**UNITED STATES**

###### **SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-Q**

 

**ý****                                ****QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended March 31, 2006**

 

**OR**

 

**o****                                ****TRANSITION REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from                             to                              **

 

**Commission File No. 0-28582**

 

**CHANNELL COMMERCIAL CORPORATION**

(Exact name of Registrant as specified in its charter)

 

**DELAWARE**

(State or other jurisdiction of incorporation or organization)

 

**95-2453261**

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

 

**26040 Ynez Road, Temecula, California**

(Address of principal executive offices)

 

**92591**

(Zip Code)

 

**(951) 719-2600**

(Registrant’s telephone number, including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

Yes**  ****ý    **No  o

 

Indicate by check mark whether the registrant is alarge accelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.(Check one):

 

LargeAccelerated Filer  o**             **AcceleratedFiler  o**                 **Non-accelerated Filer   **ý**

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).

Yes  o**    **No  **ý**

 

9,543,584 shares of common stock of the registrant were outstanding at May 10,2006.

 

 

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**PART 1 - FINANCIAL INFORMATION**

 

ITEM 1.                                                     FINANCIALSTATEMENTS

 

CHANNELL COMMERCIAL CORPORATION

CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

*(amounts in thousands, except pershare data)*

 
| ** **                                         | ** ** | **Three months ended March 31,** | ** ** |
|----------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                         | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
|                                               |       |                                                 |       |   |   |
| Net sales                                          |       | $                                                    | 24,520     |   | $ | 31,378 |   |
| Cost of goods sold                                 |       | 17,563                                               |       | 22,144 |   |
| Gross profit                                       |       | 6,957                                                |       | 9,234 |   |
|                                               |       |                                                 |       |   |   |
| Operating expenses                                 |       |                                                 |       |   |   |
| Selling                                            |       | 4,707                                                |       | 4,843 |   |
| General and administrative                         |       | 3,215                                                |       | 2,889 |   |
| Research and development                           |       | 588                                                  |       | 673 |   |
|                                               |       | 8,510                                                |       | 8,405 |   |
|                                               |       |                                                 |       |   |   |
| Income (loss) from operations                      |       | (1,553                                               | )          | 829 |   |
|                                               |       |                                                 |       |   |   |
| Interest expense, net                              |       | 102                                                  |       | 107 |   |
| Income (loss) before income tax expense            |       | (1,655                                               | )          | 722 |   |
|                                               |       |                                                 |       |   |   |
| Income tax expense (benefit)                       |       | (18                                                  | )          | 215 |   |
| Net income (loss) before minority interest         |       | (1,637                                               | )          | 507 |   |
| Minority interest in income (loss) of subsidiaries |       | (81                                                  | )          | 81 |   |
| Net income (loss)                                  |       | $                                                    | (1,556     | ) | $ | 426 |   |
|                                               |       |                                                 |       |   |   |
| Net income (loss) per share                        |       |                                                 |       |   |   |
| Basic                                              |       | $                                                    | (0.16      | ) | $ | 0.05 |   |
| Diluted                                            |       | $                                                    | (0.16      | ) | $ | 0.04 |   |
|                                               |       |                                                 |       |   |   |
| Net income (loss)                                  |       | $                                                    | (1,556     | ) | $ | 426 |   |
| Other comprehensive loss, net of tax               |       |                                                 |       |   |   |
| Foreign currency translation adjustment            |       | (342                                                 | )          | (265 | ) |
|                                               |       |                                                 |       |   |   |
| Comprehensive income (loss)                        |       | $                                                    | (1,898     | ) | $ | 161 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

2

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CHANNELL COMMERCIAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

*(amounts in thousands)*

 
| ** **                                                                                                                                                                                                               | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                               | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| ASSETS                                                                                                                                                                                                                   |       |               |       |                  |       |
| Current assets                                                                                                                                                                                                           |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                |       | $                  | 2,357      |                  | $          | 3,148 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $222 at March 31, 2006 and $396 at December 31, 2005                                                                                           |       | 11,950             |       | 8,317                 |       |
| Inventories, net                                                                                                                                                                                                         |       | 11,178             |       | 11,411                |       |
| Prepaid expenses and other current assets                                                                                                                                                                                |       | 1,197              |       | 1,000                 |       |
| Income taxes receivable                                                                                                                                                                                                  |       | 328                |       | 67                    |       |
| Deferred income taxes                                                                                                                                                                                                    |       | 927                |       | 948                   |       |
| Total current assets                                                                                                                                                                                                     |       | 27,937             |       | 24,891                |       |
|                                                                                                                                                                                                                     |       |               |       |                  |       |
| Property and equipment, net                                                                                                                                                                                              |       | 18,043             |       | 18,929                |       |
| Deferred income taxes                                                                                                                                                                                                    |       | 116                |       | 119                   |       |
| Goodwill                                                                                                                                                                                                                 |       | 14,087             |       | 14,406                |       |
| Intangible assets, net                                                                                                                                                                                                   |       | 1,402              |       | 1,477                 |       |
| Other assets                                                                                                                                                                                                             |       | 591                |       | 807                   |       |
| Total assets                                                                                                                                                                                                             |       | $                  | 62,176     |                  | $          | 60,629 |   |
|                                                                                                                                                                                                                     |       |               |       |                  |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                |       |               |       |                  |       |
| Current liabilities                                                                                                                                                                                                      |       |               |       |                  |       |
| Accounts payable                                                                                                                                                                                                         |       | 11,546             |       | 8,677                 |       |
| Short term debt (including maturities of long term  debt)                                                                                                                                                                |       | 4,585              |       | 7,459                 |       |
| Current maturities of capital lease obligations                                                                                                                                                                          |       | 81                 |       | 87                    |       |
| Accrued expenses                                                                                                                                                                                                         |       | 5,019              |       | 5,494                 |       |
| Total current liabilities                                                                                                                                                                                                |       | 21,231             |       | 21,717                |       |
|                                                                                                                                                                                                                     |       |               |       |                  |       |
| Long term debt, less current maturities                                                                                                                                                                                  |       | 4,011              |       | —                |       |
| Capital lease obligations, less current maturities                                                                                                                                                                       |       | 68                 |       | 78                    |       |
| Deferred gain on sale leaseback transaction                                                                                                                                                                              |       | 378                |       | 393                   |       |
| Commitments and contingencies (see Note 9)                                                                                                                                                                               |       | —             |       | —                |       |
| Minority interest                                                                                                                                                                                                        |       | 2,346              |       | 2,482                 |       |
|                                                                                                                                                                                                                     |       |               |       |                  |       |
| 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 9,787 shares at March 31, 2006 and December 31,  2005, outstanding 9,543 shares at March 31, 2006 and December 31,  2005 |       | 98                 |       | 98                    |       |
| Additional paid-in capital                                                                                                                                                                                               |       | 30,831             |       | 30,750                |       |
| Treasury stock - 244 shares in 2006 and 2005                                                                                                                                                                             |       | (1,871             | )          | (1,871                | )          |
| Retained earnings                                                                                                                                                                                                        |       | 5,113              |       | 6,669                 |       |
| Accumulated other comprehensive income (loss) -                                                                                                                                                                          |       |               |       |                  |       |
| Foreign currency translation                                                                                                                                                                                             |       | (29                | )          | 313                   |       |
| Total stockholders’ equity                                                                                                                                                                                          |       | 34,142             |       | 35,959                |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                          |       | $                  | 62,176     |                  | $          | 60,629 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

3

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CHANNELL COMMERCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

*(amountsin thousands)*

 
| ** **                                                                            | ** ** | **Three months ended March 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| Cash flows from operating activites:                                                  |       |                                                 |       |   |   |
| Net income (loss)                                                                     |       | $                                                    | (1,556     | ) | $ | 426 |   |
| Adjustments to reconcile net income (loss) to net  cash used in operating activities: |       |                                                 |       |   |   |
| Depreciation and amortization                                                         |       | 1,149                                                |       | 1,185 |   |
| Stock based compensation                                                              |       | 81                                                   |       | — |   |
| Gain on disposal of fixed assets                                                      |       | —                                               |       | (6 | ) |
| Amortization of deferred gain on sale leaseback                                       |       | (15                                                  | )          | (15 | ) |
| Deferred income taxes                                                                 |       | —                                               |       | (52 | ) |
| Provision for doubtful accounts                                                       |       | (174                                                 | )          | (37 | ) |
| Provision for inventory obsolescence                                                  |       | —                                               |       | 390 |   |
| Minority interest in income (loss) of subsidiaries                                    |       | (81                                                  | )          | 81 |   |
| Changes in operating assets and liabilities:                                          |       |                                                 |       |   |   |
| Accounts receivable                                                                   |       | (3,420                                               | )          | 393 |   |
| Inventories                                                                           |       | 125                                                  |       | 271 |   |
| Prepaid expenses and other current assets                                             |       | (208                                                 | )          | (312 | ) |
| Income taxes receivable                                                               |       | (258                                                 | )          | 194 |   |
| Other assets                                                                          |       | 50                                                   |       | 91 |   |
| Accounts payable                                                                      |       | 3,043                                                |       | (4,367 | ) |
| Restructuring liability                                                               |       | —                                               |       | (12 | ) |
| Accrued expenses                                                                      |       | (439                                                 | )          | (157 | ) |
| Net cash used in operating activities                                                 |       | (1,703                                               | )          | (1,927 | ) |
|                                                                                  |       |                                                 |       |   |   |
| Cash flows from investing activities:                                                 |       |                                                 |       |   |   |
| Purchase of property and equipment                                                    |       | (300                                                 | )          | (827 | ) |
| Proceeds from the sales of property and equipment                                     |       | —                                               |       | 24 |   |
| Net cash used in investing actitivites                                                |       | (300                                                 | )          | (803 | ) |
|                                                                                  |       |                                                 |       |   |   |
| Cash flows from financing activites:                                                  |       |                                                 |       |   |   |
| Repayment of debt                                                                     |       | (532                                                 | )          | (783 | ) |
| Proceeds from issuance of long-term debt                                              |       | —                                               |       | 981 |   |
| Borrowings from credit facilites                                                      |       | 1,807                                                |       | — |   |
| Repayment of obligations under capital lease                                          |       | (13                                                  | )          | (9 | ) |
| Exercise of employee stock options                                                    |       | —                                               |       | 130 |   |
| Net cash provided by financing activities                                             |       | 1,262                                                |       | 319 |   |
|                                                                                  |       |                                                 |       |   |   |
| Effect of exchange rates on cash                                                      |       | (50                                                  | )          | (45 | ) |
| Decrease in cash and cash equivalents                                                 |       | (791                                                 | )          | (2,456 | ) |
| Cash and cash equivalents, beginning of period                                        |       | 3,148                                                |       | 5,453 |   |
| Cash and cash equivalents, end of period                                              |       | $                                                    | 2,357      |   | $ | 2,997 |   |
| Cash paid during the period for:                                                      |       |                                                 |       |   |   |
| Interest                                                                              |       | $                                                    | 172        |   | $ | 135 |   |
| Income taxes                                                                          |       | $                                                    | 21         |   | $ | 106 |   |
| Non-cash investing activities:                                                        |       |                                                 |       |   |   |
| Purchases of property and equipment which are  included in accounts payable           |       | $                                                    | 37         |   | $ | — |   |

 

The accompanying notes are an integral part of these financialstatements.

