements within the meaning of thePrivate Securities Litigation Reform Act of 1995 (the “Act”), which providescertain “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 in nature;which depend upon or refer to future events or conditions; or which includewords 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) the communications industry is in a state of rapid technological changewhich can render the Company’s products obsolete or unmarketable; (2) anyfailure by the Company to anticipate or respond to technological developmentsor changes in industry standards or customer requirements, or any significantdelays in product development or introduction, could have a material adverseeffect on the Company’s business, operating results and financial condition;(3) a relatively small number of customers account for a large percentage ofthe Company’s available market; (4) the Company expects that sales to thetelecommunications industry will continue to represent a substantial portion ofits total sales and the demand for products within this industry dependsprimarily on capital spending by service providers; (5) the Company’s cost ofsales may be materially affected by increases in the market prices of the rawmaterials used in the Company’s manufacturing processes; (6) the Company issubject to the risks of conducting business internationally; and (7) 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.

 

**ITEM 3.****     QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

The market risk inherentin the Company’s market risk sensitive instruments is the potential lossarising from adverse changes in interest rates and foreign currency exchangerates.  All financial instruments held bythe Company described below are held for purposes other than trading.

 

The Company’sLoan and Security Agreement, dated September 25, 2003 with the asset basedlender, allows for the outstanding balance to bear interest at a variable ratebased on the lender’s base rate or LIBOR. The credit facility exposes the operations to changes in short-terminterest rates since the interest rates on the credit facility are variable.

 

A hypotheticalchange of 1% in the interest rate for these borrowings, assuming debt levels atSeptember 30, 2004, would change interest expense by approximately $0.03million for the three months ended September 30, 2004.  This analysis does not consider the effectsof economic activity on the Company’s sales and profitability in such anenvironment.

 

The Companyhas assets and liabilities outside the United States that are subject tofluctuations in foreign currency exchange rates.  Assets and liabilities outside the UnitedStates are primarily located in the United Kingdom, Australia, and Canada.  The Company’s investment in foreignsubsidiaries with a functional currency other than the U.S. dollar is generallyconsidered long-term.  Accordingly, theCompany does not hedge these investments. The Company also purchases a limited portion of its raw materials fromforeign countries.  These purchases aregenerally denominated in U.S. dollars and are accordingly not subject toexchange rate fluctuations.  The Companyhas not engaged in forward purchases of foreign currency and other similarcontracts to reduce its economic exposure to changes in exchange rates becausethe associated risk is not considered significant.

 

**ITEM 4.****     CONTROLS AND PROCEDURES**

 

Based on theirevaluation as of the end of the fiscal quarter covered by this report (the“Evaluation Date”), the Company’s principal executive officer and principalfinancial officer have concluded that, as of the Evaluation Date, the Company’sdisclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)under the Securities Exchange Act of 1934, as amended) are effective to ensurethat material information relating to the Company and its consolidatedsubsidiaries is recorded, processed, summarized, reported and made known to theCompany’s management, including the Company’s principal executive and financialofficers, on a timely basis by others within the Company and its consolidatedsubsidiaries.

 

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To satisfytheir responsibility for financial reporting, the Company’s CEO and CFO haveestablished internal controls for financial reporting which they believe areadequate to provide reasonable assurance that the Company’s assets areprotected from loss. These internal controls are reviewed by the Company’s managementin order to ensure compliance.  Inaddition, the Company’s Audit Committee meets regularly with management and theindependent accountants to review accounting, auditing and financial matters.  The Audit Committee and the independentaccountants have free access to each other, with or without management beingpresent.

 

As discussedin footnote 14 to the consolidated financial statements, the Companyacquired Bushmans Tanks on August 2, 2004. In connection with theacquisition, the Company implemented new internal control procedures over thenewly acquired entity. These procedures included establishing monthly reportingclosing procedures at the Bushmans locations and the hiring of additionalaccounting resources in the International business segment. With the exceptionof the new procedures in place over Bushmans Tanks, there has not been anychange in the Company's internal control over financial reporting during thethree months ended September 30, 2004 that has materially affected, or isreasonably likely to materially affect, internal control over financialreporting.

 

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**PART II - OTHER INFORMATION**

 

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

 

The Company isfrom 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 theCompany’s financial statements or results of operations, taken as a whole.