 

4

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CHANNELL COMMERCIALCORPORATION

CONSOLIDATED STATEMENT OFSTOCKHOLDERS’ EQUITY

Three months ended March 31,2006

*(amountsin thousands)*

 
| ** **                    | ** ** | ** **            | ** ** | ** **  | ** ** | ** **              | ** ** | ** **   | ** ** | ** **        | ** ** | ** **             | ** ** | **Accumulated**        | ** ** | ** ** | ** ** |
|-------------------------------|------------|-----------------------|------------|-------------|------------|-------------------------|------------|--------------|------------|-------------------|------------|------------------------|------------|------------------------|------------|------------|------------|
| ** **                    | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**          | ** ** | ** **   | ** ** | ** **        | ** ** | ** **             | ** ** | **other**              | ** ** | **Total**  | ** ** |
| ** **                    | ** ** | **Common stock** | ** ** | **paid-in** | ** ** | **Treasury stock** | ** ** | **Retained** | ** ** | **comprehensive** | ** ** | **stockholders’** | ** ** |
| ** **                    | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **capital**             | ** ** | **Shares**   | ** ** | **Amount**        | ** ** | **earnings**           | ** ** | **income (loss)** | ** ** | **equity** | ** ** |
|                          |       |                  |       |        |       |                    |       |         |       |              |       |                   |       |                   |       |       |       |
| Balance, January 1, 2006 |       | 9,787                 |       | $           | 98         |                    | $          | 30,750       |       | 244               |       | $                      | (1,871     | )                      | $          | 6,669      |       | $ | 313 |   | $ | 35,959 |   |
|                          |       |                  |       |        |       |                    |       |         |       |              |       |                   |       |                   |       |       |       |
| Stock-based compensation      |       | —                |       | —      |       | 81                      |       | —       |       | —            |       | —                 |       | —                 |       | 81         |       |
|                          |       |                  |       |        |       |                    |       |         |       |              |       |                   |       |                   |       |       |       |
| Foreign currency translation  |       | —                |       | —      |       | —                  |       | —       |       | —            |       | —                 |       | (342                   | )          | (342       | )          |
|                          |       |                  |       |        |       |                    |       |         |       |              |       |                   |       |                   |       |       |       |
| Net loss for the period       |       | —                |       | —      |       | —                  |       | —       |       | —            |       | (1,556                 | )          | —                 |       | (1,556     | )          |
|                          |       |                  |       |        |       |                    |       |         |       |              |       |                   |       |                   |       |       |       |
| Balance, March 31, 2006  |       | 9,787                 |       | $           | 98         |                    | $          | 30,831       |       | 244               |       | $                      | (1,871     | )                      | $          | 5,113      |       | $ | (29 | ) | $ | 34,142 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

5

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CHANNELL COMMERCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

March 31, 2006 and 2005

*(amounts in thousands, except per share data)*

 

**1.****                                      *Unaudited financial statements.***In the opinion ofmanagement, the accompanying unaudited condensed consolidated financialstatements contain all adjustments (consisting only of normal, recurringadjustments) that are necessary to present fairly the consolidated financialposition of Channell Commercial Corporation (the “Company”) as of March 31,2006 and the results of its operations and cash flows for the three monthsended March 31, 2006 and March 31, 2005. The results of operationsand cash flows for the three months ended March 31, 2006 are notnecessarily indicative of the results to be expected for any other interim periodor the full year. These consolidated financial statements should be read incombination with the audited consolidated financial statements and notesthereto for the year ended December 31, 2005.

 

**2.****                                      *Change in Accounting for Stock-Based Compensation****.*Effective January 1, 2006 the Company adoptedStatement of Financial Accounting Standard (“SFAS”) No. 123R, “*Share-Based Payment*,” utilizing the “modified prospective”method as described in SFAS No. 123R. In the “modified prospective”method, compensation cost is recognized for all share-based payments grantedafter the effective date and for all unvested awards granted prior to theeffective date. In accordance with SFAS No.123R, prior period amounts were notrestated. SFAS No. 123R also requires cash retained as a result of excesstax benefits associated with these share-based payments to be classified asfinancing activities in the Consolidated Statements of Cash Flows, rather thanas operating cash flows as required under previous accounting principles. TheCompany recorded no excess tax benefits for the quarter ended March 31,2006.

 

Share-basedcompensation expense recognized during a period is based on the value of theportion of share-based payment awards that is ultimately expected to vestduring the period. Share-based compensation expense recognized in our condensedconsolidated statement of operations for the three-month period ended March 31,2006 included compensation expense for share-based payment awards grantedprior to, but not yet vested as of, December 31, 2005 based on the grantdate fair value estimated in accordance with the pro forma provisions of FAS123 and share-based payment awards granted subsequent to December 31,2005 based on the grant date fair value estimated in accordance with FAS 123R.For share awards granted in 2006, expenses are amortized under the straight-lineattribution method. For share awards granted prior to fiscal 2006, expenses areamortized under the straight-line single option method prescribed by FAS123.

 

In July 1996,the Company adopted the 1996 Incentive Stock Plan (the “1996 Stock Plan”),under which it was authorized to issue non-qualified stock options andincentive stock options to key employees, directors and consultants to purchaseup to an aggregate of 750 shares of the Company’s common stock. The optionshave a term of ten years and generally become fully vested by the end of thethird year. In May 1999, the 1996 Stock Plan was amended to increase theauthorized number of shares to 1,500.

 

In January 2003,the Board of Directors approved an offer allowing current employees and non-employeedirectors to exchange all of their outstanding options granted under the 1996Stock Plan for new options to be granted under the 2003 Stock Plan or any otherstock option plan that may be adopted by the Company. The 2003 IncentiveStock Plan was approved at the Annual Meeting of Stockholders on April 25,2003. The authorized shares under the 2003 Incentive Stock Plan are 3,100.

 

A total of 1,327options to purchase shares of the Company were accepted for exchange andcancelled on March 20, 2003. On September 24, 2003, a total of 1,324new options were exchanged for options cancelled in March, 2003.

 

Eligibleoption holders who participated in the offer received a new option on the newgrant date in exchange for each old option that was validly tendered andaccepted for exchange. The number of shares covered by each new option wasequal to the number of shares covered by the old options, and the vested statusand vesting schedule of the old options was preserved and continued. Theexercise price of the new options was equal to the closing sale price of theCompany’s common stock as reported on the Nasdaq National Market on the grantdate of the new options.

 

At March 31,2006, under the two plans described above, the Company had total unvestedstock-based compensation expense of $473. The unvested stock options will vestat various intervals over the next 2.9 years. Total incremental stock-basedcompensation expense, recognized in general and administrative expenses duringthe first quarter of 2006 was $81 and caused net loss before income taxes toincrease by $81, net loss to increase by $81 and basic and diluted net loss percommon share to increase by $0.01.

 

6

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Priorto the adoption of SFAS No. 123R, the stock-based compensation plans wereaccounted for using the intrinsic value method under Accounting PrinciplesBoard Opinion (“APB”) No. 25, “*Accounting for StockIssued to Employees*,” and related interpretations. Pro formainformation regarding the impact of total stock-based compensation on netincome and income per share for prior periods is required by SFAS No. 123R.

 

Suchpro forma information, determined as if the Company had accounted for itsemployee stock options under the fair value method according to SFAS No. 123“*Accounting for Stock Based Compensation,*”during the first quarter of 2005, is illustrated in the following table:

 
| ** **                                                                                       | ** ** | **Three months ended** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                       | ** ** | **March 31, 2005**     | ** ** |
|                                                                                             |       |                             |       |
| Reported net income                                                                              |       | $                                | 426        |   |
| Add stock-based compensation expense reported in net  income                                     |       | —                           |       |
| Less total stock-based compensation expense,  determined under the fair value method, net of tax |       | (111                             | )          |
| Pro forma net income                                                                             |       | $                                | 315        |   |
|                                                                                             |       |                             |       |
| Reported basic net income per share                                                              |       | $                                | 0.05       |   |
| Add stock-based compensation expense reported in net  income                                     |       | —                           |       |
| Less total stock-based compensation expense,  determined under the fair value method             |       | (0.01                            | )          |
| Pro forma basic net income per share                                                             |       | $                                | 0.04       |   |
|                                                                                             |       |                             |       |
| Reported diluted net income per share                                                            |       | $                                | 0.04       |   |
| Add stock-based compensation expense reported in net  income                                     |       | —                           |       |
| Less total stock-based compensation expense,  determined under the fair value method             |       | (0.01                            | )          |
| Pro forma diluted net income per share                                                           |       | $                                | 0.03       |   |

 

Thefair value of options at the date of grant was estimated using the Black-Scholesoption valuation model with the following weighted average assumptions for alloptions granted during the quarter:

 
| ** **               | ** ** | **FAS No. 123R** | ** ** | **FAS No. 123** | ** ** |
|--------------------------|------------|----------------------------|------------|---------------------------|------------|
| ** **               | ** ** | **Expense**                | ** ** | **Pro forma**        | ** ** |
| ** **               | ** ** | **2006**                   | ** ** | **2005**                  | ** ** |
|                     |       |                       |       |                      |       |
| Expected term            |       | 5 years                    |       | 5 years                   |       |
| Risk -free interest rate |       | 4.50                       | %          | 3.90                      | %          |
| Expected volatility      |       | 65                         | %          | 50                        | %          |
| Expected dividend yield  |       | —                     |       | —                    |       |

 

Theweighted-average grant-date fair value of options granted during the quarterended March 31, 2006 was $2.71. There were no options granted in thequarter ended March 31, 2005. The expected volatility is based on thehistorical volatility of the Company’s stock.

 

7

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Asummary of option activity under the Plans, as of March 31, 2006 andchanges during the quarter then ended is presented below:

 
| ** **                          | ** ** | ** ** | ** ** | ** **    | ** ** | **Weighted-**   | ** ** | ** **    | ** ** |
|-------------------------------------|------------|------------|------------|---------------|------------|-----------------|------------|---------------|------------|
| ** **                          | ** ** | ** ** | ** ** | **Weighted-** | ** ** | **Average**     | ** ** | ** **    | ** ** |
| ** **                          | ** ** | ** ** | ** ** | **Average**   | ** ** | **Remaining**   | ** ** | **Aggregate** | ** ** |
| ** **                          | ** ** | ** ** | ** ** | **Exercise**  | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| **Options**                         | ** ** | **Shares** | ** ** | **Price**     | ** ** | **Term**        | ** ** | **Value**     | ** ** |
|                                |       |       |       |          |       |            |       |          |       |
| Outstanding at January 1, 2006 |       | 1,934      |       | $             | 5.10       |            |       |          |       |   |
| Granted                             |       | 9          |       | 4.65          |       |            |       |          |       |
| Exercised                           |       | —     |       | —        |       |            |       |          |       |
| Forfeited or expired                |       | (106       | )          | 8.70          |       |            |       |          |       |
| Outstanding at March 31, 2006  |       | 1,837      |       | $             | 4.89       |            | 7.6        |          | $          | 202 |   |
| Exercisable at March 31, 2006  |       | 1,513      |       | $             | 4.87       |            | 7.5        |          | $          | 197 |   |

 

Asummary of the status of the Company’s nonvested shares as of March 31,2006 and changes during the quarter then ended is presented below:

 
| ** **                        | ** ** | ** ** | ** ** | **Weighted-**       | ** ** |
|-----------------------------------|------------|------------|------------|---------------------|------------|
| ** **                        | ** ** | ** ** | ** ** | **Average**         | ** ** |
| ** **                        | ** ** | ** ** | ** ** | **Grant-Date**      | ** ** |
| **Nonvested Shares**         | ** ** | **Shares** | ** ** | **Fair Value** | ** ** |
|                              |       |       |       |                |       |
| Nonvested at January 1, 2006 |       | 563        |       | $                   | 1.96       |   |
| Granted                           |       | 9          |       | 2.71                |       |
| Vested                            |       | (199       | )          | 1.67                |       |
| Forfeited or expired              |       | (50        | )          | 3.59                |       |
| Nonvested at March 31, 2006  |       | 323        |       | $                   | 1.91       |   |

 

**3.****                                      *Inventories****.*Inventoriesstated at the lower of cost (first-in, first-out method) or market aresummarized as follows:

 
| ** **                       | ** ** | **March 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|----------------------------------|------------|------------------------------|------------|---------------------------------|------------|
|                             |       |                         |       |                            |       |
| Raw Materials                    |       | $                            | 5,131      |                            | $          | 5,567 |   |
| Work-in-Process                  |       | 2,094                        |       | 2,642                           |       |
| Finished Goods                   |       | 5,491                        |       | 4,926                           |       |
|                             |       | 12,716                       |       | 13,135                          |       |
| Less inventory valuation reserve |       | (1,538                       | )          | (1,724                          | )          |
|                             |       | $                            | 11,178     |                            | $          | 11,411 |   |

 

**4.****                                      *Income (loss) 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 three month periods ended March 31, 2006 and2005*.*Diluted income per share reflects thepotential dilution that could occur if dilutive options to acquire common stockwere exercised, the proceeds of which are then presumed to have been used torepurchase outstanding stock using the treasury stock method. For the threemonths ended March 31, 2006, there is no calculation of dilution since theCompany incurred a loss for the period, thereby resulting in the optionsbecoming antidilutive. The following is a reconciliation of the number ofshares (denominator) used in the basic and diluted income (loss) per sharecomputations for the three month periods ended March 31, 2006 and 2005:

 

8

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| ** **                        | ** ** | **Three months ended March 31,** | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|
| ** **                        | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| ** **                        | ** ** | ** **                                           | ** ** | **Per Share** | ** ** | ** ** | ** ** | **Per Share** | ** ** |
| ** **                        | ** ** | **Shares**                                           | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** |
| Basic income  (loss) per share    |       | 9,543                                                |       | $ | (0.16 | ) | 9,378 |   | $ | 0.05 |   |
| Effect of  dilutive stock options |       | —                                               |       | — |   | 491 |   | (0.01 | ) |
| Diluted income  (loss) per share  |       | 9,543                                                |       | $ | (0.16 | ) | 9,869 |   | $ | 0.04 |   |

 

The following optionswere not included in the computation of diluted income (loss) per share due totheir antidilutive effect.

 

| ** **                                  | ** ** | **March 31, 2006**    | ** ** | **March 31, 2005** | ** ** |
|---------------------------------------------|------------|---------------------------------|------------|------------------------------|------------|
| * *                                    | * *   | * *                        | * *   | * *                     | * *   |
| Options to  purchase shares of common stock |       | 1,837                           |       | 68                           |       |
| Exercise prices                             |       | $3.25 - $13.75                  |       | $10.063 - $13.75             |       |
| Expiration dates                            |       | July 2006 – February  2016 |       | July 2006 – July 2010   |       |

 

***5.******                                      Segments.***There are two segments: Americas and International. Americas includesthe United States, Central and South America and Canada. International includesEurope, Africa, Middle East, Australia and Asia. The following table summarizessegment information for the three months ended March 31, 2006 and 2005:

 

| ** **                               | ** ** | **Three months ended March 31,** | ** ** |
|------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                               | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
|                                     |       |                                                 |       |   |   |
| Revenues from  unrelated entitities (1): |       |                                                 |       |   |   |
| Americas                                 |       | $                                                    | 12,853     |   | $ | 19,540 |   |
| International                            |       | 11,667                                               |       | 11,838 |   |
|                                     |       | $                                                    | 24,520     |   | $ | 31,378 |   |
| Income (loss)  from operations:          |       |                                                 |       |   |   |
| Americas                                 |       | $                                                    | (1,196     | ) | $ | 389 |   |
| International                            |       | (357                                                 | )          | 440 |   |
|                                     |       | $                                                    | (1,553     | ) | $ | 829 |   |
| Interest  expense, net:                  |       |                                                 |       |   |   |
| Americas                                 |       | $                                                    | 86         |   | $ | 48 |   |
| International                            |       | 16                                                   |       | 59 |   |
|                                     |       | $                                                    | 102        |   | $ | 107 |   |

 

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(1) Note:                     Revenues fromAustralia exceeded 10% of total revenues for the three month periods endedMarch 31, 2006 and 2005. Revenues from Australia totaled $10,561 and $9,844 forthe three month periods in 2006 and 2005, respectively.

 

9

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

 

| ** **              | ** ** | **Three months ended March 31,** | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|
| ** **              | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
|                    |       |                                                 |       |   |   |
| Product lines:          |       |                                                 |       |   |   |
| Enclosures              |       | $                                                    | 11,262     |   | $ | 13,736 |   |
| Water related  products |       | 11,158                                               |       | 15,496 |   |
| Connectivity            |       | 1,991                                                |       | 2,032 |   |
| Other                   |       | 109                                                  |       | 114 |   |
|                    |       | $                                                    | 24,520     |   | $ | 31,378 |   |

 

***6.******                                     ******Recent Accounting Pronouncements****.* In May 2005, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 154, “*AccountingChanges and Error Corrections — a replacement of APB Opinion No. 20 and FASBStatement No. 3.”*  SFAS No. 154 replaces APB Opinion No. 20, “*Accounting Changes,”* and FASB Statement No. 3, “*Reporting Accounting Changes in Interim Financial Statements”*and changes the requirements for the accounting for and reporting of a changein accounting principle.  This statement applies to all voluntary changesin accounting principle.  It also applies to changes required by anaccounting pronouncement in the unusual instance that the pronouncement doesnot include specific transition provisions.  When a pronouncement includesspecific transition provisions, those provisions should be followed.  SFASNo. 154 is effective for accounting changes and corrections of errors made infiscal years beginning after December 31, 2005.   The Company adoptedSFAS No. 154 on January 1, 2006 and its implementation did not have a materialeffect on the Company’s consolidated financial position, results of operationsor cash flows.

 

In March 2005, the FASBissued Interpretation No. 47, “*Accountingfor Conditional Asset Retirement Obligations*,” an interpretation ofFASB Statement No. 143. This Interpretation clarifies that the term “conditionalasset retirement obligation” as used in FASB No. 143, “*Accounting for Asset Retirement Obligations,”*refers to a legal obligation to perform an asset retirement activity in whichthe timing and (or) method of settlement are conditional on a future event thatmay or may not be within the control of the entity. Accordingly, an entity isrequired to recognize a liability for the fair value of a conditional assetretirement obligation, when incurred, if the fair value of the liability can bereasonably estimated. The Interpretation became effective for the Company as ofDecember 31, 2005. The implementation of this Interpretation did not havea material effect on the Company’s consolidated financial position, results ofoperations or cash flows.