 

**ITEM 2.****                                                     UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

As part of the consideration for the Company’s acquisition of acontrolling interest in Bushman Tanks, on August 2, 2004, the Company sold anaggregate of 175,133 shares of common stock of the Company, valued at $0.7million, to Lenbridge Grange Pty Ltd., Lokan Nominees Pty Ltd., Belsiasun PtyLtd., Elcarva Pty Ltd., Douglas Robin Young and Richard James Young.  The sale of shares was made in reliance onSection 4(2) of the Securities Act of 1933, as amended, because the transactiondid not involve a public offering.

 

**ITEM 3.****                                                     DEFAULTSUPON SENIOR SECURITIES**

Notapplicable.

 

**ITEM 4.****                                                     SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

Not applicable

 

**ITEM 5.****                                                     OTHERINFORMATION**

Not applicable.

 

**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 Agreements and Restricted Stock Agreement) (8) |
|                  | 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 (12) |
|                  | 10.3.2     |            | Loan and  Security Agreement dated August 2, 2004 by and among Channell Bushman Pty Ltd  and National Australia Bank Ltd (12) |
|                  | 10.3.3     |            | Loan and  Security Agreement dated August 2, 2004 by and among Channell Pty Ltd and  National Australia Bank Ltd (12) |
|                  | 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 (12) |
|                  | 10.4       |            | Employment  Agreement between the Company and William H. Channell, Sr. (1) |
|                  | 10.5       |            | Employment  Agreement between the Company and William H. Channell, Jr. (1) |
|                  | 10.6.1     |            | Channell  Commercial Corporation 1996 Performance-Based Annual Incentive Compensation  Plan (1) |
|                  | 10.6.2     |            | Channell  Commercial Corporation 2004 Incentive Bonus Plan (10) |

 

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|   | 10.7  |   | Lease dated  December 22, 1989 between the Company and 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 |   | Lease Agreement  dated as of March 1, 1996 between Winthrop Resources Corp. and the Company  (1)                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   | 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)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | 10.15 |   | Amendment to  Employment Agreement between the Company and William H. Channell, Jr., dated  December 31, 1998 (3)                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | 10.16 |   | Further  Amendment to Employment Agreement between the Company and William H.  Channell, Jr., dated July 15, 2002 (5)                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 10.17 |   | Lease dated  June 27, 2002 between the Company and Ynez Street, Ltd (5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | 10.18 |   | Mutual  Specific and General Release between the Company and Richard A. Cude, dated  August 2, 2002 (7)                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | 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.(11) |
|   | 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. (12)                                                                                                                                                                                                                                                                                                                                                                                                               |
|   | 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. (12)                                                                                                                                                                                                                                                                                                                                                                                                               |
|   | 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 Thomas  Liguori, CFO. (12)                                                                                                                                                                                                                                                                                                                                                               |

 

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(1)          Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Registration Statement on FormS-1 (File No. 333-3621).

(2)          Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Form 8-K on May 18, 1998.

(3)          Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Form 10-K on March 31, 1999.

(4)          Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Form 10-K on April 2, 2001.

(5)          Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Form 10-Q on August 9, 2002.

(6)          Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Form 8-K on September 25, 2002.

(7)          Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Form 10-Q on November 12, 2002.

(8)          Incorporated by reference to Appendix B filedin connection with the Company’s Definitive Proxy Statement on March 26, 2003.

(9)          Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Form 10-K on March 5, 2004.

(10)    Incorporated by reference to Appendix B filedin connection with the Company’s Definitive Proxy Statement on April 16, 2004.

(11)    Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Form 8-K on August 3, 2004.

(12)    Filed herewith.

 

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SIGNATURES

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the Registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

 
| Dated:  November 5, 2004 |   |                                                                          |
|--------------------------|--------|-------------------------------------------------------------------------------|
|                     |   |                                                                          |
|                     |   |                                                                          | CHANNELL  COMMERCIAL CORPORATION |
|                     |   | (Registrant)                                                                  |   |
|                     |   |                                                                          |
|                     |   |                                                                          |
|                     | By:    |   /s/ THOMAS LIGUORI                                                     |   |
|                     |   | Thomas  Liguori                                                               |
|                     |   | Chief  Financial Officer                                                      |
|                     |   | (Duly  authorized officer and principal financial  officer of the Registrant) |
|                          |        |                                                                               |  |  |  |

 

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