 

In November 2004, theFASB issued SFAS No. 151, “*Inventory Costs, an Amendmentof ARB No. 43, Chapter 4.*” SFAS No. 151 retains the general principle of ARB No.43, Chapter 4, “*Inventory Pricing,*” that inventories are presumed to bestated at cost; however, it amends ARB No. 43 to clarify that abnormal amountsof idle facilities, freight, handling costs and spoilage should be recognizedas current period expenses. Also, SFAS No. 151 requires fixed overhead costs beallocated to inventories based on normal production capacity. The guidance inSAFS No. 151 is effective for inventory costs incurred during fiscal yearsbeginning after June 15, 2005. The Company adopted SFAS No. 151 on January 1,2006 and its implementation did not have a material impact on its consolidated financialcondition, results of operations or cash flows.

 

**7.****                                      *Sale Leaseback Agreement.***In June, 2002, the Companyentered into a sale and leaseback agreement for a facility located in Temecula,California. The proceeds from the sale totaled approximately $6,200 andresulted in a pretax deferred gain of $604. The resulting lease is beingaccounted for as an operating lease. The lease base term is ten years with twofive-year options at rental amounts to be adjusted to the fair market rentalvalue at the end of the base term. The unamortized balance of the deferred gainis being amortized over the ten-year lease base term, and as of March 31, 2006,such balance was $378. The Company recorded income of $15 and $15 in the firstquarter of 2006 and 2005, respectively, related to the amortization of thedeferred gain.

 

**8.****                                      *Income Taxes.***The effective tax rate of 1.1% for thethree months ended March 31, 2006 differed from the statutory rate of 34%primarily due to a significant percentage of the consolidated loss beinggenerated by the domestic operations of the Company for which the Company hasestablished a full valuation allowance on deferred income tax assets.

 

As the Company has nodomestic income taxes payable the recognition of a deferred tax asset would berequired for any tax benefit recognized as a result of a current net loss. However,under SFAS No. 109 *“Accounting for IncomeTaxes,”* the Company is required to record a valuation allowance toreduce its net deferred tax asset to the amount that management believes ismore likely than not to be realized. Accounting

 

10

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guidance allows theCompany to look to future earnings to support the realizability of net deferredassets. However, since the Company has had cumulative losses in recent years inits domestic operations, the Company is unable to support the realizability of domesticdeferred tax assets based on forecasted future earnings. As a result,management has concluded that a full valuation allowance against net domestic deferredtax assets is necessary. As such, no tax benefit has been recorded for thedomestic losses of the Company in the three months ended March 31, 2006 or 2005.

 

**9.*****                                     ******Commitments and Contingencies*****.***Employment Agreements****—***In December, 2003, theCompany entered into a five year employment agreement, renewable every fiveyears, with William H. Channell, Jr. Mr. Channell, Jr.’s annual salary for 2005was $760. Mr. Channell, Jr. is entitled to participate in the Stock Plan, the401(k) Plan and the Incentive Compensation Plan. Mr. Channell, Jr. is also entitledto certain other benefits paid for by the Company, including an automobileallowance, health insurance and sick leave, in accordance with the Company’scustomary practices for senior executive officers. In the event that theCompany were to terminate Mr. Channell, Jr. without cause (as defined in theagreement), or Mr. Channell, Jr. were to terminate his employment for goodreason (also as defined in the agreement and including, without limitation, achange of control of the Company), Mr. Channell, Jr. would be entitled to alump sum payment equal to three times his then current base salary, all healthand life insurance benefits for three years, and accelerated vesting of anystock options or restricted stock granted to him.

 

The Company amended inDecember, 2003 the employment agreement with Mr. Channell, Sr. originallyentered into in July, 1996. Mr. Channell, Sr.’s annual salary starting inDecember, 2003 is $50. Mr. Channell, Sr.’s benefits include (i)  during the term of the agreement, the paymentof premiums for a term disability policy providing for $250 in annual benefitsin the case of his temporary or permanent disability, (ii) during the lifetimeof Mr. Channell, Sr. and his wife, Jacqueline M. Channell, medical insurancefor each of Mr. and Mrs. Channell comparable to that provided to the Company’ssenior executive officers,  (iii) duringMr. Channell, Sr.’s lifetime, a portion of the premiums on a $1,500 lifeinsurance policy owned by Mr. Channell, Sr., under which Mrs. Channell is thebeneficiary, and (iv) an automobile allowance.

 

*Taxes**—***TheFederal income tax returns of the Company for the years ended December 31,1997, 1999, 2000, 2001 and 2002 are currently under examination by the InternalRevenue Service (“IRS”). As of March 31, 2006, the Company and the IRS haveresolved all outstanding issues except for the credit for increasing researchand development expenditures. The amount of the credit under dispute isapproximately $500. As the Company has established a full valuation reserve onthe net benefit to be obtained from this credit, the resolution of the researchand development tax credit will not have a material adverse impact on theCompany’s results of operations or financial position. In addition, the credithas not been utilized on the Company’s tax returns. The Company expects toresolve this matter within calendar year 2006.

 

In 2001, the State of Texas issued a report assessingthe Company additional sales and use tax of $1,600, including interest for theperiod of January 1, 1996 through December 31, 1999. The Company appealed theassessment and provided the State of Texas with documentation to support theCompany’s contention that the transactions did not require the Company to remitsales and use tax to the State of Texas. The State of Texas agreed to areduction of the amount owed to $587 plus interest of $330. The Company haspaid the State of Texas the entire amount of the assessment and interest owedof $917. In addition, the Company has received sales and use tax assessmentsfrom the states of Georgia, California and Massachusetts. The Company hasaccrued for the remaining sales and use tax assessments, including interest,from the State of Georgia of $119, State of California of $45 and the State ofMassachusetts of $16. The ultimate outcome of the tax assessments from theState of Georgia, State of California and the State of Massachusetts will nothave a material impact on the Company’s consolidated results of operations orfinancial position.

 

*LegalProceedings**—** Carson Industries LLC v.Channell Commercial Corporation (Calif. Superior Court Case No. BC334759)*.For a number of years, the Company has purchased grade level boxes from CarsonIndustries LLC (“Carson”) for resale to the Company’s customers. In 2004, theCompany’s customers reported the failure of a number of Carson boxes in thefield. The Company has determined that certain boxes sold to the Company byCarson in 2004 and thereafter did not conform to certain specifications. OnJune 9, 2005, Carson filed the above-captioned lawsuit against the Company,principally seeking approximately $360 for product sold to the Company but notyet paid for. On July 26, 2005, the Company cross-complained against Carsonfor, among other things, breach of contract, breach of express and impliedwarranties, fraud and intentional interference with contractual relations.

 

11

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During court orderedmediation on March 21, 2006, the parties agreed to settle the lawsuit. Thefinal agreement was signed on April 17, 2006 whereby the Company paid to Carson$290 and returned to Carson approximately $70 of inventory previously purchasedby the Company. Carson agreed to indemnify the Company against certain productwarranty claims for five years from the date of sale. As of March 31, 2006, theCompany has accrued $307 for such liability.

 

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

 

On August 2, 2004, theCompany, through a majority-owned subsidiary, acquired a controlling interestin Bushman Tanks, a manufacturer and distributor of rotational molded plastic(polyethylene) water storage tanks. Bushman Tanks currently operates out of sixleased facilities in Australia, located in Sydney, Dalby, Orange, Terang,Townsville, and Adelaide. The purchase price was $16,838. The original Shareand Asset Purchase Agreement provided for total contingent consideration ofapproximately $2,900 if the Bushman Tanks business achieves certain sales andcost reduction targets. Any amounts paid as contingent consideration willresult in additional goodwill. Management has assessed that an earn out ofapproximately $760 has been earned for achieving the 2005 sales targets as ofJuly 31, 2005 and this amount has been accrued as an increase to goodwillduring the third quarter of 2005. In the fourth quarter of 2005, $380 of thisearn out was paid, and $380 remained as an accrued liability as of March 31,2006. Also, under the original Agreement, if certain cost reduction targets areachieved, the sellers will receive one-half of the amounts of the costreductions in the specified cost items. In the event that the costs incurredfor these items exceed a predetermined threshold, the seller will be liable tothe Company for the amount of the costs exceeding the threshold. Accordingly,$146 was recorded as a receivable for warranty claims during 2005 and recordedas a reduction to goodwill. Subsequent to December 31, 2005 the Company and thesellers entered into a preliminary agreement that would modify the originalterms of the contingent consideration. As of March 31, 2006, the agreement wasnot yet finalized. If the agreement is finalized, the Company will payapproximately $150 to the sellers to settle all current claims between theparties. The sellers will forgo any additional earn out payments while theCompany will forgo any future warranty claims. The Company believes that anyimpact of this agreement, when and if finalized, will not have a materialeffect on its financial condition or results of operations.

 

**10.****                               *Related Party Transactions.***In May, 2002, the Companysold its Radio Frequency (“RF”) line of passive electronic devices to RMSCommunications, Inc., which is owned by Gary Napolitano, a former officer ofthe Company. A sale in the amount of $800 was recorded. RMS Communications,Inc. paid the Company $125 in cash at the time of sale, and the remaining $675was payable in monthly installments through June 30, 2003, bearing interest at7% per annum. The account is currently in arrears. A revised secured promissorynote superseding the previous promissory note with RMS Communications, Inc. andGary Napolitano personally has been entered into with RMS Communications, Inc.and Gary Napolitano personally. The revised secured promissory note is datedDecember 31, 2005 and called for the balance owed to the Company of $206 plusaccrued interest of $46 to be paid in monthly installments of $3.5 until theentire amount of the note is paid. The Company has security interest in theinventory and a personal guarantee from Mr. Napolitano. A reserve of $160 hasbeen recorded against the receivable as of March 31, 2006 according to theCompany’s policy for accounts receivable allowances. The Company continues topurchase RF devices from Mr. Napolitano and from other sources depending onprice and supply of product. The RF devices purchased from Mr. Napolitano’sfirm in 2005 and 2004 approximated $10 and $87, respectively, and were used inthe Company’s product lines. The purchases in 2005 and 2004 did not result in acash payment to Mr. Napolitano as the amounts were used to reduce the accountsreceivable. The balance owed at March 31, 2006 was $199. There were nopurchases from Mr. Napolitano’s company in the three months ended March 31,2006.

 

In the first quarter of2006, the Company paid Carolyn Channell $22. On June 1, 2005, Mrs. Channell washired as an employee to handle specific insurance matters for the Company. Priorto being hired as an employee of the Company, Mrs. Channell consulted oninsurance matters for the Company. In the first quarter of 2005, Mrs. Channellwas paid $17 for consulting services. Mrs. Channell is the wife of William H.Channell, Jr., the Company’s President and Chief Executive Officer.

 

12

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The Company’s facilitiesin Orange, Dalby, Terang and Adelaide, Australia, are leased from shareholdersof the Company. These shareholders are former owners of Bushman Tanks. Thefacilities comprise 94,000 square feet of manufacturing, warehouse and officespace. The lease term on all four facilities is through February 28, 2010 witha five-year renewal option. The rent expense paid under the leases in the threemonths ended March 31, 2006 was $84. The Company hired an independent firm toappraise the market lease rates for these facilities and it was determined thatthe existing leases are in excess of fair market value by approximately $27 peryear. Included in liabilities is $160 accrued for purchase accounting relatedto these unfavorable leases.

 

**11.****                               *Concentrations.***Sales to Verizon of $2,344 in the firstthree months of 2006 represented 9.6% of the Company’s sales in the period. Salesto Verizon of $9,482 in the first three months of 2005 represented 30.2% of theCompany’s sales. Sales to Comcast of $1,910 in the first three months of 2006represented 7.8% of the Company’s sales in the period. Sales to Comcast in thefirst three months of 2005 represented 6.2% of the Company’s sales for the period.

 

Accounts receivable fromVerizon of $1,089 and from Comcast of $851 represented 9.1% and 7.1%,respectively, of Company accounts receivable at March 31, 2006. Accountsreceivable from Verizon of $307 and from Comcast of $404 represented 3.7% and 4.9%,respectively, of Company accounts receivable at December 31, 2005.

 

**12.****                               *Guarantees.***In 1997, the Company guaranteed debt of theChannell Family Trust of approximately $754 incurred in connection withconstruction of the facilities leased to the Company, and such guaranteed debt iscollateralized by said facilities. The loan amount subject to the guarantee isexpected to decline before expiring in 2017. The Company has not recorded aliability for this guarantee. At March 31, 2006, the outstanding loan balancesubject to the guarantee totaled approximately $545. The Channell Family Trustdoes not qualify as a “variable interest entity” subject to consolidation underFIN46 or FIN 46(R) since there are sufficient assets held by the Trust that thelender could attach in the event of default on the loan. Under FIN 46 and Fin46(R),  the Channell Family Trust doesnot qualify as a “variable interest entity” subject to consolidation since (a)the total equity investment at risk in the Trust is sufficient to permitfinancing without additional financial support from the Company and (b) WilliamChannell, Sr., the administrator of the Channell Family Trust, has the directability to make decisions about the Trust’s activities.

 

**13.**                               ***Goodwill and Other Intangible Assets.***Thebalance of the intangible assets on the Company’s balance sheet fluctuates fromperiod to period due to the application of foreign currency translation toUnited States dollars in calculating the balance of goodwill and otherintangible assets of the Company’s foreign subsidiaries. Effective January 1,2002, the Company adopted SFAS No. 142, “*Goodwill andOther Intangible Assets.*” SFAS 142 requires that goodwill and certain intangibles no longer beamortized, but instead be reviewed at least annually for impairment.

 

The Company tests thevalue of goodwill for impairment annually (December 31 for the Canadianreporting unit and June 30 for the Bushman’s reporting unit) or whenever eventsor changes in circumstance indicate that a condition of impairment may exist. Assuch, the goodwill for the Bushmans reporting unit was reassessed forimpairment on December 31, 2005. The test involves significant judgment inestimating projections of fair value generated through future performance ofthe operating segment. In calculating the fair value, the Company relies onfactors such as operating results, business plans, economic projections, andanticipated cash flows used in discounting the cash flows. Inherentuncertainties exist in determining and applying such factors.

 

There were no impairmentsto the carrying value of goodwill in 2006 or 2005.

 

In the Share and AssetPurchase Agreement, the sellers of Bushman Tanks agreed to a “non-compete”clause whereby the sellers of Bushman Tanks would not directly or indirectly carry on or be engaged or involved in any trade,business or undertaking that is in competition with the Bushman Tanks business.The Company performed an evaluation of the non-compete agreement and determinedthe fair value to be US dollars$1,600. The non-compete agreement is recorded in the reporting unit of BushmanTanks, which is part of the International segment, as a separately identifiableintangible asset and is being amortized over the ten-year contractualterm on a straight line basis.

 

13

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The changes in thecarrying amount of goodwill and the non-compete agreement for the three monthsended March 31, 2006 are summarized as follows:

 

| ** **                              | ** ** | ** **   | ** ** | **Intangible**  | ** ** |
|-----------------------------------------|------------|--------------|------------|-----------------|------------|
| ** **                              | ** ** | ** **   | ** ** | **Non-Compete** | ** ** |
| ** **                              | ** ** | **Goodwill** | ** ** | **Agreement**   | ** ** |
|                                    |       |         |       |            |       |
| Balance at  December 31, 2005           |       | $            | 14,406     |            | $          | 1,477 |   |
|                                    |       |         |       |            |       |
| Amortization of  non-compete agreement  |       | —       |       | (43             | )          |
| Effect of  foreign currency translation |       | (319         | )          | (32             | )          |
| Balance at March  31, 2006              |       | $            | 14,087     |            | $          | 1,402 |   |

 

As of March 31, 2006, theCompany has recorded goodwill of $676 in its Canadian reporting unit, which ispart of the Americas segment, and $13,411 of goodwill in its Bushman Tanks reportingunit, which is part of the International segment.

 

The estimatedamortization expense based on current intangible balances and the March 31,2006 foreign currency exchange rates, is $165 a year for the next five fiscalyears, and $577 thereafter.

 

**14.**                               ***Loan and Security Agreements.***TheCompany has a Loan and Security Agreement with an asset-based lender in theUnited States. This Agreement contains a term loan and a revolving creditfacility. On February 28, 2006, the Loan and Security Agreement was amended,among other things, to extend the term of the loans through March 31, 2007; toeliminate the fixed charge coverage ratio financial covenant; and to reduce themaximum revolver borrowings to $10,000. The revolver under this Agreement has a$1,000 sub-limit for letters of credit. As of March 31, 2006, outstandingletters of credit totaled $986. The Agreement contains various financial andoperating covenants that impose limitations on the Company’s ability, amongother things, to incur additional indebtedness, merge or consolidate, sellassets except in the ordinary course of business, make certain investments,enter into leases and pay dividends. The Agreement requires the Company tomaintain a lockbox on the revolving credit facility. The Agreement alsocontains a subjective acceleration clause should the Company come into adefault, which allows the asset-based lender to terminate the facility andrequire that any outstanding obligation to be repaid. The balance outstanding atMarch 31, 2006 under the revolving line of credit was $1,295 and under the termloans was $1,649, both of which have been classified as current liabilities.

 

Channell Bushman Pty Ltdand controlled entities, collectively known as Channell Bushman Group, whichare subsidiaries of the Company, entered into a Loan and Security Agreementwith a commercial bank in Australia in August 2004. As of March 31, 2006, thefacilities under the agreement include the following: a term loan with originalmaximum borrowings of Australian dollars (“AUD”) $8,000 that expires in July2009; a revolving credit facility with maximum borrowings of AUD$2,000 thatexpires in November 2006; a facility to fund future “earn-out” payments to thesellers of Bushman Tanks with maximum borrowings of AUD$1,750 that expires inJuly 2009; and a capital expenditure facility with maximum borrowings ofAUD$4,500 that expires in July 2009. Translated into US dollars at March 31,2006 exchange rates, the maximum borrowings are:  term loan $5,688, revolving credit facility $1,422,“earn-out” facility $1,244, and capital expenditure facility $3,200. Thebalance outstanding under the revolving line of credit, “earn-out” facility,and capital expenditure facility at March 31, 2006 was $1,955. The Agreementcontains various financial and operating covenants that impose limitations onthe ability of Channell Bushman Group, among other things, to merge orconsolidate, sell assets except in the ordinary course of business, and paydividends. Channell Bushman Group is required to comply with an interestcoverage ratio and other financial covenants. The Agreement contractuallyobligates Channell Bushman Group to repay the revolving credit facility as itreceives payments from its customers. The Agreement also contains a subjectiveacceleration clause should Channell Bushman Group come into a default, whichallows the bank to terminate the facility and require any outstandingobligations to be repaid. As of March 31, 2006, Channell Bushman Group was notin compliance with various financial covenants. Channell Bushman Group has notreceived a waiver of noncompliance from the bank. However, Channell BushmanGroup signed a new Loan and Security Agreement with the bank dated as of April26, 2006 that amended the existing agreement. The new agreement revises thefinancial covenants and, accordingly, the long-term portion of the outstandingbalance of the credit facilities has been classified as long term debt as ofMarch 31, 2006. The new agreement, among other things, also: increases themaximum borrowings under the revolving credit facility to AUD$3,200;, reducesthe maximum borrowings under the “earn-out” facility to AUD$750 and changes theexpiration date of that facility to July 2008; and reduces the maximumborrowings under the capital expenditure facility to AUD$2,500. Translated intoUS dollars at March 31, 2006 exchange rates, the maximum borrowings, asamended, are: revolving credit facility $2,275, “earn-out” facility $533 andcapital expenditure facility $1,778.

 

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

 

### **Introduction and Overview**

### ** **

### **Channell Commercial Corporation (the“Company”) is a designer and manufacturer of telecommunications equipmentsupplied to communications network operators worldwide and water storage tanksdistributed in consumer markets throughout Australia. Major product linesinclude a complete line of thermoplastic and metal fabricated enclosures,advanced copper termination and connectorization products, fiber-optic cablemanagement systems and polyethylene water storage tanks.**

### ** **

During the last fiveyears, demand for communications infrastructure equipment has fluctuateddramatically. At various times in the past there have been significantslowdowns in capital spending by wireless network operators due to delays inthe expected deployment of infrastructure equipment and financial difficultieson the part of the network operators who were forced to consolidate and reducespending to strengthen their balance sheets and improve their profitability. Thesechanges had a significant negative impact on overall demand for infrastructureproducts, and at various times, have directly reduced demand for our productsand increased price competition within our industry, which has led toreductions in our revenues and contributed to our reported operating losses.

 

Within the water storageportion of our business, demand has continued to grow in Australia due to thecountry’s generally arid climate and the widespread water conservation efforts.

 

Within both thecommunications infrastructure market and water storage market, the increasingprice of oil has had a negative impact on our gross margins. The products manufacturedin both of the markets in which we operate are primarily composed ofpolyethylene resins, which are derived from oil. The Company is limited in itsability to pass on incremental price increases to its customers. Continuedincreases in the price of oil can have a negative impact on the Company’sperformance.

 

The Company believes thatit has maintained its overall market share within the communicationsinfrastructure equipment and water storage tank markets. The Company continuesto invest in the development of new communications infrastructure products andwater storage tanks and believes that in both markets it has the leadingproduct portfolios in terms of performance and features.

 

During the latter part of2005 and in 2006, the Company focused on cost savings while at the same timeexpanding and diversifying its market opportunities. The Company measures itssuccess by monitoring net sales and gross margins with a short-term goal ofmaintaining a positive cash flow, while striving to achieve long-term operatingprofits. The Company believes that there continues to be long-term growthopportunities within both the communications infrastructure equipment and watertank markets.

 

### **Results of Operations**

### ** **

In August of 2004 theCompany acquired 75% of the Bushman Tanks business. Bushman Tanks is Australia’slargest manufacturer of plastic water storage tanks. The Bushman Tanks’financial results have been consolidated in the Company’s financial statementsfor the three months ended March 31, 2006 and March 31, 2005. A minorityinterest has been recorded for the 25% equity owned by ANZ Private Equity, aunit of Australia and New Zealand Banking Group Ltd.

 

**Comparison of the Three MonthsEnded March 31, 2006 with the Three Months Ended March 31, 2005**

 

***NetSales*.**Net sales in the first three months of 2006 were $24.5million, a decrease of $6.9 million or 22.0% compared to the first three monthsof 2005. The decrease is primarily due to the lower sales volume in theAmericas segment.

 

Americas net sales were $12.8million in the first three months of 2006, a decrease of $6.7 million or 34.4% comparedto the same period in 2005. The decrease was primarily due to lower sales toVerizon.

 

15

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International net saleswere $11.7 million compared to $11.8 million in the first quarter of 2005.

 

Sales to Verizon of $2.3million in the first three months of 2006 represented 9.6% of Company sales inthe period. Sales to Verizon of $9.5 million in the first three months of 2005represented 30.2% of the Company’s sales. Sales to Verizon have historicallyfluctuated from period to period. Accordingly, the Company cannot accuratelypredict what sales to Verizon will be in 2006. The second largest customer inthe first three months of 2006 was Comcast with sales of $1.9 millionrepresenting 7.8% of the Company’s sales. Sales to Comcast of $2.0 million inthe first three months of 2005 represented 6.2% of the Company’s sales for theperiod.

 

***GrossProfit*.**Gross profit in the first quarter of 2006 was $7.0million, a decrease of $2.2 million or 23.9% compared to the first quarter of2005. The decrease was primarily due to the reduction in sales volume in theAmericas segment along with a lower gross profit percentage in theInternational segment. Gross profit dollars in the Americas segment declined$1.7 million from $4.8 million in the first quarter of 2005 to $3.1 million inthe first quarter of 2006. Gross profit of $3.9 million in the first quarter of2006 in the International segment was $0.5 lower than the 2005 period.

 

As a percentage of netsales, gross profit decreased from 29.4% in the first three months of 2005 to 28.4%in the first quarter of 2006. The decline is primarily due to a lower grossprofit percentage in the International segment from 37.4% in the first quarterof 2005 to 33.0% in the first quarter of 2006. This decline is primarily due tohigher raw material costs related to higher oil prices.

 

***Selling***.Selling expenses were $4.7 million in the first three months of 2006 comparedto $4.8 million in first three months of 2005.

 

As a percentage of netsales, selling expense increased from 15.4% in the 2005 period to 19.2% in the2006 period. The higher percentage is primarily due to a reduced sales level inthe Americas segment without a similar decrease in selling expenses.

 

***Generaland Administrative*.**General and administrative expenseswere $3.2 million in the first three months of 2006, an increase of $0.3million or 10.3%. The increase is primarily due to higher professional fees, travelexpenses and stock-based compensation.

 

As a percentage of netsales, general and administrative expense increased from 9.2% in the 2005period to 13.1% in the 2006 period. The increase is due to the decreased saleslevel without a corresponding decrease in general and administrative costs.

 

***Researchand Development*.**Research and development expenses were $0.6million in the first three months of 2006, and $0.7 million in the first threemonths of 2005. Spending on new product development programs remainedrelatively constant.

 

As a percentage of netsales, research and development expenses increased from 2.1% in the first threemonths of 2005 to 2.4% in the first three months of 2006 due to lower salesvolume in the Americas segment.

 

***Incomefrom Operations*.**As a result of the items discussedabove, income (loss) from operations was ($1.6) million in the first threemonths of 2006 compared to income from operations of $0.8 million in the firstthree months of 2005. Operating margin as a percent of sales was (6.3%) in the2006 period compared to 2.6% in the 2005 period.

 

***InterestExpense, Net***. Interest expense, net of interest income,was $0.1 million in the first three months of 2006 and 2005.

 

***IncomeTaxes*.**There was an income tax benefit of eighteen thousanddollars in the first three months of 2006 compared to $0.2 million in the firstthree months of 2005. The effective tax rate was 1.1% in the first three monthsof 2006 and 29.8% for the same period in 2005. Since the Company has a fullvaluation allowance on the realization of the domestic net deferred tax asset,no tax benefit is currently being recorded on the loss in the US, and fromforeign operations the tax benefit netted out to eighteen thousand dollars.

 

16

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**Liquidity and Capital Resources**

 

Net cash used inoperating activities was ($1.7) million for the three months ended March 31,2006, compared to net cash used in operating activities of ($1.9) million insame period ended 2005. The negative cash effect of the current period net lossof approximately ($1.6) million was increased by additional net working capitalof approximately $1.1 million. This was offset by approximately $1.0 million innon-cash deductions, including depreciation.

 

Net cash used ininvesting activities was ($0.3) million for the three months ended March 31,2006, compared to ($0.8) million in the 2005 period. The decrease in 2006 isdue to a decrease in the acquisition of property and equipment resulting fromthe Company’s efforts to reduce non-critical cash expenditures in the currentperiod.

 

Net cash provided byfinancing activities was $1.3 million for the three months ended March 31, 2006,compared to net cash provided by financing activities of $0.3 million in thesame period of 2005. Of the increase, $1.1 million represents additionalborrowings needed to fund the operations losses in the current period.

 

Cash and cash equivalentson March 31, 2006 were $2.4 million, a decrease of $0.8 million from December2005. The decrease in cash was primarily due to cash used to operate thebusiness in excess of cash receipts and the acquisition of property andequipment offset by cash provided by additional bank borrowings.

 

Net accounts receivable increasedto $11.9 million at March 31, 2006 from $8.3 million at December 31, 2005. Interms of days sales outstanding, accounts receivable increased from 33 days atDecember 31, 2005 to 44 days at March 31, 2006. The increase in days salesoutstanding is due to a higher percentage of sales occurring at the end of thefirst quarter.

 

Inventories decreased to$11.2 million at March 31, 2006 from $11.4 million at December 31, 2005. Daysinventory decreased from 60 days at December 31, 2005 to 57 days at March 31,2006.

 

Accounts payable increasedfrom $8.7 million at December 31, 2005 to $11.5 million at March 31, 2006. The increaseis primarily due to an increase in the payable balance in the Internationalsegment. Days payables were 46 days at December 31, 2005 and 59 days at March31, 2006.

 

The Company is activelymanaging expenditures for capital assets and working capital requirements toreduce cash needs for 2006 and beyond. The Company has reduced mostexpenditures for capital assets to purchases for projects that will provide apositive return to long-term cash flow. In addition, the Company is pursuingmarket opportunities and designing products that will consume idle or slowmoving inventory to further reduce the need for current and long-term cash flow.The Company believes that cash flow from efforts coupled with availableborrowings under the credit facilities described in Note 14 will be sufficientto fund the Company’s capital expenditure and working capital requirementsthrough 2006.

 

**Off-Balance Sheet Arrangements**

 

The Company’s off-balancesheet arrangements consist of operating leases, employment contracts andpurchase obligations. In addition, the Company guaranteed the debt of theChannell Family Trust of approximately $754,000 in 1997. The guaranteed debtwas incurred in connection with construction of the facilities leased to theCompany and is collateralized by said facilities. The loan amount subject tothe unsecured guarantee is expected to decline before expiring in 2017. TheCompany does not anticipate that it will incur losses as a result of thisguarantee and has not recorded a liability. If the Channell Family Trust wereto default on the outstanding loan balance, the Company might be required torepay the remaining principal balance. The maximum potential amount the Companywould be required to pay is equal to the outstanding principal and interestbalance of the loan to the Channell Family Trust. At March 31, 2006, theoutstanding loan balance subject to the guarantee totaled $545,000.

 

**Critical Accounting Policies**

 

The Company’s discussionand analysis of its financial condition and results of operations are basedupon its consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United Statesof America. The preparation of these financial statements requires the Companyto make estimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and related disclosure of contingent assetsand liabilities.

 

17

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The Company believes thatthe estimates, assumptions and judgments involved in the accounting policiesdescribed in the “Management’s Discussion and Analysis of Financial Conditionand Results of Operations” section of its most recent Annual Report on Form10-K have the greatest potential impact on its financial statements, so itconsiders these to be its critical accounting policies. Because of theuncertainty inherent in these matters, actual results could differ from theestimates the Company uses in applying the critical accounting policies.Certain of these critical accounting policies affect working capital accountbalances, including the policies for revenue recognition, the reserve foruncollectible accounts receivable and inventory reserves. These policiesrequire that the Company make estimates in the preparation of its financialstatements as of a given date.

 

Within the context ofthese critical accounting policies, the Company is not currently aware of anyreasonably likely events or circumstances that would result in materially differentamounts being reported.

 

**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. Allforward-looking statements made herein are made pursuant to the Act. Forward-lookingstatements include statements which are predictive in nature; which depend uponor refer to future events or conditions; or which include words such as “expects”,“anticipates”, “intends”, “plans”, “believes”, “estimates”, or variations ornegatives thereof or by similar or comparable words or phrases. In addition,any statement concerning future financial performance, ongoing businessstrategies or prospects, and possible future Company actions that may beprovided by management are also forward-looking statements as defined by theAct. Forward-looking statements are based on current expectations andprojections about future events and are subject to risks, uncertainties, andassumptions about the Company; and economic and market factors in the countriesin which the Company does business, among other things. These statements arenot guarantees of future performance, and the Company has no specificintentions to update these statements. Actual events and results may differmaterially from those expressed or forecasted in forward-looking statements dueto a number of factors including, among others: (1) the communications industryis in a state of rapid technological change, which can render the Company’sproducts obsolete or unmarketable; (2) any failure by the Company to anticipateor respond to technological developments or changes in industry standards orcustomer requirements, or any significant delays in product development orintroduction, could have a material adverse effect on the Company’s business,operating results and financial condition; (3) a relatively small number oftelecommunications customers account for a large percentage of the Company’savailable market; (4) the Company expects that sales to the telecommunicationsindustry will continue to represent a substantial portion of its total sales,and the demand for products within this industry depends primarily on capitalspending by service providers; (5) the Company’s cost of sales may bematerially affected by increases in the market prices of the raw materials usedin the Company’s manufacturing processes; (6)  the Company’s water relatedsales could be materially affected by weather conditions and governmentregulation; (7) the Company is subject to the risks of conducting businessinternationally; and (8) the industries in which the Company operates arehighly competitive. Additional risks and uncertainties are outlined in theCompany’s filings with the Securities and Exchange Commission, including itsmost recent Annual Report on Form 10-K.

 

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

 

The risk inherent in theCompany’s market sensitive instruments is the potential loss arising fromadverse changes in interest rates and foreign currency exchange rates. Allfinancial instruments held by the Company described below are held for purposesother than trading.

 

**Interest Rate Sensitivity**

 

The Company and itssubsidiaries have entered into three financing agreements. In September 2002,the Company entered into a three-year Loan and Security Agreement with an assetbased lender in the United States that has been extended through March 31, 2007.The agreement contains a term loan and a revolving line of credit. In July2004, a subsidiary of the Company entered into a one-year Loan and SecurityAgreement, which consists of a revolving line of credit with a commercial bankin Australia. In August 2004, another subsidiary of the Company entered into afive-year Loan and Security Agreement which contains a term loan, revolvingline of credit, an “earn-out” facility, and a capital expenditure facility witha commercial bank in Australia. The loan and security agreements allow for theoutstanding balance to bear interest at a variable rate based on the lender’sbase rate. The credit facilities expose the Company to changes in short-terminterest rates since the interest rates on the credit facility are variable.

 

18

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Based upon the amount ofvariable rate debt outstanding at the end of the quarter, and holding thevariable rate debt balance constant, each one percentage point increase ininterest rates occurring on the first day of a quarterly period would result inan increase in interest expense of approximately $0.02 million. This analysisdoes not consider the effects of economic activity on the Company’s sales andprofitability in such an environment.

 

**Exchange Rate Sensitivity**

 

The Company has assetsand liabilities outside the United States that are subject to fluctuations inforeign currency exchange rates. Assets and liabilities outside the UnitedStates are primarily located in the United Kingdom, Australia, and Canada. TheCompany’s investment in foreign subsidiaries with a functional currency otherthan the U.S. dollar is generally considered long-term. Accordingly, the Companydoes not hedge these investments. The Company also purchases a limited portionof its raw materials from foreign countries. These purchases are generallydenominated in U.S. dollars and are accordingly not subject to exchange ratefluctuations. The Company has minimal foreign currency transaction gains orlosses. The Company has not engaged in forward purchases of foreign currencyand other similar contracts to reduce its economic exposure to changes inexchange rates because the associated risk is not considered significant.

 

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

 

**Evaluationof Disclosure Controls and Procedures**

 

The Company maintainsdisclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) of the Securities and Exchange Act of 1934 (the “Exchange Act”), thatare designed to ensure that information required to be disclosed in the Company’sExchange Act reports is recorded, processed, summarized, and reported withinthe time periods specified in rules and forms of the Securities and ExchangeCommission regulations, and that such information is accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow timely decisions regarding requireddisclosure. As of March 31, 2006, the management of the Company carried out anassessment concluding that the Company’s disclosure controls and procedureswere not effective because of the material weaknesses described below.

 

Due to the materialweaknesses described below, the Company’s management performed additionalanalyses and other post-closing procedures including reviewing all significantaccount balances and disclosures in the consolidated financial statementscontained in this Quarterly Report on Form 10-Q, to ensure the Company’sconsolidated financial statements are in accordance with accounting principlesgenerally accepted in the United States of America. Accordingly, managementbelieves that the consolidated financial statements included in this AnnualReport, fairly present in all material respects, the Company’s financialcondition, results of operations, and cash flows for all periods presented.

 

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

 

Management of the Companyis responsible for establishing and maintaining adequate internal control overfinancial reporting, as such term is defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act. The Company’s internal control over financialreporting is a process designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external reporting purposes in accordance with accounting principlesgenerally accepted in the United States of America. Internal control over financialreporting includes those policies and procedures that (i) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the Company; (ii) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the Company arebeing made only in accordance with authorizations of management and directorsof the Company; and (iii) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of theCompany’s assets that could have a material effect on the interim or annual consolidatedfinancial statements.

 

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements.  Also, projectionsof any evaluation of effectiveness to future periods are subject to the risk thatcontrols may become inadequate because of changes in conditions, or that thedegree of compliance with the policies or procedures may deteriorate.

 

19

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A material weakness is acontrol deficiency, or combination of control deficiencies, that results inmore than a remote likelihood that a material misstatement of the annual orinterim financial statements will not be prevented or detected. Managementidentified the following control deficiencies which represent material weaknessesin the Company’s internal control over financial reporting as of March 31,2006 that relate to the Company’s acquired Australian subsidiary, Bushmans. Bushmanswas previously a closely held, family run business with mostly manual controlsin place. During the process of assessing the status of the internal controlinfrastructure, the Company has identified significant deficiencies in internalcontrols that rise to the level of “material weaknesses” in the revenue and purchasingcycles. Management has also identified other significant deficiencies in thepayroll cycle, capital asset purchasing cycle, information technology andgovernance.

 

The control deficienciesdescribed above could result in a misstatement of the aforementioned accountsor disclosures that would result in a material misstatement to the Company’sinterim or annual consolidated financial statements that would not be preventedor detected. Accordingly, management has determined that the control deficienciesdescribed above constitute material weaknesses. Management does not believethat these material weaknesses resulted in material errors in the Company’s March31, 2006 financial results, as reported in this filing.

 

**Changesin Internal Control Over Financial Reporting**

 

During the fiscal yearended December 31, 2005, the Company did not have effective controls toaccurately calculate current income tax expense. Specifically, the Company didnot have effective controls to monitor the difference between the income taxbasis and the financial reporting basis of assets and liabilities and reconcilethe difference to its deferred income tax asset and liability balances. Thiscontrol deficiency resulted in restatements to the Company’s 2002, 2003, and2004 annual consolidated financial statements to correct deferred taxes and thetax provisions. In addition, the Company did not have effective controls toaccurately calculate current income tax expense and the effect on additionalpaid in capital for the exercise of non-qualified stock options. These controldeficiencies could result in a misstatement of deferred taxes, tax accruals andthe tax provision that would result in a material misstatement to the Company’sinterim or annual consolidated financial statements that would not be preventedor detected. Accordingly, management had determined that this controldeficiency constituted a material weakness.

 

During the first quarterof the 2006, the Company identified and gathered the necessary financialinformation and set up a procedure to accurately prepare and review itsaccounting for income taxes and the determination of income taxes payable,deferred income tax assets and liabilities and the related income tax provision.The Company has also engaged additional personnel qualified as Certified PublicAccountants to assist in the preparation of the Company’s income tax provisionas well as general accounting matters.

 

Also, during the fiscalyear ended December 31, 2005, due to the limited tenure of the Company’sdomestic and Australian accounting staff, additional reconciliations and postclosing adjustments were necessary to properly account for certain items ofincome an expense that the staff was not fully aware of. The most significantmanifestations of this material weakness involved the accounting of the Company’sworkers’ compensation liability as well as the Company’s unvouchered accountspayable balance.

 

During the first quarterof 2006, the Company has continued to employ the same accounting personnelinvolved with the 2005 fiscal year audit. The current staff has been trainedwith regard to the accounting for the workers’ compensation liability as wellas the Company’s unvouchered accounts payable balance.

 

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

 

The Company continues toimplement enhancements and changes to its internal control over financialreporting to remediate the material weaknesses described above. Thisremediation began in 2005.

 

These improvementsinclude further formalization of policies and procedures, improved segregationof duties, improved information technology system controls, and additionalmonitoring controls.

 

20

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The Company has enhancedthe competence of the organization by hiring staff competent in accountingprinciples generally accepted in the United States of America, and the Companywill continue to enhance its financial accounting and reporting competencies byrecruiting additional qualified staff and further developing its existing staffby reinforcing existing continuing education programs.

 

The Company’s Audit Committee meets regularly with management and theindependent accountants to review accounting, auditing, financial matters andinternal control structure.  The Audit Committee and the independentaccountants have free access to each other, with or without management beingpresent.

 

**PART II - OTHER INFORMATION**

 

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

 

*LegalProceedings**—** Carson Industries LLC v.Channell Commercial Corporation (Calif. Superior Court Case No. BC334759)*.For a number of years, the Company has purchased grade level boxes from CarsonIndustries LLC (“Carson”) for resale to the Company’s customers. In 2004, theCompany’s customers reported the failure of a number of Carson boxes in thefield. The Company has determined that certain boxes sold to the Company byCarson in 2004 and thereafter did not conform to certain specifications. OnJune 9, 2005, Carson filed the above-captioned lawsuit against the Company,principally seeking approximately $360,000 for product sold to the Company butnot yet paid for. On July 26, 2005, the Company cross-complained against Carsonfor, among other things, breach of contract, breach of express and impliedwarranties, fraud and intentional interference with contractual relations.

 

Duringcourt ordered mediation on March 21, 2006, the parties agreed to settle thelawsuit. The final agreement was signed on April 17, 2006 whereby the Companypaid to Carson $290,000 and returned to Carson approximately $70,000 ofinventory previously purchased by the Company. Carson agreed to indemnify theCompany against certain product warranty claims for five years from the date ofsale. As of March 31, 2006, the Company has accrued $307,000 for suchliability.

 

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

 

**ITEM 1A.****                                      RISKFACTORS**

Notapplicable.

 

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

Notapplicable.

 

# **ITEM 3.**                DEFAULTS UPON SENIOR SECURITIES

Notapplicable.

 

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

Not applicable.

 

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

 

On May 10, 2006, ChannellBushman Pty Ltd and its controlled entities (collectively referred to as “ChannellBushman Group”), which are subsidiaries of the Company, entered into a new Loanand Security Agreement dated as of April 26, 2006 with National Australia BankLimited (“NAB”) that amended the existing Loan and Security Agreement betweenChannell Bushman Group and NAB. The new agreement, among other things (i)revised the financial covenants in the existing agreement; (ii) increased themaximum borrowings under the revolving credit facility to Australian Dollars (“AUD”)$3,200,000; (iii) reduced the maximum borrowings under the facility to fundfuture “earn-out” payments to the sellers of Bushman Tanks to AUD$750,000 andchanged the expiration date of that facility to July 2008; and (iv) reduced themaximum borrowings under the capital expenditure facility to AUD$2,500,000.

 

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

 
| 3.1    |   | Restated  Certificate of Incorporation of the Company (Exhibit 3.1)(1)                                                                                                                                                                                                                                                                                                                 |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 3.2    |   | Bylaws  of the Company (Exhibit 3.2)(1)                                                                                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 4      |   | Form  of Common Stock Certificate (Exhibit 4)(1)                                                                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.1   |   | Tax  Agreement between the Company and the Existing Stockholders (Exhibit 10.1)(1)                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.2*  |   | Channell  Commercial Corporation 1996 Incentive Stock Plan (including forms of Stock  Option Agreements and Restricted Stock Agreement) (Exhibit 10.2)(1)                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.3*  |   | Channell  Commercial Corporation 2003 Incentive Stock Plan (including forms of Stock  Option Agreement and Restricted Stock Agreement)(7)                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.4*  |   | Channell  Commercial Corporation 2004 Incentive Bonus Plan(9)                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.5   |   | 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) (Exhibit 99)(6) |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.6   |   | Loan  and Security Agreement dated October 24, 2003 by and between Channell Pty Ltd  and National Australia Bank Ltd (Exhibit 10.3.1)(11)                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.7   |   | Loan  and Security Agreement dated August 2, 2004 by and between Channell Bushman  Pty Ltd and National Australia Bank Ltd (Exhibit 10.3.2)(11)                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.8   |   | Loan  and Security Agreement dated August 2, 2004 by and between Channell Pty Ltd  and National Australia Bank Ltd (Exhibit 10.3.3)(11)                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.9   |   | Investment  and Shareholders Agreement dated August 2, 2004 by and among Channell Bushman  Pty Ltd and Australia and New Zealand Banking Group Ltd.(Exhibit 10.3.4)(11)                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.10* |   | Employment  Agreement dated July 8, 1996 between the Company and William H. Channell, Sr.  (Exhibit 10.8)(1)                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.11* |   | Channell  Commercial Corporation 1996 Performance-Based Annual Incentive Compensation  Plan (Exhibit 10.10)(1)                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.12  |   | Lease  dated December 22, 1989 between the Company and the Channell Family Trust (as  successor in interest to William H. Channell, Sr.), as amended (Exhibit  10.11)(1)                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.13  |   | Lease  dated May 29, 1996 between the Company and the Channell Family Trust (Exhibit  10.12)(1)                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.14  |   | Lease  dated October 26, 2000 between the Company and Belston Developments Inc.  (Exhibit 10.15)(4)                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.15  |   | Third  Amendment to Lease dated December 22, 1989 between the Company and the  Channell Family Trust (as successor in interest to William H. Channell, Sr.),  effective as of June 1, 2005 (Exhibit 99.1)(12)                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.16  |   | Form  of Indemnity Agreement (Exhibit 10.17)(1)                                                                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.17  |   | Form  of Agreement Regarding Intellectual Property (Exhibit 10.18)(1)                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.18  |   | 401(k)  Plan of the Company (Exhibit 10.19)(3)                                                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.19  |   | A.C.  Egerton (Holdings) PLC Share Purchase Agreement (Exhibit 2)(2)                                                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.20  |   | Lease  dated June 27, 2002 between the Company and Ynez Street, Ltd.(Exhibit  10.29)(5)                                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.21* |   | Amendment  to Employment Agreement dated December 9, 2003 between the Company and  William H. Channell, Sr. (Exhibit 10.19)(8)                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.22* |   | Employment  Agreement dated December 9, 2003 between the Company and William H. Channell,  Jr. (Exhibit 10.20)(8)                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.23  |   | 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                                                                                                     |

 

22

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|   |   | 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 (Exhibit 99.2)(10)                                                                                                                                |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.24* |   | Employment  Letter dated June 27, 2005 between the Company and Jerry Collazo (Exhibit  99.2)(13)                                                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.25* |   | Employment  Letter dated June 30, 2005 between the Company and Greg Balla (Exhibit  10.23)(14)                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.26* |   | Long-Term  Incentive Plan for William H. Channell, Jr. (Exhibit 10.1)(15)                                                                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.27  |   | Waiver  and Third Amendment to Loan and Security Agreement dated as of November 18,  2005 by and among the Company, Channell Commercial Canada Inc., Channell  Limited, Channell Commercial Europe Limited, Bank of America, N.A., BABC  Global Finance Inc., Bank of America, N.A., and the lenders party to the Loan  and Security Agreement dated as of September 25, 2002 (as amended) (Exhibit  10.25)(16) |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.28  |   | Assignment  and Assumption Agreement dated November 18, 2005 by and between Banc of  America Leasing and Capital, LLC and Bank of America, N.A. (relating to U.S.  Loan and Security Agreement) (Exhibit 10.26)(16)                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.29  |   | Waiver  and Fourth Amendment to Loan and Security Agreement dated as of February 28,  2006 by and among Channell Commercial Corporation, Bank of America, N.A.,  BABC Global Finance Inc., Bank of America, N.A. and the lenders party to the  Loan and Security Agreement dated as of September 25, 2002 (as amended)  (Exhibit 10.1)(18)                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.30  |   | Loan  and Security Agreement dated as of December 1, 2005, by and among Channell  Bushman Pty Ltd, Bushmans Group Pty Ltd, Channell Pty Ltd, certain other  subsidiaries of the Company and National Australia Bank Ltd(19)                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.31  |   | Loan  and Security Agreement dated April 26, 2006, by and among Channell Bushman  Pty Ltd, Bushmans Group Pty Ltd, Channell Pty Ltd, certain other subsidiaries  of the Company, and National Australia Bank Ltd(19)                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                            |
| 14     |   | Channell  Commercial Corporation Code of Business Conduct and Ethics (Exhibit 14)(8)                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                            |
| 21     |   | Subsidiaries  of the Company (Exhibit 21)(17)                                                                                                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                            |
| 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(19)                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                            |
| 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(19)                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                            |
| 32.1   |   | Certification  pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the  Sarbanes- Oxley Act of 2002 by William H. Channell, Jr., CEO and Jerry  Collazo, CFO(19)                                                                                                                                                                                                                           |

 

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*Management contract or, compensatory plan or arrangement.

 

(1)                                  Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Registration Statement on FormS-1 (File No. 333-03621).

 

(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 12, 2002.

 

(6)                                  Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Form 8-K on October 1, 2002.

 

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

 

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

 

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

 

(10)                            Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Form 8-K on August 6, 2004.

 

(11)                            Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Form 10-Q on November 15, 2004.

 

(12)                            Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Form 8-K on June 15, 2005.

 

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(13)                            Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Form 8-K on June 28, 2005.

 

(14)                            Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Form 10-Q on August 15, 2005.

 

(15)                            Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Form 8-K on September 9, 2005.

 

(16)                            Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Form 10-Q on November 21, 2005.

 

(17)                            Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Form 10-K/A on November 21,2005.

 

(18)                            Incorporated by reference to the indicatedexhibits filed in connection with the Company’s Form 8-K on March 6, 2006.

 

(19)                            Filed herewith.

 

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SIGNATURES

 

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

 
| Dated: May 15, 2006 |   |                                              |
|---------------------|--------|---------------------------------------------------|
|                |   | CHANNELL COMMERCIAL  CORPORATION                  |
|                |   | (Registrant)                                      |
|                |   |                                              |
|                |   |                                              |
|                | By     | /s/ Jerry Collazo                                 |   |
|                |   | Jerry Collazo                                     |
|                |   | Chief Financial Officer                           |
|                |   | (Duly authorized  officer and principal financial |
|                |   |    officer  of the Registrant)     |

 

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